Bottom line: state auto-IRA programs are working, and more Americans are building their retirement nest egg. And it’s also important to note that more states are starting to take action to help individuals get on track for retirement as they recognize and accept that our country is in a retirement crisis.
This year, at least 21 states have proposed legislation or formed study groups to establish new programs. This results in all but four states currently working to create state-run retirement programs. The four states who are not currently addressing the retirement crisis are Alaska, Alabama, Florida, and South Dakota. Washington D.C. also has not recently made any efforts to alleviate the issue.
Out of the 46 states acknowledging the retirement savings gap, 16 states and two cities have established retirement plan programs. Most programs are set up as automatic IRAs or “auto-IRAs,” and the outliers are established as voluntary programs. California, Connecticut, Illinois, and Oregon each have auto-IRA programs currently open to all eligible employers and workers in the private sector. In my home state, California, CalSavers was rolled out over three years – 2020, 2021, and 2022.
This year, employers with five or more employees were required to adopt their retirement plan or sign up for CalSavers by June 30. Connecticut and Oregon also implemented their program in waves based on the number of employees. In contrast, Illinois’s program only impacts businesses with 25 or more employees that have operated in the state for at least two years.
This is being shown to be true across the state auto-IRA programs that are set up with savings rate automatically starting between 3% and 5%. Some programs also include annual automatic escalation. For example, CalSavers begins at 5% and automatically increases by 1% each year until the individual saves 8% of their income. Employees can always opt-out if they don’t want to save.
Many of the state auto-IRA programs are set up as Roth IRAs. As financial planners, we help lower-income individuals understand the benefit of making after-tax contributions to a Roth IRA rather than a pre-tax contribution to a Traditional IRA.
No long-term value
There is no significant long-term value in contributing to a Traditional IRA if the person only receives a nominal tax deduction or none. A person with a lower income today will likely benefit more by making after-tax contributions should tax rates increase at retirement. While no one knows what tax rates will be in the future, the top federal tax rates have been generally around 30-40% over the last 30 years.
The inconvenient yet not surprising truth is that the average American lacks the basic understanding of financial skills, which includes the importance of saving. If Americans understood the fundamentals of personal financial management, maybe more individuals without access to a retirement plan at work would open and contribute to Individual Retirement Accounts (IRAs) as an alternative.
While many states are introducing legislation to mandate personal finance education, financial literacy may not be the only factor driving the retirement crisis. Behavioral finance and psychology create significant setbacks; our brains aren’t naturally good at saving.
If we understand and accept both factors, advisors and state policymakers can use tools and features like automatic enrollment and escalation to improve outcomes. My team’s experience working with business owners to set up their company’s 401(k) plan is like the state auto-IRA programs: plans with automatic enrollment features have higher participation rates and, as a result, better retirement outcomes.
Change is a result of the action, and with the right leadership, financial planners and policymakers can work together to achieve the same goal – helping more Americans get on track for retirement.