Why state-mandated auto-IRAs are good for your retirement practice

Since early November, the governments of California, Oregon, and Illinois have been in various stages of onboarding businesses and employees to their auto-IRA programs. Virtually identical in design, these programs are required for employers that don’t already offer retirement plans of their own. 

Even during these times of historically high employment rates, many U.S. workers have no workplace retirement benefits. Although 74% of the workforce in organizations with 500 or more employees has workplace plans available to them, this number drops to just 22% in firms with 10 or fewer people.¹ According to California officials, as many as 7.5 million employees may be living in that state’s retirement plan gap.²

What do state-run auto-IRA programs offer employees?

All three of the enacted programs work in a similar fashion. Once employers forward information about their workers, the state begins movement toward auto-enrolling each individual into a Roth IRA with a 5% initial default rate. Both California’s and Oregon’s programs also include annual automatic contribution increases as default features, while it’s optional for the Illinois plan.

California and Oregon call for the first $1,000 contributed to be defaulted into a money market fund and capital preservation fund, respectively, with subsequent investments going to a target-date fund (TDF). TDFs are the sole default funds in Illinois. 

Participants are free to adjust their contribution percentage, switch investments (each program offers a small handful of stand-alone funds), turn off or on auto-escalation, or opt out of the program altogether.

In all cases, administration and investor fees are built into the cost of each investment option and debited by the plan administrator throughout the year.³ 

There’s some work required for employers

As for the employer experience, it’s straightforward. Each business is responsible for registering itself and its employees by the required dates, sending the required employee data to the program administrator, enabling auto-enrollment of new employees, and keeping the payroll deductions and account contributions flowing.

Other than the labor involved in performing these tasks, there’s no other employer cost.  

Retirement professionals could see auto-IRA programs as an encroachment on their territory; however, given the limited benefits these programs provide, we believe they could also create opportunity for financial representatives and consultants.

Here, then, are a few facts related to auto-IRAs that could ultimately help build your retirement territory and practice.

1    Stand-alone Roth IRA investing is good for some, but falls short for many
For starters, annual IRS limits on Roth IRA contributions are just a fraction of 401(k) limits, including phased-out eligibility for higher earners. And although current-year tax benefits make Roth saving a solid move for more modest earners, tax-deferred opportunities can be crucial to the long-term strategies of those earning more than $50,000 annually.⁴

2    Auto-IRA programs exclude employer contributions
This takes a powerful motivator off the table. The employer match has always been a critical driver of 401(k) participation and increased deferral rates. Saving to match is a prime indicator of plan engagement,⁵ and the availability of 401(k)-based profit-sharing contributions can be a valuable tool for both growing and established companies.

3    A handful of investment options may not be enough
If you count TDFs as one investment selection, the California, Oregon, and Illinois programs offer four, three, and four choices, respectively. Compare this against the 401(k) universe, where plans offer an average of 25 investment options,⁵ and tools such as managed accounts can help participants make the most of those options. How many options are enough for a given employee population? That’s where a little plan design freedom—and your professional experience—come in.

4    By their nature, auto-IRA programs invite benchmarking
Once employers get a taste for offering retirement benefits, some are bound to start wondering what a little planning, effort, and money could help accomplish. Does it help them in today’s extreme competition for talent? Could it help them grow? A friendly review of plan design trends might be enough to set a prospect’s sights on a 401(k) plan.

5    Mandated, state-run programs overlook one very important success factor
Seven out of ten 401(k) plan sponsors depend on guidance from a financial professional or a consultant to keep their plan aligned with their interests.⁵ Your consultative and relationship skills are a key reason for businesses in your territory to look beyond the auto-IRA.

6    It’s harder to gauge the business impact of the auto-IRA
Benchmarking is an important tool for organizations seeking the best possible return from their retirement programs. Of ten performance benchmarks commonly used by 401(k) plan sponsors, just four might be useful in measuring the impact of an auto-IRA.

Measures effective with either a 401(k) or an auto-IRA include:

• Participation rates
• Current deferral rates 
• Appropriate asset allocation
• Increases in deferral rates

Measures less effective or not readily available with an auto-IRA include:

• Plan benchmarking 
• Saving to match
• Satisfaction surveys
• Use of advice tools
• Retirement income ratio achievement
• Retirement goal achievement⁵

According to the Georgetown Center for Retirement Initiatives, ten states and one major city have enacted retirement savings programs for private sector workers. In addition to the three auto-IRAs mentioned earlier, these include Connecticut, Maryland, New Jersey, and Seattle, Washington (also auto-IRAs); New York (a voluntary payroll-deduction IRA); Massachusetts and Vermont (multiple employer plans); and the state of Washington (a retirement plan marketplace).

As the organization’s website states, “Since 2013, at least 43 states have acted to implement a new program, undertake a study of program options, or consider legislation to establish state-facilitated retirement savings programs.”³

States view auto-IRAs as a first step—and you should as well 

In public statements, California officials have invited employers to look beyond their program and toward a 401(k) approach that might provide broader benefits.⁶ It’s a recommendation that’s great for your clientele and smart for your retirement practice. 

1 “Employer-based Retirement Plan Access and Participation across the 50 States,” pewtrusts.org, 1/13/16. 2 “CalSavers Employers Get Heads-up, Gig Workers Get Access,” pionline.com, 10/10/19. 3 “State-facilitated Retirement Savings Programs: A Snapshot of Program Design Features,” cri.georgetown.edu, 8/30/19. 4 Based on John Hancock research on tax-optimized contribution strategies, 2019. 5 “2019 DC Survey: Recordkeepers,” PLANSPONSOR, 2019. 6 “CalSavers retirement program officially opens,” pionline.com, 7/1/19.