Is a state-run IRA right for you?

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For years, much publicity and press have been focused on the retirement savings gap. Some 45 percent of working-age households, or 38 million, have no retirement account assets, according to the National Institute on Retirement Security. The average working household has virtually no retirement savings.

Research also finds that households that have retirement accounts such as 401(k) or IRA accounts, have much higher income and wealth than those that don’t. Households with retirement accounts have over double the income and five times the non-retirement assets than those without.

Likewise, the Employee Benefits Research Institute’s latest report highlights the usefulness of retirement plans. People with personal retirement accounts or employer-sponsored retirement benefits tend to save more and have greater confidence in having enough money for a comfortable retirement.

However, about 20 percent of workers aren’t offered a retirement plan at work, according to the Bureau of Labor Statistics. Many of these work at smaller businesses. Many small employers don’t offer 401(k)s or other plans to their employees, because these plans are usually complex to set up and administer and come with high fees. These workers must open their own retirement accounts. But not everyone has the experience or incentive to set up a personal retirement savings account and contribute to it regularly.

The federal government’s myRA program, created late last year, allows people to set up and contribute to government-sponsored Roth IRAs. But these still require individuals to take the initiative to create their accounts and set up direct deposit. Also, the accounts are limited to a balance of $15,000 and the investment options are limited to Treasury securities, which currently return around 1.5% annually.

Recently some efforts have been made to address this gap. Austin-based startup company Honest Dollar makes a variety of retirement plans available to small businesses, with low fees and no setup cost. Participants have a choice of low-cost exchange-traded funds at Vanguard Group and other companies.

State governments are getting into the act as well. About half of states either have opened or are considering state-run IRAs for workers at small businesses. California led the way in 2012 with its California Secure Choice Retirement Savings Program.

Oregon, Massachusetts, Washington, and Illinois have also passed laws to create their own plans, and another 22 states have introduced bills or are looking into the issue. Under these plans, workers are  enrolled by default but can opt out. Up to 3% of each paycheck is automatically withdrawn for deposit into the IRA account. Workers can choose to contribute more, up to the IRA contribution limits of $5,500 per year, or $6,500 for those age 50 or over.

The funds are placed in investments based on the worker’s expected retirement date. The plan is administered by the state or by a private company, such as Vanguard. The administrator, not the employer, has the responsibility for running the plan and properly managing the investment funds. The employer pays the cost to run the plans and the fees are capped. Unlike a 401(k), there’s no employer matching or withdrawals for medical or education expenses.  Workers

The Oregon Retirement Savings Plan takes effect July 1, 2017 and affects one million Oregonians who have no employer-sponsored retirement plan. The Oregon state plan will include automatic enrollment and direct deposit, and annual increases in workers’ contributions. One advantage of state-run funds is that there’s no need to roll over the funds when you change employers.

A big issue for both state and private savings account is the Employee Retirement Income Security Act of 1974, known as ERISA. This law requires plans to adhere to fiduciary guidelines and makes employers liable if a plan violates these guidelines. Many states are hesitant to set up state-operated IRAs under the law, because it would add more required checks and complexity to state-run plans.

The U.S. Department of Labor is currently reviewing a proposal to exempt state-run IRAs from the law’s provisions, as long as the IRAs include a specific set of features. If approved, the proposal would make many states more willing to implement their own IRA programs.  California’s IRA program is explicitly subject to the condition that it be exempt from ERISA.

If a state-run IRA is offered in your state, and you are eligible, should you enroll or opt out? Here are some considerations.

1. Exempting state-run IRAs from ERISA would remove crucial investor protections provided by the law. These include stringent provisions regarding management and safekeeping of investors’ funds. Many states including California and Illinois are facing severe budget shortfalls. Without ERISA protections there is a possibility that investments in state-run IRAs could be comingled with other state funds, and not be available when workers need them. 

2. The Financial Services Institute expects litigation to be filed to challenge exempting state-run IRAs from ERISA. It’s unknown how existing state programs would be affected while that litigation is in progress. Would they continue to function and would the funds invested continue to grow?

As an alternative to state-run IRAs, the Department of Labor has also issued a bulletin to help states assist employers to create 401(k) plans. The state would set up a marketplace enabling employers to choose from private plans. Another option is for the state to create industry plans, so that all companies in the same industry would have access to a statewide plan under one administrator. Both of these types of plans would be covered by the ERISA law.

Here’s one financial observer’s take on the state-run retirement accounts:

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