President Obama, in his State of the Union address, announced plans to create a new myRA retirement account to help the 50% of workers who do not have an employer-sponsored plan to start saving. While myRA is a credible starter retirement account, its benefits as a short-term or home down-payment fund should not be overlooked. Offering guaranteed principal, superior interest rates, and the ability to withdraw principal at any time, the myRA may be the best short-term or emergency fund available for nearly all workers -- not just those without employer-sponsored plans.
Eligibility with employer plans
The myRA account is intended to help low- and middle-income employees who do not have retirement accounts start saving for retirement. The incentives to start saving include:
- Automatic payroll deductions of as little as $5 a pay period after a $25 initial investment.
- A safe investment where the principal is guaranteed by government bonds.
- No fees whatsoever.
- Ease of decision making as the only investment available is government bonds.
While the plan targets the millions of employees who do not have employer-sponsored plans, myRA accounts will be available to employees with employer-sponsored plans that meet certain income limits. Under the proposal, myRA will be available to singles with adjusted gross incomes up to $129,000 a year and couples with income up to $191,000. Note that eligibility does not guarantee availability, as employers are under no obligation to offer the plan to employees and myRA is not being offered to the self-employed. The rollout of myRA is planned for the end of 2014.
Guaranteed principal, superior returns
The myRA account will be a type of Roth IRA, with the investment limited to the G Fund of the Thrift Savings Plan for federal employees. The plan invests solely in government savings bonds. The bonds will be backed by the U.S. government so that savers can never lose their principal investment. myRA guarantees a savers' principal, which is a necessity for an emergency or short-term savings fund. While most bank accounts are also U.S. government-insured (up to $250,000), the government bonds in G Fund have easily outperformed bank accounts.
The G Fund paid 2.81% in 2010, 2.45% in 2011, and 1.47% in 2012, the latest year for which performance data is available. Although 2012 was the worst year for the G Fund in the last 10 years, it still outperformed the average bank savings account, which paid a measly 0.08% that year. In other words, savers earned an average of only $0.08 per year on every $100 sitting in a bank account in 2012; the G Fund returned 18 times that.
One concern with myRA is that while the principal is guaranteed, the interest rate is not, and the rate of G Fund bonds could fall below the rate of inflation. This happened in 2012 when the rate of inflation, as measured by the Consumer Price Index, was 2.08% versus the G Fund return of 1.47%. However, the G Fund has beaten the inflation rate over time. In the 10 years from 2003 to 2012, the average annualized return of the G Fund was 3.6%, which easily outpaced the inflation rate of 2.6% over the same period.
With a short-term fund, it does not matter if its rate falls below inflation: The saver is shopping for the best return among investments that protect principal. In this regard, G Fund bonds have outperformed other safe investments including bank accounts, CDs, and even three-month Treasury Bills, a favorite of institutional investors.
Contribution and withdrawal
The minimum myRA contribution is only $5 per pay period, but there is a contribution limit of $5,500 per year ($6,500 if over age 50) in accordance with Roth IRA rules. Employees who invest in a myRA account can still fund another Roth IRA but will be subject to the overall limit. Also, while a family's adjusted gross income can go up to $191,000 to participate in a myRA or any Roth IRA, a phase-out of the benefit begins at $181,000; for individuals, the limit is $129,000, with the phase-out beginning at $114,000.
Another limitation of the myRA is that once the account reaches $15,000 or has been in existence for 30 years, it must be converted to a regular Roth IRA. This may inconvenience retirement savers who do not want to make new investment decisions, but it is not as much of a problem for savers using their myRA account as a short-term or emergency fund except that they will have to keep their account balance below $15,000. Once the myRA limit has been reached and the account converted to a regular Roth IRA, participants cannot open a new myRA. However, there is nothing stopping savers from voluntarily transferring some of their myRA contribution to another Roth IRA to maintain their balance below $15,000. The participants could then keep their myRA with its guaranteed principal and higher rate as a short-term savings account.
The principal contributed by the employee can be withdrawn at anytime and for any reason without penalty. The growth in the account from the interest on the bonds will be taxed under Roth rules. The earnings may be withdrawn tax-free at the defined retirement age of 59 and a half, provided that the account was open for at least five years. If the earnings are removed before the retirement age of 59 and a half, they are taxable and subject to a 10% withdrawal penalty with several exceptions, including earnings being used to pay for qualified first-time home-buyer expenses. The qualified first-time home-buyer exception for the withdrawal of earnings requires that the account has been open for five years and limits the earnings withdrawn to $10,000, while principal withdrawals are always tax-free.
A practical short-term fund
Employees saving for their first home would especially benefit from having a myRA account to help save for their down payment. The principal is safe, the return is superior, and the principal -- and, in some situations, the earnings -- can be withdrawn tax-free. One possible issue for home buyers is that the $15,000 limit on the myRA account may not be enough in many parts of the country for a full down payment. Even then the myRA would be a good starter account before the funds were transferred to a Roth IRA for the account to grow larger.
The myRA should be preferred as a short-term fund because it has consistently outperformed other safe investments. For example, the G Fund has earned a compound annualized return of 51% since August 1990. A $1,000 investment in 1990 would be worth $3,185 in February 2014. A bank savings account would have only earned a fraction of that. G Fund rates continue to outperform the alternatives. In February 2014 the G Fund rate was 2.25%, while, according to Bankrate.com, the one-year certificate of deposit rate averaged 0.81% and the savings rate averaged 0.11%. In addition to rates, there are other advantages to myRA as a short-term fund. Bank accounts and CDs are both subject to higher account minimums than myRA and often require fees, while CD funds can only be withdrawn at specified times, lest the client face significant penalties.
The myRA account allows low payroll deposits, requires no fees, and has rates well above bank accounts, CDs, and other safe investments. If offered by your employer, the myRA is the best place to save your short-term and emergency savings.