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Auto-IRAs Not Necessarily an Auto-Solution

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While automatic IRAs could have a significant impact on retirement readiness if they became universal, just how significant that impact might be would depend on several factors.

That’s according to new research from the Employee Benefit Research Institute (EBRI), which said that three major factors have to be considered when determining the effects of a universal auto-IRA plan:

  • age

  • default contribution rate

  • opt-out rate (the percentage of eligible employees who choose not to participate)

IRAs were designed to help people who don’t have an employer-sponsored retirement plan, particularly those who work at small companies, put money away for retirement in a tax-deferred account. However, most people who don’t have a retirement plan at work also don’t have an IRA.

There’s been discussion about the possibility of proposed legislation that would obligate employers without retirement plans to be required to automatically invest a specific amount of employees’ pay into an IRA, via a payroll deduction, unless the employee changes the arrangement or opts out.

EBRI analyzed the potential of a generic auto-IRA plan to increase the probability of a “successful” retirement and decrease the national retirement savings deficit by using its proprietary Retirement Security Projection Model (RSPM).

The model, according to EBRI, produces so-called Retirement Readiness Ratings (RRRs)—which measure the likelihood of workers not running out of money in retirement—and Retirement Savings Shortfalls (RSS), which measure the present value of the retirement deficit at age 65.

“The ability of auto IRAs to reduce retirement deficits obviously depends on the age of the employee as well as the opt-out rates assumed,” Jack VanDerhei, EBRI research director and author of the report, said in a statement.

VanDerhei continued, “For example, among those households ages 3539, the average RSS is reduced by 10.6 percent assuming no opt outs. … This value drops to 9.7 percent t if there is a 10 percent opt out and falls to only 2.7 percent at a 75 percent opt out.”

Younger groups, the report said, “will have a longer exposure to the auto-IRAs and hence a greater likelihood to provide meaningful supplementation to their regular retirement savings than someone on the verge of retirement.”

— Check out Ordinary Americans Shouldn’t Need a Ph.D. in Finance to Retire on ThinkAdvisor.

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