State Auto-IRA Programs: The Keys to Financial Self-Sufficiency

Very few workers save for retirement unless their employer offers them a retirement plan, typically a 401(k). But only about half of all private sector workers currently has access to such plans. In the absence of federal action to close this coverage gap, several states have stepped in. California, Connecticut, Illinois, Maryland, and Oregon have passed laws that will require employers without a plan to automatically enroll their workers in a state-sponsored program of Individual Retirement Accounts (“auto-IRAs”). These programs would be administered by private sector companies, with oversight by the state. States that have passed auto-IRA laws face a challenge: these programs must pay for themselves. Addressing this challenge is difficult because, in the beginning, program costs will rise more rapidly than revenues. Costs are driven by the number of accounts, and the programs are expected to enroll many participants in the initial years. In contrast, revenues are driven by assets under management, which are initially low as employee contributions and investment returns take time to accumulate. These facts suggest that, unless the fees charged to participants are set prohibitively high, it may be a number of years before state auto-IRAs “break even” and pay back any initial losses. This brief, which is based on a study for the state of Oregon’s Retirement Savings Plan, will: 1) examine what fees may be required to enable auto-IRA programs to be self-financing; and 2) identify the most important drivers of, and barriers to, financial self-sufficiency. The discussion proceeds as follows. The first section describes the costs of an auto-IRA program, including the start-up and ongoing administrative costs. The second section describes how program assets accumulate, resulting in higher revenue from fees. The third section discusses how costs and asset balances interact to dictate program finances, and how long it may take for auto-IRAs to break even as well as to pay back any initial losses. The final section concludes that auto-IRA programs can break even and pay back initial losses in about 9 years as long as: 1) initial fees are allowed to be higher in the short-run – around 100 basis points – before dropping down to their long-term equilibrium; 2) the default contribution rate is meaningful; and 3) per-account costs are relatively low.