[1]. This paper does not address any issues relating to Social Security reform. The paper is intended to have no implications, one way or the other, regarding proposals to finance individual accounts using Social Security taxes or to offset Social Security benefits by individual accounts. Also outside the scope of this paper are potential reforms to the private pension system (including employer-sponsored defined contribution and defined benefit plans).
[2]. Craig Copeland, “Employer-Based Retirement Plan Participation: Geographic Differences and Trends: Employee Benefit Research Institute Issue Brief No. 286,” October 2005 (referred to below as “Copeland, EBRI Issue Brief No. 286”), Figure 1, p. 7. The nonparticipants include those who are not eligible for their employer’s plan as well as those who are eligible but who fail to participate. Among the subset of approximately 92 million full-time, full-year wage and salary workers between the ages of 21 and 64, 65 percent work for an employer that sponsors a plan, and 57 percent participate in an employer-sponsored plan. Id.
[3]. This paper uses the term “direct deposit” in some instances to include payroll-deduction contributions that small employers could make in a nonautomated way rather than by automated or electronic direct deposit; but in either case employees benefit from regular, automatic payroll-based saving. In addition, for convenience, the paper refers to “saving” in many instances where in fact it is uncertain to what extent additional contributions or deposits to IRAs will actually add to net savings as opposed to simply shifting asets from other investments or being offset by increased Borrowing.
[5]. Copeland, EBRI Issue Brief No. 286, Figure 1, p. 7.
[6]. Profit Sharing/401(k) Council of America, “The 48th Annual Survey of Profit Sharing and 401[k] Plans,” October 2006.
[7]. Copeland, EBRI Issue Brief No. 286, Figure 1, p. 7.
[8]. See, for example, Copeland, EBRI Issue Brief No. 286, Figure 2, p. 8, and Patrick J. Purcell, “Pension Sponsorship and Participation: Summary of Recent Trends,” CRS Report for Congress (2004), Tables 4 and 8. For example, in 2003, in firms with under 25 employees, 27% of employees participated in an employer-sponsored retirement plan, compared to 68% in firms with 100 or more employees. See Purcell, Table 4. Participation in an employer-sponsored retirement plan among full-time, year-round private-sector wage and salary workers (ages 25 to 64) in the top and bottom quartiles of earnings was 72% and 28%, respectively. See Purcell, Table 8.
[9]. See, e.g., William G. Gale, J. Mark Iwry, and Peter R. Orszag, “The Automatic 401(k): A Simple Way to Strengthen Retirement Savings” (Retirement Security Project, March 2005; available at www.retirementsecurityproject.org).
[10]. See, for example, Alicia H. Munnell and Annika Sunden, Coming Up Short: The Challenge of 401(k) Plans (Brookings Institution Press, 2004).
[11]. As noted, this paper is intended only to outline a proposal, not to resolve all of the specific but significant design and implementation issues that cannot be addressed within the limited scope of this paper.
[12]. In the Conference Report to the Tax Reform Act of 1997, Congress stated that “employers that choose not to sponsor a retirement plan should be encouraged to set up a payroll deduction [IRA] system to help employees save for retirement by making payroll-deduction contributions to their IRAs” and encouraged the Secretary of the Treasury to “continue his efforts to publicize the availability of these payroll deduction IRAs” (H.R. Rep. No. 220, 105th Cong., 1st Sess. 775 [1997]).
[13]. Department of Labor Interpretive Bulletin 99-1 (June 18, 1999), 29 C.F.R. 2509.99-1(b); IRS Announcement 99-2.
[14]. Neither the IRS nor the Department of Labor guidance addressed the possible use of automatic enrollment in conjunction with direct deposit IRAs (discussed at length below).
[15]. Gale, Iwry, and Orszag, “The Automatic 401(k).”
[16]. Since 1998, when the U.S. Treasury Department first defined and permitted automatic enrollment, advance written notice has been required. See Revenue Ruling 98-30, 1998-25 I.R.B. 8; Revenue Ruling 2000-8, 2000-7 I.R.B. 617. The IRS has recently affirmed that plans are permitted to increase the automatic contribution rate over time in accordance with a specified schedule or in connection with salary increases or bonuses. See letter dated March 17, 2004, from the Internal Revenue Service to J. Mark Iwry.
[17]. Brigitte Madrian and Dennis Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” Quarterly Journal of Economics 116, no. 4 (November 2001): 1149–87; and James Choi and others, “Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance,” in Tax Policy and the Economy, vol. 16, edited by James Poterba (Cambridge, Mass.: MIT Press, 2002), pp. 67–113. See also Sarah Holden and Jack VanDerhei, “The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at Retirement,” Employee Benefits Research Institute Issue Brief No. 283 (July 2005).
[18]. In this instance, new employees were defined as those with between three and 15 months’ tenure at their current job. See Peter R. Orszag and Eric Rodriguez, “Retirement Security for Latinos: Bolstering Coverage, Savings, and Adequacy,” Retirement Security Project Brief No. 2005-7, 2005.
[19]. Any such statutory provision could usefully make clear that automatic enrollment in direct deposit IRAs is permitted irrespective of any state payroll laws that prohibit deductions from employee paychecks without the employee’s advance written approval. Assuming that most direct deposit IRA arrangements are not employer plans governed by ERISA, such state laws, as they apply to automatic IRAs, may not be preempted by ERISA because they do not “relate to any employee benefit plan.”
[20]. The absence of an employer match might make some employers more willing to offer auto enrollment on direct deposit IRAs because increased participation would not come at the cost of increased employer matching contributions. On the other hand, the absence of the match tends to make participation in the plan less attractive to workers, which could exacerbate employee concerns or complaints about having been enrolled in a program that reduces their take-home pay without their explicit prior written authorization. As a result, the absence of a match might also make employers more fearful of possible employee backlash against auto enrollment.
[21]. Between August 28 and 31, 2005, in a survey commissioned by The Retirement Security Project, The Tarrance Group, in conjunction with Lake, Snell, Mermin/Decision Research, interviewed 1,000 registered voters nationwide about retirement security issues. A full report of the survey findings can be found at www.retirementsecurityproject.org.
[22]. James Choi, David Laibson, Brigitte Madrian, and Andrew Metrick, “Active Decisions” NBER Working Paper No. 11074 (January 2005).
[23]. Employers that sponsor a SIMPLE-IRA plan may deposit all employee contributions in IRAs at a single designated financial institution selected by the employer (IRS Notice 98-4, 1998-2 I.R.B. 25).
[24]. Considerable challenges are involved in building and implementing a workable universal saving system based on employer direct deposits of contributions to IRAs. These challenges include dealing with the contingent workforce, with employees who have multiple jobs, who work part-time, and often who earn relatively low wages, and with small employers. A somewhat different and thoughtful approach to designing such a system can be found in the evolving work of the Conversation on Coverage, a collaborative effort among individuals (including one of the authors) drawn from a diverse range of stakeholder organizations. See Conversation on Coverage, “Covering the Uncovered,” Report of Working Group II (2005) For a recently published analysis by a non-partisan expert panel (including one of the authors) of the issues involved in designing arrangements for distributions from individual accounts, see National Academy of Social Insurance, Uncharted Waters: Paying Benefits from Individual Accounts in Federal Retirement Policy (2005). There have been various other efforts to design such systems or programs, but this paper does not attempt to catalogue those.
[25]. Until recently the federal Thrift Savings Plan had five investment funds: three stock index funds (S&P 500, small and midcapitalization U.S. stocks, and mostly large-Capitalization foreign stocks), a Bond index fund consisting of a mix of government and corporate bonds, and a fund consisting of short-term, nonmarketable U.S. Treasury securities. Effective August 1, 2005, the Plan added a set of life-cycle funds, each one of which is composed of a mix of the other five investment funds.
[26]. This was part of the impetus behind the 2001 statutory provision to the effect that the Secretaries of Labor and Treasury may provide, and shall give consideration to providing, special relief with respect to the use of low-cost individual retirement plans for purposes of automatic rollovers and for other uses that promote the preservation of assets for retirement income (Economic Growth and Tax Relief Reconciliation Act of 2001, Public Law 107-16, 115 Stat. 38, Section 657[c][2][B]).
[27]. The difference in expense between passively managed index funds and actively managed mutual funds has been estimated to be—as a broad generalization—roughly 100 basis points (1 percent) a year (William F. Sharpe, “Indexed Investing: A Prosaic Way to Beat the Average Investor” presented at the Spring President’s Forum, Monterey Institute of International Studies (May 2002).
[28]. One of the authors has testified before Congress regarding the British retirement plan system and has been critical of the UK’s attempt to impose a limit on charges. See David C. John, testimony before the Subcommittee on Social Security of the Committee on Ways and Means, U.S. House of Representatives (June 16, 2005); David C. John, “What the United States Can Learn from the UK’s Pensions Commission Report” (forthcoming).
[29]. The federal Thrift Savings Plan consists mainly of index funds. It has recently added several life-cycle funds, with several different maturity dates, composed of the preexisting index funds. The Thrift Savings Plan informational materials state that the life-cycle funds “provide a way to diversify your account optimally, based on professionally determined asset allocations. This provides you with the opportunity to achieve a maximum amount of return over a given period of time with a minimum amount of risk. . .” (Federal Thrift Savings Plan website, www.tsp.gov). To the extent that a professionally run “managed account” could achieve similar results at no greater cost, that might be another attractive option. However, managed accounts, which are growing in popularity as an option in 401(k) plans, may be more suitable for those retirement savings plans, which tend to have more substantial account balances and greater flexibility to accommodate individual preferences while allocating costs to individuals who opt for costlier alternatives.
[30]. The question of how best to fit the direct deposit IRAs, with their improved and simplified investment structure, into the larger IRA universe is related to a broader issue: the potential simplification of IRAs. We favor simplification and revision of the current array of IRA options. However, the specifics of any such proposals are beyond the scope of this paper.
[31]. The Tarrance Group and Lake Snell Perry Mermin/Decision Research conducted a retirement security poll August 28-31, 2005, of 1,000 registered voters nationwide. The margin of error for the poll was 3.1 percent. The question that elicited these results was as follows: “Would you support or oppose a requirement that every company offer their employees some sort of retirement plan—either a traditional pension, a 401(k) or an IRA that the employer sets up but does not contribute to. The company would choose which one they wanted to offer employees. Would you support or oppose requiring every employer to give employees at least one of these options?” A full report of the survey findings can be found at www.retirementsecurityproject.org.
[32]. See Craig Copeland, “Retirement Plan Participation and Retirees’ Perception of Their Standard of Living,” Employee Benefits Research Institute Issue Brief No. 289 (January, 2006), pp. 1-6, Figure A4.
[33]. J. Mark Iwry, “Using Tax Refunds to Increase Savings and Retirement Security” (Retirement Security Project, forthcoming, November 2005).
[34]. Among the issues such an approach would need to address is the means of reimbursing those private financial institutions that have no federal income tax liability to offset because they are tax exempt or in a loss position.
An alternative mechanism would modify the existing saver’s credit (a federal income tax credit to households with income below $50,000 for contributing to an IRA or employer plan) to convert it to a direct matching deposit to an IRA or other savings account. (As currently structured, the saver’s credit reduces the household’s federal income tax liability and is nonrefundable; thus, it is not automatically saved.) A variation would be to have such a direct matching deposit delivered by the financial institution that sponsors the IRAs or serves as financial provider to the 401(k) plan to which the individual contributes. One of the authors was involved in developing the Saver’s Credit and, in congressional testimony and writings, has advocated its extension and expansion. See, e.g., William G. Gale, J. Mark Iwry, and Peter R. Orszag, “The Saver’s Credit: Expanding Retirement Savings for Middle- and Lower-Income Americans” (Retirement Security Project, March 2005). However, issues relating to the Saver’s Credit and its potential expansion are beyond the scope of this paper.
Another significant asset-building approach targeted to lower- and moderate-income households is reflected in the Individual Development Accounts (IDAs). See, e.g., Michael Sherraden, Assets and the Poor: A New American Welfare Policy (M. E. Shapre, 1992), and Ray Boshara, “Individual Development Accounts: Policies to Build Savings and Assets for the Poor” (Brookings, Policy Brief, March 2005).
[35]. Esther Duflo, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez, “Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block” (Retirement Security Project, May 2005).
[36]. A detailed treatment of the matching deposit option is beyond the scope of this paper.
The views expressed in this working paper are those of the authors alone and should not be attributed to the Heritage Foundation, the Brookings Institution, Georgetown University’s Public Policy Institute, or the Pew Charitable Trusts.
