Automatic IRAs present risks, opportunities

Unless workers opt out, contributions to 401(k)s and similar retirement plans are automatically deducted from their paychecks. Now Congress wants to add IRAs, too.

from the September 17, 2007 edition

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More companies are setting up automatic 401(k) enrollment systems for their employees. Last year, Congress passed a bill legalizing automatic 401(k)s for companies that chose to have them, superseding any state laws that prohibited the practice. As of this June, 12 percent of the Vanguard Group's 401(k)s automatically enroll employees, up from 8 percent in 2006, says Rebecca Cohen, spokeswoman for the investment-management company.

Marlene Vega, a cashier assistant at a Costco in Queens, N.Y., was automatically enrolled in her company's 401(k) after she was hired last April. She didn't know which of Costco's 10 plans her money was being invested in, but she was glad she had automatically been enrolled. "It's not money you see, so you don't miss it," she says.

But many don't have access to 401(k)s. The AARP-commissioned study says that employees at small companies and lower-income workers are least likely to have access to retirement plans at work. The study says only 44 percent of workers in companies with fewer than 100 employees have access to a retirement plan, compared with 78 percent of workers in bigger companies. And low-income workers are less likely than other workers to have access to pension plans, it says.

AARP, which supports the legislation, says that a worker who saved $1,000 a year over the course of 30 years at a 4 percent real interest rate would accumulate almost $60,000 – which would provide nearly $200 a month in interest income in retirement.

"The key thing is that no matter how small your savings, it makes a big difference in your retirement savings down the road," says Ms. Morton. "We're not saying it's enough, but it's better than not having it."

Indeed, half of people over age 65 live on less than $16,000 a year of income, according to the Current Population Survey. And many have scarcely saved for retirement at all – 34 percent of aged beneficiaries depend on Social Security for more than 90 percent of their income.

But for some, the relatively small amount of additional retirement income may come at a heavy cost. With few exceptions, people who withdraw money early from their IRA will be hit with a 10 percent penalty. CEPR's Mr. Baker recommends having a "modest cushion in an accessible form," especially if you're a parent, before locking money away in a retirement savings account.

Investment fees may also eat into retirement savings. The Senate version of the bill states the "costs of investment management and administration are kept to a minimum," but doesn't set a cap. An increase in fees of 0.5 percentage points on an investment with a 4 percent real return would decrease earnings by almost 10 percent.

And an increase in credit-card debt could quickly wipe out financial gains from saving for retirement. Cardweb.com notes that average credit-card debt for households with at least one credit card is approaching $10,000. "Almost certainly it's better to pay off credit-card debt first," says Baker. Borrowing money at a higher rate than you're investing it at is a "losing proposition," he says.

Despite her credit-card debt, Ms. Vega sees her 401(k) as a good investment. "The more money I have, the more I waste," she says. "As I get older I can do more things with the money."

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