On Wall Street

[Community Manager]

Do you think individuals should be automatically enrolled in a Roth IRA or a traditionally IRA? Why?

[debaser]

Absolutely not. Most people don't need money sitting in Roth IRAs, they need liquid, safe savings. Once a family has a good emergency account (I recommend 6 months of gross income), then they have permission to lock their money up in a retirement account.


And for the record, I know there is more flexibility with a Roth than a Traditional IRA, but the power of tax deferral comes with time. If someone taps into their retirement account early, it defeats the purpose.

[Lucullus]

Debaser,

You write "Absolutely not. Most people don't need money sitting in Roth IRAs, they need liquid, safe savings. Once a family has a good emergency account (I recommend 6 months of gross income), then they have permission to lock their money up in a retirement account."

I don't dispute your argument that an Emergency Fund needs to be funded before a retirement fund. That said, I don't believe that this fact should necessarily suggest that "most people" should "absolutely not" be enrolled automatically in an IRA (or Roth IRA) because -

1. Some folks already have Emergency Funds.
2. A Roth IRA can serve as an Emergency Fund. This is, I know, a view many advisors will not share. But consider that -
a. if the Roth IRA is funded initially with a fixed dollar (or even fixed rate) allocation and if the fund expenses are not overly burdensome, it enjoys the benefit of tax deferral of gain, while retaining the tax-free nature of distributions of amounts not in excess of original contributions.
3. The "automatic" enrollment, combined with salary deduction funding, means that such an account is more likely to be continually funded than a "we'll fund when we feel like it" Emergency Fund. Many people don't get around to "feeling like" funding such accounts. Those folks need to have a bit of enforced discipline, and payroll deduction funding can supply that.

Of course, OUR clients are different (and I say that with tongue thrust firmly in cheek). Consumers who have the services of a professional financial advisor are getting, not only advice, but nagging, from their advisors. (At least I HOPE that most of us "nag" our clients when they don't do what they need to do). But most folks don't have professional advisors/naggers. For those people, automatic enrollment in a Roth IRA may be very valuable.

Just my two centimes' worth...

John Olsen

[debaser]

I don't disagree that a lot of people would benefit from forced savings, but putting money into a Roth IRA is the best of a crappy list of options. If the investment option is a fixed account, I have less of a problem with it. However, what about putting salary-deducted money into, say, a money market account with no IRA ties? The opt-out could be to have the Roth IRA, Traditional IRA, or no option.

[Bradly T.]

In agreement with all.....forced (or at least facilitated) savings is a good idea for most Americans. Would like to see Roth expanded (separate from DC & DB) to include most of what all families need to save for, much of which is already allowed for Roth. But why not combine with HSA and 529 and home down payment savings? A simple and consolidated savings plan. I'd like to see pre-tax contributions allowed for working class (some range of average income) to seriously promote household savings and tax free distributions for most everything savings are for!!! Like HSAs, no "investment" options are available until a certain balance is achieved and maintained - rather, low balances (and all balances if preferred) are in fixed interest deposit instruments. Accumulated balances become debt accelerators or additional retirement savings or unemployment/disability bridges. Lots of reasonable options. I believe Bush recommended something similar but got lost in "self directed" Social Security debate....while I agree ANY funded pension is superior to ANY unfunded pension (like SS), based on the 401k portfolios I've seen, very few Americans should be allowed to "self direct" a pension that would require taxpayers to bail out stupid fund selections by uneducated and inexperienced "investors".

[Tad Borek]

This auto-enrollment idea has a lot of validity based on behavioral-finance research I've read, about ways to bump up the savings rate. It's common sense stuff -- Out of sight, out of mind! And we're all much better at sticking with the status quo than taking the herculean effort of filling out a one-page form (so why not make that form the one to un-enroll from your retirement plan, instead of the one to enroll in it?). And...most spending is discretionary, so if you deprive someone of 3% of their income it's not going to have much effect on living standards.

And on the numbers, if you're picking an IRA by default it should be a Roth IRA. Most people pay so little income tax that a Trad IRA has little immediate tax benefit. Plus, hey - more tax revenue today if you default to Roths.

And while the red pen is out: raise the penalty for early IRA distributions to something so punitive it makes early distributions rare (50% tax?). It would both discourage saving "too much", and discourage tapping limited assets to cover current spending. Leave in exceptions to cover unexpecteds, maybe even expand them a bit. DC plans and IRAs aren't really optional for anyone who wants an enjoyable retirement, with the decline of the DB plan. But most people aren't saving. Stuff like this could only help.

-Tad

[investmentor]

Automatic deduction: Good idea, given the studies on the general public's action and inaction on savings decisions. Auto savings feature tends to boost savings rate and capital formation.

Advantages of a Roth account:
1) Leaves principal (original contributions) available without tax consequences (including no 10% penalty) -- removes the hesitancy that some savers have to commit their funds due to the potential penalties and fear of "tying up their funds".

2) Accumulation of tax-free versus tax-deferred earnings -- If $100,000 in IRA savings results in a $400,000 balance at retirement due to compound earnings, $300,000 in earnings would be taxable with a traditional account (not to mention the initial principal deposits) versus no taxes with a Roth.

Note: Others will whip out the present value charts and argue that if the immediate-year tax deferment of each traditional IRA deposit were also invested in an alternate taxable account, total accumulated capital would be somewhere near the same. I would argue that the tax-bleeding on the taxable account would prevent an adequate accumulation, as well as the failure of many savers to adhere to more complex savings plans. Also, a number of these arguments have failed to adequately address the impact of the totally tax-free earnings, and current historically low tax rates.

3) Asset protection: Balances in Roth IRA's are protected in bankruptcy in all states under the federal code, and against judgments in many states -- an important factor if the saver's financial condition has deteriorated to the point that s/he is relying on the Roth as a financial reserve -- or they are relying on it as a primary retirement source with no earned income capacity.

4) Probability of higher future tax rates: Bush tax cuts will sunset in 2011. 10% tax bracket and expansions of other deductions and exemptions will go away. Congress doesn't have to take any action to increase taxes -- just let the cuts expire. Massive increases in government spending in past two years, with various proposals for even more massive increases. Future pressures from entitlement programs (Social Security, Medicare, Medicaid, various welfare programs -- Earned Income Tax Credit, food stamps, SCHIP, ADC, etc.) almost guarantee major deficits unless taxes are raised. US has just about used up its credit lines with other countries -- which are starting to shift to gold and alternate currencies as reserves.

5) Future tax consequences of withdrawals: No RMD with Roth. Inheritance issues. No "spikes" in AGI if large withdrawals are made for medical expenses, car or home purchase or paydown, etc. Roth distributions not shown in AGI and do not impact total AGI used to determine if taxes must be paid on Social Security payments.

[Bob H]

Everything has good and bad. I like the auto-savings method.