Little or No Cost to Employers

For many if not most employers, offering direct deposit or payroll deduction IRAs would involve little or no cost. Unlike a 401(k) or other employer-sponsored retirement plan, the employer would not be maintaining a retirement plan. First, there would be no employer contributions: employer contributions to direct deposit IRAs would not be required or permitted. Employers willing to make retirement contributions for their employees would continue to do so in accordance with the safeguards and standards governing employer-sponsored retirement plans, such as SIMPLE-IRAs, 401(k)s, and traditional pensions. (The SIMPLE-IRA is essentially a payroll deposit IRA with an employee contribution limit that is in between the IRA and 401(k) limits and with employer contributions, but without the annual reports, plan documents, and most of the other administrative requirements applicable to other employer plans.)  Employer-sponsored retirement plans are the saving vehicles of choice and should be encouraged; the direct deposit IRA is a fallback designed to apply to employees who are not fortunate enough to be covered under an actual employer retirement plan. (As discussed below, it is also intended to encourage more employers to make the decision sooner or later to “graduate” to sponsorship of an employer plan.)

Direct deposit or payroll deduction IRAs also would minimize employer responsibilities. Firms would not be required to

• comply with plan qualification or ERISA rules,
  
  
• establish or maintain a trust to hold Assets (since IRAs would receive the contributions),
  
  
• determine whether employees are actually eligible to contribute to an IRA,
  
  
• select investments for employee contributions,
  
  
• select among IRA providers, or
  
  
•  set up IRAs for employees.

Employers would be required simply to let employees elect to make a payroll- deduction deposit to an IRA (in the manner described below, with appropriate disclosures to employees) and to implement deposits elected by employees. Employers would not be required to remit the direct deposits to the IRA provider(s) any faster than the timing of the federal payroll deposits they are required to make.  (Those deposits generally are required to be made on a standard schedule, either monthly or twice a week.) Nor would employers be required to remit direct deposits to a variety of different IRAs specified by their employees (as explained below). 

A requirement to offer payroll-deduction to an IRA would by no means be onerous. Employers of course are already required to withhold federal income tax and payroll tax from employees’ pay and remit those amounts to the federal tax deposit system. While this withholding does not require the employer to administer an employee election of the sort associated with direct deposit to an IRA, the tax withholding amounts do vary from employee to employee and depend on the way each employee completes the Form W-4 relating to withholding.  The payroll deposit election might be made on an attachment or addendum to the Form W-4. Because employees’ salary reduction contributions to IRAs would ordinarily receive tax-favored treatment, the employer would report on Form W-2 the reduced amount of the employee’s taxable wages together with the amount of the employee’s contribution.

Direct Deposit; Automated Fund Transfers

Our proposed approach would seek to capitalize on the rapid trend toward automated or electronic fund transfers. With the spread of new, low-cost technologies, employers are increasingly using automated or electronic systems to manage payroll, including withholding and federal tax deposits, and for other transfers of funds. It is common for employers to retain an outside payroll service provider to perform these functions, including direct deposit of paychecks to accounts designated by employees or contractors. Other employers use an on-line payroll service that offers direct deposit and check printing (or that allows employers to write checks by hand). Still others do not outsource their payroll tax and related functions to a third-party payroll provider but do use largely paperless on-line methods to make their federal tax deposits and perhaps other fund transfers (just as increasing numbers of households pay bills and manage other financial transactions on line). (The IRS encourages employers to use their free Electronic Federal Tax Payment System for making federal tax deposits.)  

For the many firms that already offer their workers direct deposit, including many that use outside payroll providers, direct deposit to an IRA would entail no additional cost, even in the short term, insofar as the employer’s system has unused fields that could be used for the additional direct deposit destination.  Other small businesses still write their own pay checks by hand, complete the federal tax deposit forms and Forms W-2 by hand, and deliver them to employees and to the local bank or other depositary institution. Our proposal would not require these employers to make the transition to automatic payroll processing or use of on-line systems (although it might have the effect of encouraging such transitions). 

At the same time, we would not be inclined to deny the benefits of payroll deduction savings to all employees of employers that do not yet use automatic payroll processing (and we would not want to give small employers an incentive to drop automatic payroll processing). These employees would benefit from the ability to save through regular payroll deposits at the workplace whether the deposits are made electronically or by hand. Employees would still have the advantages of saving that, once begun, continues automatically, that is more likely to begin because of workplace enrollment arrangements and peer group reinforcement, and that often will not require employees to reduce their take-home pay from its previous level.

Accordingly, we would suggest a three-pronged strategy to address these situations efficiently and with minimal cost.  

First, a large proportion of the employers that still process their payroll by hand would be exempted under the exception for very small employers described below. As a result, this proposal would focus chiefly on those employers that already offer their employees direct deposit of paychecks but have not used the same technology to provide employees a convenient retirement savings opportunity. 

Second, employers would have the ease of “piggybacking” the payroll deposits to IRAs onto the federal tax deposits they currently make. The process, including timing and logistics, for both sets of deposits would be the same. Accompanying or appended to the existing federal tax deposit forms would be a similar payroll deposit savings form enabling the employer to send all payroll deposit savings to a single destination. The small employer who mails or delivers its federal tax deposit check and form to the local bank (or whose accountant or financial provider assists with this) would add another check and form to the same mailing or delivery.

Third, as noted, the existing convenient, low-cost on-line system for federal tax deposits would be expanded to accommodate a parallel stream of payroll deduction savings payments.

Since employers making payroll deduction savings available to their employees would not be required to make contributions or to comply with plan qualification or ERISA requirements with respect to these arrangements, the cost to employers would be minimal. They would administer and keep track of employee elections to participate or to opt out and would implement those elections through their payroll systems. On occasion, it might be expected that employers would need to address occasional mistakes or misunderstandings regarding employee payroll deductions and deposit directions. These concerns, though, could generally be expected to be minimized through orderly communications, written or electronic, between employees and employers, facilitated by the use of standard forms that “piggyback” on the existing IRS forms.

Exemption for Small and New Employers

As discussed, the requirement to offer payroll deposit to IRAs as a substitute for sponsoring a retirement plan would not apply to the smallest firms (those with up to ten employees) or to firms that have not been in business for at least two years. However, even small or new firms that are exempted would be encouraged to offer payroll deposit through the tax credit described earlier.  (In addition, a possible approach to implementation of this program would be to require payroll deposit for the first year or two only by non-plan-sponsors that are above a certain size. This would try out the new system and could identify any “bugs” or potential improvements before broader implementation.)

Employees of small employers that are exempted—like other individuals who do not work for an employer that is part of the payroll deposit system outlined here—would be able to use other mechanisms to facilitate saving. These include the ability to contribute by instructing the IRS to make a direct deposit of a portion of an income tax refund, by setting up an automatic debit arrangement for IRA contributions (perhaps with the help of a professional or trade association), and by other means discussed below.

Employee Participation

Like a 401(k) contribution, the amount elected by the employee as a salary reduction contribution generally would be tax-favored, i.e., either “pre-tax”—deducted or excluded from the employee’s gross income for tax purposes—or a contribution to a Roth IRA, which instead receives tax-favored treatment upon distribution. An employee who did not qualify to make a deductible IRA contribution or a Roth IRA contribution (for example, because of income that exceeds the applicable income eligibility thresholds), would be responsible for making the appropriate adjustment on the employee’s tax return. The statute would specify which type of IRA is the Default, and the firm would have no responsibility for ensuring that employees satisfied the applicable IRA requirements.

Employees Covered

Employees eligible for payroll deposit savings might be, for example, employees who have worked for the employer on a regular basis (including part-time) for at least 30 days and whose employment there is expected to continue.  Employers would not be required, however, to offer direct deposit savings to employees they already cover under a retirement plan, including employees eligible to contribute (whether or not they actually do so) to a 401(k)-type salary-reduction arrangement.  Accordingly, an employer that limits retirement plan coverage to a portion of its workforce generally would be required to offer direct deposit or other payroll deduction saving to the rest of the workforce.