Whether automatic IRAs (individual retirement accounts) could significantly increase retirement readiness and reduce the national retirement savings deficit depends largely on age, the default contribution rate and the opt-out rate (the percentage of eligible employees who choose not to participate), according to new research by the Employee Benefit Research Institute (EBRI).
While IRAs have been shown to produce significant retirement accumulations by those who contribute to them, the vast majority of people who do not have a tax-qualified retirement plan at work also do not take advantage of an IRA. To measure what difference auto-IRAs might make, EBRI used its proprietary Retirement Security Projection Model (RSPM) to analyze the potential of a generic auto-IRA plan to increase the probability of a “successful” retirement and decrease the national retirement savings deficit.
The model produces so-called Retirement Readiness Ratings (RRRs), which measure the likelihood of workers not running out of money in retirement and Retirement Savings Shortfalls (RSS), which measure the present value of the retirement deficit at age 65.
The EBRI analysis found that in the best-case participation scenario (assuming no opt outs), the introduction of an auto-IRA for households currently ages 35 to 39 working for small employers would increase the probability of a “successful” retirement (as measured by the RRR) by 8.4%; this declines as employer size increases, since larger employers are more likely to sponsor a retirement plan. Even when a 75% opt-out rate is assumed there is a small increase in RRR: only 2.2% for those working for small employers and 1.1% for those with large employers.
Looking at the potential impact on the estimated $4.13 trillion national retirement savings deficit, among households where the family head is ages 35 to 64, adding auto-IRAs with no opt outs would reduce the savings deficit to $3.86 trillion (a 6.5% decrease). As opt-out rates rise, there is progressively less reduction in the aggregate deficits; at a 75% opt-out rate, the aggregate deficit is $4.06 trillion (only a 1.7% decrease).
“The ability of auto IRAs to reduce retirement deficits obviously depends on the age of the employee as well as the opt out rates assumed,” says Jack VanDerhei, EBRI research director and author of the report. “For example, among those households ages 35 to 39, the average RSS is reduced by 10.6% assuming no opt outs. This value drops to 9.7% at if there is a 10% opt out and falls to only 2.7% at a 75% opt out.”
Proponents of auto-IRAs have been pushing for legislation which would require certain employers without retirement plans to automatically invest a designated amount of each employee’s compensation to an IRA, unless the employee changes the amount of the contribution or opts out of the arrangement.
The full report, “Auto-IRAs: How Much Would They Increase the Probability of “Successful” Retirements and Decrease Retirement Deficits? Preliminary Evidence from EBRI’s Retirement Security Projection Model” is published in the June 2015 EBRI Notes, online at www.ebri.org.