GAO Says Automatic IRA no Silver Bullet

Although recent proposals to boost retirement savings for workers without access to employer-sponsored plans could increase the portion of Americans saving for retirement, the programs are not without their problems, according to a new Government Accountability Office (GAO) report.

The report said a federally mandated automatic individual retirement account (IRA), where certain employers could be required to enroll eligible employees in payroll-deduction IRAs unless the worker specifically opted out, could broaden the population that saves for retirement at minimal cost to employers. However, the proposal faces a number of challenges, including uncertainty about the extent to which it would help low-income workers accumulate significant retirement savings.

The GAO also addressed proposals for state-assisted retirement savings programs, which could raise coverage and, ultimately, savings by involving state governments in facilitating retirement savings for workers without access to an employer-sponsored plan. However, such programs face uncertainty about employer and worker participation levels, as well as legal and regulatory issues, according to the report.

IRA providers told the GAO that some employers may be reluctant to adopt a payroll-deduction IRA because they believe that publicizing the payroll-deduction IRAs may be construed as an endorsement of the policy, which could potentially violate the Employee Retirement Income Security Act (ERISA). The providers also noted employers may not be aware of how payroll-deduction IRAs work, and some small employers may not be aware that this option exists.

There is also concern that the benefits resulting from the automatic IRA could be relatively small. According to the GAO report, a 2009 preliminary analysis funded by the Department of Labor illustrates potential outcomes of two automatic IRA scenarios using specific behavioral assumptions about participation and contribution rates, among other things. The analysis found that the resulting increase in average retirement benefits at age 70 is small (even when ignoring account fees and offsetting reductions in other savings) and is weighted toward the third of the population with the highest lifetime earnings.

Participants may also not fully benefit from the tax incentives provided by automatic IRAs. According to an analysis sponsored by AARP, 50% of automatic IRA participants would be lower-income. Therefore, with the exception of Social Security and Medicare taxes, they would pay little, if any, income tax and may not benefit from the tax incentives traditional IRAs offer, the GAO report said.

The report also noted that proper administration of accounts, including recordkeeping, could be a problem as workers would be responsible for ensuring that they do not exceed applicable limits on annual contributions to an automatic IRA. Automatic IRA proposals do not impose recordkeeping responsibilities on employers, beyond withholding and transmitting IRA contributions, the GAO noted.

Experts the GAO interviewed expressed concern about the cost and administrative burden that an automatic IRA would place on affected small employers. Industry officials and some experts also noted that establishment of an automatic IRA could affect the market for 401(k) plans.

Gaps in Current Efforts

While existing studies show that automatic enrollment significantly increases participation rates in 401(k) plans, this approach may not be suitable for all plan sponsors, and available data show that some plan sponsors have not augmented automatic enrollment policies with other policies designed to ensure adequate savings, the GAO said.

Four of six studies reviewed by the GAO found that automatically enrolled participants are likely to accept the plan's default contribution rate, and three of the studies found that some participants would have selected a contribution rate higher than the default rate had they not been subject to automatic enrollment and had they chosen to enroll in the plan voluntarily. Further, two of the three studies also found that some participants were likely to accept a default investment fund with relatively low future prospects for return on investment, such as money-market or stable-value funds, compared to the investment fund they would have selected if they had voluntary enrolled.

"Thus, these studies concluded that overall savings for these particular participants were lower under automatic enrollment," the GAO report noted.

Available data shows that many plans with automatic enrollment have not adopted default automatic escalation policies, which, in combination with low default contribution rates, could result in low saving rates for participants who do not increase contribution rates over time. In addition, the report said, experts noted that a trend toward target-date funds as default investments, while potentially beneficial in important respects, also raises questions about the investment risks and transparency for those close to retirement.

The GAO reported that various factors, including higher costs, management views, concerns about legal and regulatory challenges, and lack of awareness, may delay or prevent the adoption of automatic enrollment policies by some plan sponsors.

State-Assisted Retirement Programs

As for the proposed state-assisted retirement savings program, the report noted that there will be no additional employee tax benefit for participants and, for that reason, the program would have to compete on an equal footing with plans in the marketplace. An analysis conducted by the state of Maryland concluded that the program might be difficult to establish or market in the absence of a federal requirement that all employers have a retirement savings plan.

Additionally, analyses from the three states showed they would face initial and ongoing costs for program development and administration, communications and marketing, and recordkeeping. An analysis by the state of Washington estimated a total cost of about $4.4 million to implement and operate the program in the first two years.

State-assisted savings programs would also have to comply with both federal and state law that, according to the state analyses, could provide additional challenges. One analysis noted that states would need to obtain requisite federal approvals to ensure that the programs adhere to all federal requirements governing the operation of retirement plans. For example, if the program establishes 401(k) accounts, the state would need to submit plan documents to the IRS and Department of Labor for approval.

In addition, the Maryland and Washington analyses found that if a state sponsored the establishment of a 401(k) plan, such plans would be subject to ERISA's fiduciary requirements and expose either the state or the employer to potential liability in the event that participants suffer financial losses.

The GAO found state governments will need to determine the extent to which administrative and management responsibilities will be borne by the state, and how much will be contracted out to financial services providers. States would also need to determine what types of investment funds will be used, including any default funds.

The GAO report is here.