With many employers, especially small businesses, failing to offer workplace retirement plans, state lawmakers are stepping up. Maine is the latest state to require most employers who don't offer workplace plans, such as 401(k)s, to enroll workers in an individual retirement account run by the state.
These "auto-IRA" programs are up and running in three states, and in the works in 14 others. Ultimately, these plans will cover around 20 million of the estimated 57 million workers who lack access.
Employees are usually enrolled with an automatic payroll deduction of typically 3% to 5% unless they opt out.
Legislators are hoping auto-IRAs will boost retirement savings rates. While workers can start their own IRA or brokerage account, they are 15 times more likely to save if they can do so through a workplace plan, according to AARP. Automating investment boosts rates even higher: Savers with auto-enrollment stash away 56% more in 401(k) plans than those without it, according to research from Vanguard. (That figure includes contributions from employers.)
"The more options there are available to workers, the better," Angela Antonelli, executive director of Georgetown University's Center for Retirement Initiatives, told CNBC. "There's a huge gap to fill."
Despite serving a similar function, the new auto-IRAs differ from 401(k)s in a few key ways. For one, employees enrolled in the IRA programs should not expect to receive a matching contribution from their company, a common perk at companies that offer 401(k)s.
What's more, they won't be eligible to contribute as much. As with any other IRA, auto-IRA contributions are capped at $6,000 per year, with an extra $1,000 "catch-up" contribution permitted for workers age 50 and older. For 401(k) plan participants, the maximum contribution for 2021 is $19,500, with an extra $6,500 "catch-up" contribution allowed for older workers.
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However, there's one advantage auto-IRA enrollees might enjoy over peers with workplace plans: Roth status. The vast majority of workplaces only offer "traditional" 401(k) plans, which are funded by pre-tax dollars. That means your contributions can be deducted from your taxable income, but you'll have to pay taxes on whatever you withdraw in retirement.
But participants in Maine's program will have their money diverted into a Roth IRA — an account funded with money on which they've already paid taxes. That means they'll get the benefit of having their investments grow tax-free. Funds you contribute to a Roth IRA can be withdrawn at any time without tax or penalty, and once you reach retirement age, you won't owe a penny to the IRS when you withdraw your money — not even on the gains on your investments.
Given the choice between a traditional or Roth IRA, "you should always invest through a Roth IRA," IRA expert Ed Slott, a certified public accountant and founder of Ed Slott & Company, told Grow. "To start building your retirement account from dollar one, tax-free, is the Holy Grail."
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