The automatic revolution: Legislation would provide tax credit for employers to channel contributions to an IRA

There is a growing concern among American economists, financial analysts and policy makers that Americans are not financially prepared for retirement. According to investment professionals, a comfortable retirement requires an annual income of about 75% of pre-retirement earnings. For most workers, Social Security will not cover that amount.

The traditional defined benefit pension plan has given way to one that focuses on employee contribution instead. Too many Americans, however, are not using traditional savings vehicles to prepare for retirement. Nearly one out of two American workers — an estimated 75 million — currently have no employer-sponsored saving plan and therefore no vehicle for saving. Many are moderate- to lower-income workers and small business employees whose employers don’t sponsor savings plans.

Others are daunted by the complexity of private pension plans. Today, eligible workers are required to not only take the initiative to save, but also to bear more investment risk, and make more of their own decisions about their retirement saving. When faced with such complex choices and paperwork, many workers choose not to enroll at all.

For others, saving for retirement has taken a back seat to other financial issues, such as paying for their children’s education, buying a new home, or paying for skyrocketing health-care costs. With Americans living longer than ever before, retirement savings should be increasing, rather than decreasing, to keep pace with the needs of those facing retirement.

We believe that Americans shouldn’t need an advanced degree to do something as elementary and important as saving for their future. That’s why we’ve introduced a bill to offer employees without access to an employer-sponsored savings plan the opportunity to save through an automatic IRA.

And while Democrats and Republicans in Congress may not agree on Social Security reform, we do agree on this. Along with support from the AARP, the automatic IRA, which is based on a proposal from the Retirement Security Project*, has gained widespread and bipartisan support on Capitol Hill. A similar bill sponsored by Rep. Phil English, R-Pa., and Rep. Richard E. Neal, D-Mass., was introduced in the House. A House hearing on retirement security issues, including the automatic IRA, was held Nov. 8.

Under the automatic IRA, employers above a certain size (e.g., more than 10 employees), that have been in business for at least two years but do not sponsor any retirement plan for their employees, must allow their employees to use the employer’s payroll system to channel employee money to an IRA. To offset administrative costs, a small, temporary tax credit is provided to employers.

Auto IRAs dramatically simplify retirement saving for both employers and employees. Employers facilitate employee saving without having to sponsor a plan, make matching contributions or process complex eligibility rules. Employees are enrolled automatically into a savings plan, unless they choose to opt out, and retain the option to choose how much and where to save. This policy also offers savings options for the self-employed and independent contractors, as well as continuity of saving for those who are changing jobs.

By banking on the power of inertia, automatic enrollment is changing the way Americans save. The automatic revolution was launched last year with the passage of the 2006 Pension Protection Act, which included for the first time a provision for automatic enrollment in 401(k) plans. Studies on the success of this policy have shown that automatic enrollment dramatically boosts 401(k) participation rates to nine of 10 eligible workers from seven of 10.

Only one in 10 eligible individuals contributes to an IRA now. The Retirement Security Project estimates that the automatic IRA could increase participation rates significantly and, ultimately, could increase net national savings by nearly $8 billion annually.

By giving workers an easy, effective way to take responsibility for their financial futures, we are giving them a future they can enjoy. That’s a revolution we can all support.

*The Retirement Security Project promotes ideas to improve retirement income prospects of American workers. It is supported by The Pew Charitable Trusts and is affiliated with Georgetown University’s Public Policy Institute and The Brookings Institution, all in Washington.

Sen. Jeff Bingaman, D-N.M., and Sen. Gordon Smith, R-Ore., both serve on the Senate Committee on Finance and are co-sponsors of S.1141, the Automatic IRA Act.

(updated with correction)