“We’re from the government, and we’re here to help!”
Those few words have struck fear into Generations of Americans. One recent instance is the notion of further forcing employers to help employees build retirement nest eggs, need it, or not.
The trouble is, a great many American workers need it! A July 2007 Wall Street Journal Start Up Journal report by Kelly Spors announced the news this way: “Growing calls among lawmakers and economic researchers to create ‘automatic’ Individual Retirement Accounts (IRAs), which would require employers that don’t offer a retirement-savings plan to automatically deduct a portion of full-time employees’ paychecks and deposit it into IRAs under the employee’s name.”
The Basic Problem; A Proposed Solution
Personal saving as a percentage of disposable personal income in the U.S has fallen from over 10 percent in the early 1980s to rates of 1 to 2 percent over the past four or five years. According to the Commerce Department’s Bureau of Economic Analysis, the U.S. personal saving rate has fallen into negative territory. Automatic IRAS are intended to address these national problems.
Two bills introduced in the House and Senate support creating Automatic IRAs and mandating employers adopt them.
• Federal, state and local government employers and churches or church associations would be exempt, as would two additional groups;
• Employers with fewer than 10 employees paid $5,000 or more in the past calendar year, and employers under two years old that, in the past two years, had 100 or fewer employees paid $5,000 or more.
The intentions are noble — According to Craig Copeland’s, “Employer-Based Retirement Plan Participation: Geographic Differences and Trends: Employee Benefit Research Institute: Making saving easier by making it automatic has been shown to be remarkably effective at boosting participation in 401(k) plans, but roughly half of U.S. workers are not offered a 401(k) or any other type of employer-sponsored plan. Among the 153 million working Americans in 2004, over 71 million worked for an employer that did not sponsor a retirement plan of any kind, and another 17 million did not participate in their employer’s plan.
Automatic IRAs – The Mechanics
Checking under the hood of both Automatic IRA proposals, Heritage Foundation Employee Benefits guru, Craig Copeland summarized what he learned:
• Investment management, record keeping and other administrative functions would be contracted to private sector financial institutions as much as practicable.
• Costs would be minimized through a no-frills design, economies of scale, and maximum use of electronic technologies.
• When participant accounts reached a predetermined balance (e.g., $15,000) sufficient to make them sufficiently profitable to attract the interest of other IRA providers, account owners would have the option of transferring to IRAs of their choosing.
• Automatic IRAs require no employer contributions, no employer compliance with qualified plan or ERISA requirements; no employer liability or responsibility for IRA investment or provider selection, or for opening IRAs for employees.
• Also avoided, adverse effects on employer-sponsored plans or incentives encouraging firms to adopt new plans. The intent is drawing small employers into the private pension system.
• Copeland explains Automatic IRA contributions for the self-employed and those with no employer would be handled in one of ways:
(1) Extending the direct deposit option to independent contractors who work for employers (other than the very smallest businesses);
(2) Allowing participants to direct the IRS to make direct deposit of a portion of their income tax refunds; and
(3) Opening access to automatic debit arrangements, such as on-line and traditional means through professional and trade associations, which help arrange for automatic debit and direct IRA deposits.
“Automatic debit models the power of payroll deduction by continuing automatically once initiated,” Copeland concludes. Contribution incentives such as matching IRA deposits may be added: with private financial institutions maintaining these accounts delivering matching contributions are reimbursed through tax credits.
Largess is Grand, but So is Forethought!
Without question, jacking up Americans’ dismal savings rate is worthy: Hence the growing calls among lawmakers and economic researchers urging creation of Automatic IRAs requiring employers not offering other retirement-savings plans automatically to deduct a portion of full-time employees’ paychecks and deposit it into IRAs in their employees’ names.
Similar to automatic-enrollment in 401(k)s, where employees are automatically enrolled in their employers’ 401(k) plans unless they opt out – employers without retirement plans would automatically invest employees’ money in an IRA, though employees could elect a default option with investments geared toward the individual’s expected retirement age. Employees would also have the choice to opt out entirely.
Count on small businesses to be most effected by these rules, assuming they ever pass our increasingly deadlocked Congress. Still, that pesky low savings rate and lack of retirement planning resources plaguing many working Americans persists! Of firms with fewer than 100 employees, reports the retirement group. AARP, just 9% offer defined benefit retirement plans, with 41% offering defined contribution plans, such as traditional 401(k)s. While only 37% of employees at small firms participate in any plan employer-sponsored retirement plan, states the AARP report.
A supporter of both proposed pieces of legislation, however, AARP believes Automatic IRAs would bring retirement savings to those sorely lacking it. Spor says, adding: “The report finds that a $1,000 annual savings into an automatic IRA with a modest 4% annual return would create $31,000 after 20 years and $58,300 after 30 years.”
Automatic IRA critics are concerned small businesses will be discouraged from establishing their own, more-generous retirement plans by automatically directing employee money into these IRAs; and the AARP concedes the administrative costs alone of tracking of Automatic IRA withdrawals could be a show-stopper, especially among small, non-exempt SBOs. Though bills encouraging cost-offsetting employer tax credits are proposed, many small employers not facing annual tax bills will reap few if any benefits of those credits.
Traditional IRAs – The Downside
The operative term associated with tax-deferred retirement plans, such as IRAs, 401(k)s and 401bs, tax-deferred, not tax-free! Tax-deferral is good, but it’s not the panacea it was once thought to be. While we recognize the benefits of tax-deferred retirement savings: because the money grows untaxed until withdrawn, and IRAs are more flexible than other retirement plans such as 401(k) or 403(b) plans, etc. because you can invest it in almost anything, from stocks and mutual funds to bonds and real estate.
Reducing taxes on IRA withdrawals. As in anything to do with our personal finances, however, education is critical to successful retirement planning. Even now, many IRA and 40l (k) participants fail to realize taxes are due on their tax-deferred retirement money at withdrawal. What was originally conceived of as an advantage–funds were expected to be taxed at lower rates after retirement–may turn out to be wishful thinking.
In proposing Automatic IRAs, Congress may be a day short and a dollar late once again! For example, in “Helping You Avoid IRA Distribution Mistakes,” Tampa, FL financial advisor, David Siracusa, of Carlton Associates, Inc. makes the following observations: “You own two pots of money: The money that has already been taxed (let’s call it ‘regular money’) and the money that has not been taxed (let’s call this ‘retirement money, such as IRAs, 401b,etc.). When you spend a dollar of regular money, the cost to you is exactly $1. When you spend $1 of retirement money, the cost to you is could be as much as $1.54 (1.65) because you have to pay off Federal income tax on the amount you withdraw. Therefore, if you want to reduce your taxes,” consider not taking more than the required distribution from your retirement money.
“Some people think they should never spend their principal, but this can be a mistake if you want to save taxes,” Siracusa continues:”It could be better to spend some of your regular assets first, so that you can take advantage of the tax-deferral benefits associated with IRAs and qualified plans.
Want to know More? The Carlton &Associate report is available free-of-charge from Mr. Siracusa by emailing: firstname.lastname@example.org
or phoning (813) 267-4087).
Or as Tampa financial strategist, Joseph De Paulo puts it to seminar audiences: “Are you planning your retirement or Uncle Sam’s? You should be aware that your IRA, pension and 401 (k) benefits will be taxed at a higher rate at retirement.”
Large employers already do their share for employees through qualified retirement plans and matching 401(k) contributions; the Feds pitch in through Social Security Retirement benefits (though for various reasons that program is immune to annulment, younger Americans should not bet the ranch on retiring in comfort on Federal money alone). Also available, an already generous assortment of Individual Retirement Accounts: all discretionary to participants, but carrying the tax caveats described above.
If Automatic IRAs become law, businesses that have no other retirement plan would now automatically invest a portion of their employees’ money in its mandatory IRA. Workers can stick with the automatic plan or elect default investments based on their expected retirement ages: or simply pass on the whole deal.
Though you may be surprised by the extensive level of benefits provided, many SBOs concede being in a “David-and-Goliath” struggle with the big boys and girls. “They do not have the advantages of gigantic human resources departments and marketing departments, and can’t always match their competitors’ salaries and benefits,” wrote Dave Siminoff in The Tampa Tribune in July. When that happens, small employers can find themselves in a very tight financial bind.
Forget the Age of Aquarius. How About the Age of Infinity?
This whole issue is moot for the many older workers who have been saving the bare minimum, dragging down US saving rates to new lows while recklessly living only for today. They’ve already dropped the ball on retirement planning, and retrieving it won’t be easy! The problem is, many of these folks are expected to live decades longer than their forebears, and, if they hold true to form, can be counted on to spend millions more in retirement than anticipated. We Baby Boomers never did do things the easy way!
“What? Me retire? Heck, no!” It may be too late to do much about that now, which is why so many Boomers are scrambling to secure late-in-life careers: reinventing themselves by becoming born-again SBOs or returning to work in so-called “bridge” careers. Of course, they “love” every minute of it (or so it says here): But then that’s one reason Freestyle Entrepreneur was created!
Automatic IRAs – A Forecast
A do-nothing Congress focused squarely on the 2008 presidential race, with both parties awash in acrimony over Iraq, the influences of radical Islam, and defending America in the international War on Terror, is not expected to produce much new legislation this term or next: Automatic IRAs included.
That government is best that governs least, Thomas Paine famously said. Help or hindrance, or otherwise, our current state of political ennui may allow the pros and cons of Automatic IRA measures before Congress to be more fully debated (among the key provisions benefiting from further discussion: collective v. individual responsibility; the very backbone of democracy), which considering the long-term impact of these proposals, may be the best way to go.
Meanwhile, perhaps the wheels of retirement planning education and awareness will continue spinning in America, wising up workers to their hapless state of financial preparedness, and the need to act sooner than later to set things straight.
• Start-Up Journal, Automatic IRAs for Small Employers? Kelly Spors, http://www.startupjournal.com/howto/management/20070712-memos.html?mod=RSS_Startup_Journal&sjrss=wsj
• Employee Benefit Research Institute, Employer-Based Retirement Plan Participation: Geographic Differences and Trends, By Craig Copeland, http://www.ebri.org/about/team/index.cfm?fa=CraigCopeland
• KirkWalsh.com, Automatic IRAs — a Quick Fix for Workers Without Pensions? http://www.kirkwalsh.com/blog/2006/03/03/automatic-iras-a-quick-fix-for-workers-without-pensions/
• Heritage Foundation, Automatic IRAs — a Quick Fix for Workers Without Pensions? http://www.heritage.org/Research/SocialSecurity/tst062906a.cfm
• Washington Post, Automatic IRAs — a Quick Fix for Workers Without Pensions? By Albert B. Crenshaw, http://www.washingtonpost.com/wp-dyn/content/article/2006/02/18/AR2006021800130.html
• Market Watch, Shifting IRAs to automatic — A plan for workers with no other retirement-savings vehicle, By Robert Powell, http://www.marketwatch.com/news/story/new-push-automatic-retirement-savings-plans/story.aspx?guid=%7BD7C2CAB4-C363-4A5E-AA37-67AFF7BB8BD4%7D
Bill Willard is a freelance writer in Clearwater FL. Email him at email@example.com, Call 727 724-8338, or visit his Website at http://www.writergazette.com/WillardAssociates.shtml
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