For years, you've heard how you should have an IRA to help boost your retirement savings. Now, though, the government wants to make IRAs automatic for most workers. If these proposals become law, automatic IRAs could change the way many people save for retirement -- but is it a smart thing for you?
A good idea, mostly
As proposed by Sen. Jeff Bingaman of New Mexico last week, the Automatic IRA Act would require all employers with 10 or more employees to automatically enroll their workers into an IRA if they don't offer an alternative retirement plan, such as a 401(k) plan. Although the law wouldn't force workers to participate, they would have to affirmatively opt out of the program if they didn't want to make IRA contributions.
Here are some of the particulars of the proposed law:
- The default contribution rate would be 3% of salary.
- Contributions would be made to a Roth IRA unless a worker chose a traditional IRA instead.
- The default investment would be a special new type of investment dubbed an "R-Bond" until workers had accumulated $5,000 or more in their IRAs. After that, the default would change to a balanced or life-cycle mutual fund as offered by the IRA provider.
- Employers would have the option of choosing a provider for all employees or allowing individuals to choose providers on their own.
One definite winner from an automatic IRA law would be the discount brokers that set up IRAs. With Charles Schwab (NYSE: SCHW ) , E*TRADE (Nasdaq: ETFC ) , and TD AMERITRADE (Nasdaq: AMTD ) all battling for position with other brokers in an ultracompetitive financial industry right now, a government-legislated flood of new accounts could be exactly what the doctor ordered.
What about workers, though? Does the law go far enough for them?
Giving workers a push
On its face, the proposed automatic IRA law makes a lot of sense. Doing more to encourage more people to save for retirement is a good idea and long overdue. Participation in employer-sponsored retirement plans is abominable, with just 60% of workers making any contribution at all. More than half of those who do participate contribute 5% or less of their salaries.
That lack of planning shows up in how little most people have saved for retirement. According to a study from the Employee Benefits Research Institute, fewer than half of workers have saved more than $25,000 toward their retirement. Even among those closer to retirement who've had longer to save, less than one in five has saved more than $250,000, a figure that itself probably wouldn't be enough to let anyone retire comfortably.
The better strategy
So it's clear something like Bingaman's proposal is necessary. But in many ways, it doesn't go far enough. A default contribution rate of 3% is far too low for most people to meet their financial needs in retirement. Defaulting to a Roth IRA makes plenty of sense for young, lower-income workers who are in low tax brackets, but older workers with higher incomes might be better off in a traditional IRA.
Perhaps most importantly, using a fixed-income investment option as a default isn't the right strategy for anyone trying to build retirement savings. Most investors need to save aggressively for retirement, and stocks like Hansen Natural (Nasdaq: HANS ) or Chipotle (NYSE: CMG ) that have shown a strong history of solid growth and extraordinary returns on invested capital would give them a better chance of getting there than a bond investment. Even for conservative investors, Altria Group (NYSE: MO ) and AT&T (NYSE: T ) are among the many high-yielding dividend stocks that tend to react less turbulently even when the overall market is bouncing up and down.
The government's efforts show how hard it is to push people toward doing the right thing with their money. Even if automatic IRAs are better than nothing, you're still far better off taking responsibility for your own savings and putting together a custom-made plan that works best for your own individual needs.
Need a plan of your own for retirement? The experts at Rule Your Retirement can show you the way, and a 30-day free trial is just a click away.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.