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Auto-IRA vs. Emergency Savings Account: Which Is Better for Workers?

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The pandemic has drawn attention to an issue that has been proposed from time to time for years: how employers can better encourage employees to save.

Some states, like New York, have focused on automatic IRAs and setting up rules that would require employers to automatically divert a portion of employee pay into an IRA unless the employee specifically opts out.

Other proposals would focus on creating a new type of tax-preferred universal emergency savings account (ESA) to help employees save. Unlike retirement accounts, the ESA would not be subject to the typical penalties that apply to an employee’s ability to take withdrawals from a retirement savings account. Variations on the theme have been proposed. Some would create Roth-style tax treatment, while others would allow pretax employee contributions.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about which type of account is more valuable, given a choice between the two savings options.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: Ideally, every American would have sufficient income to fund both an emergency savings account and retirement savings accounts. However, given a choice between the two, these universal emergency savings accounts would do little more than encourage wealthy taxpayers to shift savings from taxable accounts into these tax-preferred vehicles in order to escape paying taxes on the account’s earnings over time. The middle class would be much better served by an auto-IRA model geared toward protecting their financial security during retirement. 

Byrnes: Far too many people don’t save for retirement or for the future because IRAs and other retirement accounts impose harsh penalties for early withdrawals. In other words, the qualification rules mean that if the individual saves for retirement, they may not also be able to access those savings in an emergency. Lack of access is a powerful disincentive to savings that the ESA model would fix. 

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Bloink: An auto-IRA model would provide a savings plan that people don’t have to think about, that is completely taken care of at the employer level so that when it comes time for retirement, these people aren’t relying solely on Social Security for income. That could keep countless older Americans out of poverty in the future.

Byrnes: The entire point of the ESA is that it allows for “leakage.” Lower- and middle-income taxpayers do not want to lock their limited funds up in an account that they can’t access without penalty for 30 years. Auto-IRAs are just another form of IRA, meaning that the saver can’t access those funds until reaching retirement age. 

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Bloink: Retirement accounts make allowances and exceptions for special situations. Loosening the hardship withdrawal rules could provide a more meaningful solution. With the universal savings account, taxpayers are much more likely to view those funds as available for any expenditure — like a vacation fund or saving for a new car. Unless there are restrictions on the reasons for making a withdrawal, the reality is that these accounts will provide savers with a tax benefit if they save for just about any expense, regardless of social or future value. 

Byrnes: Retirement accounts are infinitely valuable. The problem is that in most cases, auto-IRAs won’t encourage any additional savings whatsoever because they have the same unattractive features as a traditional IRA. Employees will simply opt out of the program. ESAs let the saver decide what events are important enough to justify a withdrawal. Hardworking Americans should be given an option that allows them to reap the tax benefits of saving — which is always a valuable thing — while also protecting themselves in case of emergency.

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