What are Automatic IRAs?

Creating a retirement corpus for yourself with sufficient savings to carry you through your golden years can be challenging. It involves having knowledge on different kinds of retirement accounts, the associated tax benefits and liabilities, contribution rules and withdrawal limits, along with the various growth opportunities afforded by them. In addition, you have to ensure that you choose the right investment vehicle for your unique financial needs and goals. If you end up with insufficient retirement savings, this can put your future financial security in danger. Alternatively, if you end up living frugally to make sure you save enough funds for retirement, it can lead to frustration and discontentment, as you may have been making compromises with your standard of living to save the required amount for your retirement corpus.

Many employers offer a 401(k) to their employees. A 401(k) is an employer-sponsored retirement account wherein you can save for retirement and benefit from the power of compounding. However, not all your employers offer a 401(k), and if that is the case with you, you may consider investing in an Automatic Individual Retirement Account (IRA). You also have the option of consulting with a professional financial advisor who can help you explore different retirement options and come up with a strategy to save for retirement. The advisor can also discuss different retirement plans with you, their pros and cons, taxation, etc based on which you can make an informed decision.

With that said, let us discuss automatic IRAs in detail.

What is an automatic IRA?

An automatic IRA is an alternative option for investors to save for retirement who were not given the opportunity to enroll themselves into an employer-sponsored traditional retirement account like a 401(k) account or a pension plan. There is less paperwork involved in an automatic IRA and any individual can invest in it irrespective of the kind of job or industry they work in.

The first state to launch an auto-IRA program was Oregon under its state-sponsored IRA program, OregonSaves in the year 2017. Over the years, several states such as California, Illinois, Connecticut, and Maryland have launched similar programs in their respective states. If you live in a state wherein an automatic IRA is not available, you can either wait for them to launch one or go ahead and open one yourself.

Can I enroll in an automatic IRA myself?

Yes, you can. Enroll yourself in an auto-IRA by following these steps:

1. To open an automatic IRA, first, you need to have an earned income.
2. Select the kind of IRA you wish to invest in: a traditional IRA or Roth IRA.
3. Once you have opened your account, you need to select the ‘auto funding’ feature.
4. Choose the frequency of transfers to be made to your account i.e. on a monthly, quarterly, half-yearly or annual basis as per the annual contribution limit of the IRA set by Internal Revenue Services (IRS) each year.

How does an automatic IRA work?

Most retirees in the US bank on their Social Security benefits to see them through their retirement. However, based on multiple studies and evidence given by retirees, Social Security benefits are not sufficient to live comfortably in retirement if they are your only means of income. This is why you need a retirement or pension plan to ensure you can meet your expenses in retirement.

Let us discuss how an automatic IRA works:

• Employers who do not offer a sponsored retirement plan need to enroll their employees in a private payroll deduction Roth IRA or a similar retirement account automatically.
• If an employer has been in business for 2 years or more and has more than 10 employees on the company payroll, can offer an automatic IRA to their employees.
• Though employers must enroll their employees, they are bound by any obligation to make a contribution to their retirement account.
• In an automatic IRA, the contributions are made by the employees and are deducted automatically. Employees have the option to opt out of the auto-IRA plan anytime they want.
• In an automatic IRA, the employee can increase or reduce their contribution by 5% of the default contribution rate.
• The automatic contribution can be directly deposited into the retirement account via payroll.
• Employees can invest in target-date funds or some other investment as per their choice.
• Employers offering auto IRAs can avail of a temporary tax credit based on the number of employees who are participating in automatic IRAs in their firm.

What are the advantages of an automatic IRA?

Auto IRAs offer the following advantages to their holders:

• Similar to a 401(k) account: Automatic IRAs are similar to a 401(k) account and offer a reliable place where investors can save money for their future retirement.


• Can be set up by any employee: Any individual working either in the organized or unorganized sector can start an automatic IRA for themselves.


• Can opt at any time: If you are facing a financial emergency and need to take out money from your auto-IRA account, you can do so and opt out of the account at any time you prefer.


• Availability of auto-enrollment: Once the employer is up for an auto-IRA, the employee is automatically enrolled for an auto-IRA. Once this is done, a portion of the employee’s salary gets automatically deducted and deposited into the IRA.


• No hidden charges: There are no hidden or additional costs incurred by an employee once their automatic IRA account has been set up.

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What are the disadvantages of an automatic IRA?

Even though the primary purpose of offering employees an automatic IRA is to help them save for retirement easily, they do have certain demerits such as:

• Employers do not contribute to an auto-IRA: As stated above, only employees make contributions to auto IRAs. The employer is not bound by fiduciary duty to contribute to the said IRA.


• Saddled by high administrative fees: In an automatic IRA, high administration fees are levied on the investment returns that negatively affect the overall earnings. For example, OregonSaves charges 1 percent administrative fees on an asset for all kinds of investments which significantly lowers an investor’s returns.


• Opting out of an auto-IRA may result in inadequate retirement savings: Having the flexibility to opt-out of an auto-IRA can be beneficial for meeting short-term needs and expenses. However, this may affect your retirement savings negatively in the long run. There are no stringent withdrawal rules or penalties in an auto-IRA that may lead to withdrawal of funds before employees have reached their retirement years. This can lead to solely relying on Social Security benefits which as we explained earlier is not a wise strategy.


• Not everyone might end up with a similar corpus: Your earnings depend on several factors such as your age, income, and your discipline to save. If you open an automatic IRA at a young age and contribute on a regular basis, you can create a large retirement corpus for yourself. On the other hand, if you start saving at a later age or withdraw your funds prematurely, you may find yourself with insufficient savings to support you in your golden years.

What makes automatic IRAs essential?

Automatic IRAs are important because of a wide gap that exists between the number of people saving regularly for their retirement and the actual number of retirees in the US. Below are some numbers that highlight the existing problems in the system and how auto IRAs can help reduce this gap.

• Out of 80 percent of taxpayers who are eligible to make contributions to an IRA, only 11 percent make regular contributions to a retirement account.


• More than 50 percent of employees presently employed in the country work in firms having less than 500 employees in total. The smaller the company, the lower is the probability of the firm offering an employer-sponsored retirement plan to their employees.

An automatic IRA affords all employees an opportunity to save for their retirement in an orderly manner. According to the latest numbers, almost 400,000 people have invested in auto IRAs with combined assets over $330 million as of September 2021 with a 142 percent increase in the number of active Auto IRA savers compared to the last year, almost 3x increase in contributions as well as an increase of 50 percent in the number of participating employers.

To conclude

Automatic IRAs are a good alternative to those employees who do not have the option to contribute to an employer-sponsored plan. They offer a number of benefits to employees but are not without certain limitations as stated above. What works in your favor is the fact that you can opt out of an auto-IRA whenever you want. However, this may not be a wise decision if you do not have supplementary savings to rely on. Similar to the case of Social Security benefits, you need to combine your auto-IRA with other investments to secure your financial future. Reach out to a professional financial advisor who can help you understand and clear any doubts that you may have about auto-IRAs and how you can sign up for one in your state.

To get in touch with a qualified financial advisor, use the free advisor match tool and get connected with 1-3 background-verified financial fiduciaries. You may also set up a free initial consultation with them before deciding to hire one.