New York City is latest to adopt an 'auto IRA' to enroll workers without a job-based retirement plan

New York City has joined a short but growing list of jurisdictions aiming to get workers into a retirement plan.

Mayor Bill de Blasio signed a bill into law this week that will require most employers not offering a workplace plan to automatically enroll their workers in an individual retirement account through a program administered by the city. While it will take a couple of years for the initiative to become operational, the city is joining a handful of states that already have launched such auto-IRA arrangements or are close to doing so.

Additionally, a federal appeals court in California last week rejected a challenge to that state’s auto-IRA program, CalSavers. The ruling essentially says that the program does not run afoul of federal rules governing workplace retirement plans.

“If anything, this just continues to give states the incentive and momentum to forge ahead and adopt these programs,” said Angela Antonelli, executive director of Georgetown University’s Center for Retirement Initiatives.

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Since 2012, at least 45 states have either implemented or considered legislation intended to help the estimated 57 million people without access to a retirement plan through their job, according to the retirement center.

While large employers are more likely to offer a retirement option, cost and administrative burdens can stand in the way of small business owners’ pursuit of setting one up. Thus, these state-run programs largely end up increasing access to a workplace plan for that contingent of workers.

It’s not the only movement afoot to boost the ranks of retirement savers. The Secure Act, passed in 2019, made it easier for small businesses to band together to offer their workers a 401(k) plan through so-called pooled employer plans. The idea is that businesses can share in the administrative and cost aspects of operating a retirement savings plan. 

“The more options there are available to workers, the better,” Antonelli said. “There’s a huge [retirement savings] gap to fill.”

Workers appear to need all the help they can get. For instance, the median account balance for individuals nearing retirement — those age 55 to 64 — is $69,000, according to Vanguard.

Part of the hurdle is access. While it’s possible to set up a retirement account outside of employment, individuals are 15 times more likely to save for their golden years if they can do so through a workplace plan, according to AARP, the advocacy group for older Americans. Add in automatic signup, and the outcome is better: The total average savings rate is 56% higher (including employer contributions) among 401(k) plans with auto enrollment, Vanguard research shows.

Three states already have auto-IRA plans up and running: Oregon, Illinois and California. Although there are some minor differences among the programs, the general idea is that employees are automatically enrolled through a payroll deduction (starting around 3% or 5%) unless they opt out. There is no cost to employers, and the accounts are managed by a professional investment company.

Several more states are expected to launch pilot testing this year for their own auto-IRA programs, including Maryland, Connecticut and Colorado, Antonelli said. Additionally, Virginia lawmakers passed a bill this year that authorizes such a plan.

A handful of other states — including Massachusetts, New York, Vermont and Washington — have programs that operate differently, with participation voluntary.

Altogether, workers in these state-run programs have amassed more than $220 million in retirement assets, the majority of which is in the three states with auto-IRA arrangements up and running, Antonelli said.

For instance, OregonSaves, which was the first to launch in 2017, has nearly $100 million in more than 100,000 worker accounts. The opt-out rate is about 33%.

For workers who end up in one of these auto-enrolled accounts, it’s worth knowing how they operate and how they differ from 401(k) plans, which many companies already offer.

For starters, money deducted from your paycheck — assuming you don’t opt out — goes into a Roth IRA that is managed by an investment company, not your state government. Contributions to Roth accounts are not tax-deductible as they are with 401(k) plans. (Traditional IRAs, whose contributions may be tax-deductible, might be available as an alternative option, depending on the specifics of the state’s program).

Meanwhile, Roth IRAs — unlike, in general, 401(k) plans — also come with no penalty if you withdraw your contributions before age 59½.

This means that if a worker wants to take back any contributions before retirement, there is no penalty because they already paid taxes on it. (For earnings, however, there could be a tax and/or penalty.) In other words, the account could become an emergency fund more easily instead of being exclusively for retirement.

Additionally, these Roth accounts generally won’t come with the incentive of an employer match on work contributions, as 401(k) plans often do.

Yearly Roth IRA contribution limits also are lower. You can contribute $6,000 in 2021, although higher earners are limited in what they can contribute, if at all. Also, anyone age 50 or older is allowed an additional $1,000 contribution.

For 401(k) plans, the contribution limit is $19,500 in 2021, with the 50-and-over crowd allowed an extra $6,500.