State-Run IRAs May Not Be the Best Solution for Low-Income Earners

Social Security may be enough to cover their retirement needs, while the accumulation of personal savings can jeopardize other key safety net benefits.

Around the country, more than half of state governments are pushing to establish automatically enrolled individual retirement accounts (IRAs) for low-income workers, who most likely are not being offered a retirement plan at their workplace, according to new research from the American Enterprise Institute. 

The state plans have initial deferral rates ranging between 3% and 6%, with some pairing that with automatic deferral escalation up to an 8% ceiling. While the intention is to help these people have a better quality of life in retirement, researchers observe that Social Security pays lower-wage workers much higher relative benefits compared with the more richly paid. The lower-paid also pay less taxes and are more likely to receive disability-related income and survivor benefits.

The Institute notes that Census Bureau data shows that only 8.8% of Americans aged 65 and older had incomes below the poverty line, which the Institute attributes to “Social Security’s progressive benefit formula, which pays more generous benefits to low earners.” For instance, for a person earning an average wage of $12,000 a year, Social Security would replace 90% of those earnings. “It is not clear why a worker with poverty-level earnings would place a great emphasis on saving for retirement versus other potentially more pressing needs.”

Additionally, there is the danger that low-income workers who are automatically enrolled into an IRA will seek out loans with high interest rates and increase their credit card debt, the Institute says. “While auto enrollment likely would result in [these] workers reaching retirement with greater retirement-specific assets, those workers may also retire holding greater debts,” the Institute says.

Finally, automatically enrolling low-income workers can easily make them ineligible for means-tested government benefits, such as Medicaid, Temporary Aid for Needy Families, food stamps, Supplemental Security Income, Section 8 housing assistance and the Low Income Home Energy Assistance Program. “Even at low contribution rates and modest investment returns, it would not take many years for low-income, auto-IRA participants to bump up against common asset thresholds,” the Institute says.

In conclusion, the Institute says, “Many low-income workers may be rational in not saving substantial amounts for retirement over and above what Social Security will provide.”

American Enterprise Institute’s full report, “How Hard Should We Push the Poor to Save for Retirement?”, can be downloaded here.