Can the Government Make You Get an IRA?

Probably, but that doesn’t mean Obama’s proposals will help workers.

The State of the Union address didn’t deliver many surprises. It was broadly populist in tone, with promises to rein in a bloated budget through (token) spending freezes and deliver relief to a middle class that’s grown disillusioned with an unemployment rate of 10 percent and a still-moribund real estate market.

The administration’s main olive branch is a package of tax cuts, rebates and policies created by the Joe Biden-led Middle Class Task Force. It’s a grab bag of feel-goodies like student loan forgiveness and a larger tax credit for child care. Obama alluded to a few of these in the State of the Union; more detail had already been given at another speech two days earlier.

Several of the proposals touched on last night and outlined in more detail by the Middle Class Task Force are part of a push to improve and standardize American retirement planning. This is where Obama could do the most good—but whether average workers or financial service firms and insurance companies will be the chief beneficiaries remains to be seen.

Make no mistake, something needs to be done about the state of retirement planning in this country. Since 401(k)s have largely replaced traditional pensions, the financial state of our collective golden years has become precarious. First, not all companies offer retirement plans. Those that do often make them available only to full-time or salaried employees. Workers further down the income ladder are left out of the loop by design or by their own decision; if they can barely make ends meet, they’re not going to voluntarily sock away a chunk of their paycheck. There’s also the fact that retirement benefit plans are complicated, offering a myriad of choices that sometimes freezes would-be participants into inertia.

According to Center for Retirement Research at Boston College, 51 percent of households won’t be able to maintain their standard of living after retirement. Even before the financial crisis struck, that number was at a worrisome 43 percent.

The President’s plan is to make retirement contributions opt-out: the default will be for employers to enroll their employees in Automatic IRA, the cornerstone of the Retirement Security Project developed by David John of the Heritage Foundation along with Mark Iwry, a former Brookings Institution scholar who decamped to the Treasury Department last year. All but companies with 10 or fewer employees would be required to participate, which John estimates will increase the number of Americans with retirement-plan access to 89 percent, up from roughly 50 percent today.

The idea of more-or-less requiring Americans to do the right thing isn’t a new one, and it’s no surprise to see it coming from this administration. Cass Sunstein, Obama’s appointee to head the Office of Information and Regulatory Affairs, gained notoriety for his co-authorship of Nudge. The book uses the psychology of human behavior to argue that lawmakers have an obligation to craft policies that shepherd citizens towards a desired outcome. Retirement saving is one topic the authors tackle specifically, pointing out that when private employers offer incentives for saving and take steps to make the process simpler, participation increases.

Retirement Security Project developers envision private-sector administration of auto-IRA, with a small number—perhaps as few as three—target-date investment options offered, based on index funds to keep both risk and overhead low. Progressive groups want to see a publicly-managed option offered, as well, to keep what could be substantial fees down by increasing the amount of competition. Others have kicked around the idea of caps on fees plan administrators could charge.

Initially, a worker just starting out would have his or her money invested in an “accumulation account” until it reached $5,000. The Project calls for the creation of a special type of bond, called an R-bond, to house these embryonic nest eggs. Upon hitting the $5,000 threshold, the money would roll over into a target date fund unless the worker specified otherwise. If the amount never reached that $5,000 threshold—say, if the person left the workforce to start a family and never returned—the money would be treated like any other inactive IRA account. (In other words, the government couldn’t claim those funds through escheatment the way it does with unclaimed tax refunds.)

In reality, the R-bond will probably never see the light of day. The term has barely crept into the mainstream, but conspiracy-mongers have already latched onto it as a supposed example of government confiscation of private funds, pointing to Argentina’s 2008 nationalization of the country’s pensions to gain access to badly-needed capital. It sounds crazy, but given the level of credence other wild-eyed theories ranging from the President’s birthplace to “death panels” have commanded, it would probably be an ill-advised use of political capital to try and push through the R-bond.

A second facet of this nationwide retirement plan is an improvement of the credit offered to low- and moderate-income workers who invest pre-tax dollars into a retirement plan. The previous credit was nonrefundable, meaning that if a worker made too little to itemize or pay income tax, he or she got nothing. Now, the government will offer a 50 percent match for the first $1,000 in employee retirement contributions every year, so long as the family’s annual pay stays under $65,000. (Above that, it’s gradually phased out for incomes up to $85,000.) The money goes into the IRA, so even people who don’t itemize or pay income taxes will be able to reap the benefit. This would not only help low-income workers, but would provide an incentive to new college grads earning entry-level salaries.

The final plank of this platform is a push for workers to convert their retirement investments into annuities. Unlike a traditional pension, 401(k) contributions are available at retirement as a lump sum or in the form of monthly payments for a fixed period of time. Either option comes with the danger that the money can run out before the beneficiary dies, a danger brought into sharp relief when the drop in the stock market eviscerated many Americans’ nest eggs. According to a survey by Prudential Financial of more than 1,000 employees, 65 percent of those age 45 to 64 said they plan to delay retirement because they can’t afford to stop working.

Annuities are a good alternative in theory, but implementing a nationwide plan for their use raises a lot of logistical and regulatory questions. First, they’re an infamously complex type of investment, and the buyer has to take what’s essentially a gamble that they won’t be hit by a bus before they’ve made back the money they paid.

The bigger problem is that annuities are, technically speaking, a form of life insurance. They’re not sold by banks or brokerage firms; they’re sold by companies like—and including—AIG. Since insurance is only regulated at the state level, there’s nothing like an insurance version of the FDIC that protects bank deposits. The states do have their own regulatory agencies and risk pools, but there’s no standard—and no guarantee that a major insolvency wouldn’t overwhelm a state program.

To some, the natural solution would be to regulate insurance agencies at the federal level, but that’s a political third rail the Administration probably won’t want to go near. Some sort of federal reinsurance program is also a possibility, but it’s also likely to meet resistance from the industry and the anti-regulation camp. The same contingent that views automatic IRAs as a stealth appropriation of private funds sees much the same bogeyman in mandatory annuities.

Some are already calling these initiatives another outright giveaway to the financial sector. The fear that Wall Street will collect some of these funds shouldn’t be enough to abandon the idea. America’s retirement is a shambles, and the problem is only going to get worse once boomers start retiring in droves. But legislators will need to make sure that these new programs come with enough regulatory fencing to keep industry interests from running roughshod over the funds with which they’re entrusted.

Explainer thanks Dean Baker of the Center for Economic and Policy Research, David John of the Heritage Foundation, Olivia Mitchell of the Pension Research Council at the University of Pennsylvania’s Wharton School and Alicia Munnell, director of the Center for Retirement Research at Boston College.