Require Automatic Enrollment in IRAs and Enhanced Small Employer Startup Credit
The president proposes to establish automatic enrollment in IRAs for employees without access to an employer-sponsored saving plan. Currently, workers who wish to contribute to an IRA must first establish the account, actively make a decision to contribute each year, transfer funds into the IRA, and decide how to invest their contributions. The president proposes to make this process automatic. Under the proposal, most employers who do not currently offer retirement plans—except those with less than 10 employees or firms in business less than two years—would have to enroll employees in a direct-deposit IRA account unless the worker opts out. The default contribution rate would equal 3 percent of compensation, and contributions would automatically go into standard, low-cost investments. Furthermore, the default option would be a Roth IRA, funds for which come from after-tax income and are untaxed upon withdrawal, as opposed to a deductible IRA, which is funded from pretax income and from which withdrawals are subject to income tax.
Research has shown that changing the default from an opt-in provision to an opt-out provision markedly increases worker participation in 401(k)–type plans, especially for demographic groups with traditionally low saving rates. The administration suggests that automatic enrollment in IRAs can similarly increase saving rates for workers without workplace retirement plans and help to reverse the nation’s prolonged trend of low saving rates.
In conjunction with automatic enrollment, the administration proposes a modest non-refundable credit of up to $500 for the first year and $250 for the second year for small businesses of no more than 100 employees who offer an automatic IRA arrangement. The credit will help defray the costs of automatic enrollment, and for the first six years of offering automatic enrollment, these businesses would also be eligible for another nonrefundable credit of $25 per enrolled employee, up to $250. Finally, the proposal would double the existing tax credit for small businesses starting new employee retirement plans from $500 to $1,000, available for a maximum of three years.
This proposal would cost about $15 billion through 2022. However, making Roth IRAs the default option reduces the short-term cost of automatic enrollment since the tax benefit of Roth IRAs—and the consequent revenue loss—does not come until workers withdraw funds in retirement. That outcome shifts much of the cost of this proposal beyond the 2013–22 budget window, causing the 10-year revenue loss to substantially understate the provision’s lifetime cost.
Tax Policy Briefing Book: Savings and Retirement: How might saving be encouraged for low- and middle-income households?
Tax Topics: Pensions and Retirement Savings.Benjamin H. Harris and Rachel M. Johnson, “Automatic Enrollment in IRAs: Costs and Benefits,” Tax Notes, August 31, 2009.