Americans don’t save enough for retirement. Only 32% invest in a 401(k) plan, when 59% have the ability to do so. And only 46.4 million people invested in an IRA, a shockingly low number relative to the 157 million working adults in the U.S. Fewer still maximize their contributions.
State governments are coming up with ways to nudge people to save for retirement. There are ethical and philosophical reasons why governments should stay out of the personal finances of citizens, but it is probably necessary in this case.
The main problem is that not all private employers provide access to 401(k) accounts, mostly because their companies are simply too small. Of course, IRAs are available, but not everyone takes the initiative to set one up.
Enter the auto IRA, which is a public retirement savings program for private sector workers.
The way it works is that upon employment, the employee is automatically enrolled in a state-run IRA program. The employee, who has the ability to opt out of the program, can make contributions up to the $6,000 annual limit, which rises to $7,000 for workers over age 50. The contributions are made through automatic payroll deductions. This is a neat solution to a problem that has been mishandled by the government, in the form of Social Security, which is woefully underfunded and provides uneven outcomes.
Oregon had an early version of this program, called OregonSaves, and it has enrolled about 70,000 participants since it started in 2017. Ten states now have auto IRAs or similar programs, and more are considering following suit.
The three auto IRA programs that are in existence have help just over 151,000 people to save almost $90 million, according to David John, an AARP policy adviser who helped develop the model for OregonSaves. In the second quarter of this year, there was a 14% increase in the number of accounts and a 35% increase in the amount saved, he noted, citing data compiled by Masena Associates.
The key to the auto IRA program is the opt out feature. Employees aren’t exactly being compelled to enroll, but it doesn’t seem to be easy to not participate. A Google search of OregonSaves reveals a suggested search of “How do I opt out of OregonSaves?” This also implies that a fair number of people might not want to participate.
A behavioral economist would describe automatic enrollment as a “nudge.” The government isn’t technically forcing anyone to do anything, but is trying to incentivize certain behavior. Our entire tax code is based on nudging. For example, the government wants people to invest in residential real estate, so it made the interest on a mortgage deductible for tax purposes. We observe an outcome—not enough people are saving for retirement—and give them a little shove in the right direction.
Not everyone is in favor of the nudge. The American Enterprise Institute argued forcefully against it last year. The argument is, for starters, that the intention of Social Security was that it would be enough to maintain one’s standard of living in retirement, and it’s a little distasteful to take payroll taxes through coercion to fund one’s Social Security, and then take an additional couple of percent through pseudo-coercion to fund private retirement savings.
This is especially true when it comes to low-wage workers, who need every dollar they can get to meet their everyday needs. A low-wage worker is likely to have a greater amount of debt relative to their income, and auto IRA contributions would decrease the amount of money available to service that debt, leaving the worker in a worse financial position than before.
I am mostly scornful of attempts to nudge people into certain behaviors. In this particular case, I have an open mind. The whole idea of Social Security was to ensure that people didn’t find themselves destitute in their old age. Social Security solved that problem, but now we have the problem of people living at a subsistence level in old age. It should be pointed out that an auto IRA is not a tax, and participants’ money is invested in stocks and bonds.
Auto IRAs are a better option than expanding Social Security, an idea floated by Sen. Elizabeth Warren during the Democratic primaries. Social Security is not enough for most people to live comfortably in retirement. In many cases, it’s not enough for people to live without government assistance, putting even more stress on state budgets. This is because people don’t save enough during their working years, and are forced to retire early. About 30% of people take Social Security benefits at age 62, which ensures the lowest level of benefits. Waiting until age 70 generates almost twice as much, but only 5% of people wait that long.
Auto IRAs are a private sector solution to a public sector problem. But there should be no coercion involved. When a worker is signed up for an auto IRA, the instructions for opting out should be made clear.
There are legitimate reasons to opt out. As long as employees can freely choose not to participate, there is nothing wrong with a nudge in the right direction.
Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of 'Street Freak' and 'All the Evil of This World.' He may have a stake in the areas he writes about.
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