This approach involves no employer contributions, no employer compliance with qualified plan or ERISA requirements, and, as noted, no employer liability or responsibility for selecting investments, for selecting an IRA provider, or for opening IRAs for employees. It also steers clear of any adverse impact on employer-sponsored plans or on the incentives designed to encourage firms to adopt new plans. In fact, the indirect intended effect of the proposal would be to draw small employers into the private pension system, as described below.

For the self-employed and others who have no employer, regular contributions to IRAs would be facilitated in three principal ways: (1) extending the direct deposit option to many independent contractors who work for employers (other than the very smallest businesses); (2) enabling taxpayers to direct the IRS to make direct deposit of a portion of their income tax refunds; and (3) expanding access to automatic debit arrangements, including on-line and traditional means of access through professional and trade associations that could help arrange for automatic debit and direct deposit to IRAs.  Automatic debit essentially replicates the power of payroll deduction insofar as it continues automatically once the individual has chosen to initiate it.

In addition, a powerful financial incentive to contribute might be provided by means of matching deposits to the IRAs. Private financial institutions that maintain the accounts could deliver matching contributions and be reimbursed through tax credits.

The Basic Problem and Proposed Solution

Much has been written about the nation’s low personal saving rate and about Americans’ relative lack of financial preparedness for retirement even as we are generally living longer after retirement. Conventional measures suggest that net personal saving in the United States, as a percentage of disposable personal income, has declined steadily from over 10 percent in the early 1980s to a rate of 1 to 2 percent over the past four or five years.  By the last three quarters of 2005, according to the Commerce Department’s Bureau of Economic Analysis, the U.S. personal saving rate had actually dipped into negative territory.[4] The approach outlined in this paper is designed to help address these serious national problems.

In general, the households that tend to be in the best financial position to confront retirement are the 42 percent of the workforce that participate in an employer-sponsored retirement plan.[5] Traditionally, the takeup rate for IRAs (those who contribute as a percentage of those who are eligible) is less than 1 in 10, but the takeup rate for employer-sponsored 401(k) plans tends to be on the order of 7 in 10. The 401(k) programs make saving relatively easy by enabling employees to elect to have a portion of their pay deposited regularly and directly in a retirement account. The contributions are invested and accumulate on a tax-favored basis and are often matched by employer contributions.  

Moreover, an increasing share of 401(k) plans include automatic features that make it even easier to save and substantially bolster participation by employees.  A key element accounting for the power of 401(k)s to encourage saving is that, once the employee first elects to participate, the saving typically continues on “automatic pilot” with every paycheck during the year and from year to year unless the employee takes the initiative to change the initial election. Moreover, under automatic enrollment, even workers’ initial decision to participate occurs automatically unless they opt out (as opposed to making workers sign up for the plan in order to participate). In these plans, 401(k) account balances are invested on an automatic (Default) basis in investments—which can be diversified balanced funds, life cycle or life style funds, professionally managed accounts, or stable value funds—that are specified by the plan if the employee does not choose a different investment. In 2004, according to a recent survey, 10.5 percent of 401(k) plans and 30.6 percent of 401(k) plans with 5,000 of more participating employees used automatic enrollment. Compared to 2002 levels, these figures represent a 25 percent increase for all plans and a 44 percent increase for plans with over 5,000 participants.[6]

At the same time, at any given moment, an estimated 89 million workers, or 58 percent of the U.S. workforce, do not participate in a retirement plan at work.[7] In general, participation in an employer-sponsored plan is less likely for those who have lower incomes, who are less educated, and who work for smaller employers.[8] While much more can and should be done to expand employer plan coverage,[9] the fraction of the workforce that is covered by employer plans has hovered around one half for at least three decades. Even if private employer-sponsored pension coverage were to increase dramatically, tens of millions of households would still remain without a retirement plan.

These households—the uncovered portion of the workforce—consist disproportionately of moderate- and lower-income families. These families have the greatest need to save more to achieve retirement security, but their low tax brackets mean they benefit little if at all from the tax incentives provided under the current system. Policymakers wanting to increase retirement security and expand more widely the benefits of asset accumulation must therefore carefully consider how to encourage such workers to save more for retirement.

When firms are not willing to sponsor 401(k)-type plans, the automatic IRA proposed here would apply many of the lessons learned from 401(k) plans[10] so that more workers could enjoy automated saving to build Assets—but without imposing any significant burden on employers. Employers that do not sponsor plans for their employees could facilitate saving by employees—without sponsoring a plan, without making employer matching contributions, and without complying with plan qualification or fiduciary standards. Employers can help employees save simply by offering to remit a portion of their pay to an IRA, preferably by direct deposit, at little or no cost to the employer.  

Such direct deposit savings using IRAs would not and should not replace retirement plans, such as pension, profit sharing, 401(k), or SIMPLE-IRA plans. Indeed, the automatic IRA would be carefully designed so as to avoid any adverse effect on employer sponsorship of “real” plans, which must adhere to standards requiring reasonably broad or proportionate coverage of moderate- and lower-income workers and various safeguards for employees, and which often involve employer contributions.  Instead, payroll-deduction direct deposit savings, as envisioned here, would promote wealth accumulation for retirement by filling in the coverage gaps around employer-sponsored retirement plans. Moreover, as described below, the arrangements we propose are designed to set the stage for small employers to “graduate” from offering payroll deduction to sponsoring an actual retirement plan.