February 11, 2019
“Auto-IRA” programs are the latest initiative aimed at helping Americans accumulate for retirement. These relatively new state-based plans are for employees who are not offered a 401(k) plan, or equivalent, by their employers. To date, nine states have taken steps to launch auto-IRA programs, with Oregon being the first in 2017.
The default setting for Oregon’s auto-IRAs is for 5% of an employee’s pay to be contributed to a Roth IRA. Each year, the contribution rate will automatically increase 1% until reaching 10% of earnings. Unlike 401(k) plans, the employee’s account is portable between employers. Employees can opt out if they choose. Under Oregon’s rules employers of a certain size must adopt the auto-IRA if they do not offer another retirement plan. The phased roll-out of this program gives priority to employers with more staff. The auto-IRAs do not provide for any employer matching contributions.
Key to the auto-IRA approach is setting the default action to be one that makes sense for accumulating a meaningful nest egg for retirement. This “automatic” saving overcomes any barrier to action. Many people fail to make provision for retirement because of factors such as lack of familiarity, indecisiveness, other priorities capturing attention, and even simple procrastination. In today’s Keurig-fueled world of hyper-convenience and Prime Now instant gratification, it is no surprise that taking action on saving for retirement often earns a spot on the back burner.
Auto-IRAs are using an approach which has been demonstrated to promote behaviors to save. In its recent annual study of 401(k) plan trends, Vanguard observed that plans with automatic enrollment had a 92% participation rate vs. voluntary participation plans at just 57%. Happily, automatic enrollment is now a feature of nearly half of 401(k) plans as compared with only one in a hundred back in 2003.
“Pre-programming” the implementation of a given decision can be productive and freeing. For example, pre-scheduling the next doctor or dentist appointment, subscribing to automatic purchases of certain household necessities, and planning meals ahead of time, can all free up brain space for more important things.
There are many applications of pre-programming in the financial world from using automatic payments for credit cards or other bills, to setting automated balance and activity alerts for checking, debit, and credit accounts. These simple techniques can save time and foster healthy habits for financial management. Regular retirement plan contributions cultivate the discipline of steady investing. Free services like Credit Karma promote behaviors to improve FICO scores and even provide notification of passwords for a registered email address that may have been compromised in data breaches. All these approaches allow energy otherwise spent mastering the mundane to be redirected to higher value activities, and even having fun!
Time will tell if the auto-IRA catches on. Hopefully the newly enrolled employees whose paychecks suddenly shrink will use this as a catalyst to make room in their budgets to save and embrace the power of making routine contributions to their future financial health.