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If your workplace doesn’t offer a retirement savings plan, such as a 401(k), you may be left wondering how you can adequately invest for the future. Thankfully, many states are now sponsoring auto-IRA plans in an effort to bridge the retirement plan coverage gap that exists for many employees. Let’s take a look at what an auto-IRA is, how it works and how you can enroll in one. Consider working with a financial advisor as you prepare financially for your retirement.

What Is an Auto-IRA?

An automatic individual retirement account, also known as an auto-IRA, is a state-sponsored retirement savings vehicle. It is designed for the millions of employees whose workplaces don’t offer retirement plans such as a 401(k) or pension.

According to a recent U.S. Bureau of Labor Statistics study, there are nearly 40 million Americans working in the private sector without these retirement plan options. In order to save adequately for their futures, these individuals will not only need to develop an individual investment strategy but also stick with that strategy for decades to come. Not to mention, this can be a confusing and difficult thing for an employee to navigate on their own.

Luckily, auto-IRAs aim to solve this problem. Auto-IRAs are payroll-based retirement accounts that are offered and managed by a handful of states. They combine payroll deduction with automated investing for the future, for employees who aren’t otherwise offered workplace-sponsored plans.

Auto-IRAs are fairly new, only being created in 2008 as a nonpartisan collaboration between The Brookings Institution and the Heritage Foundation. As of 2021, auto-IRAs are offered by eight states (California, Colorado, Connecticut, Illinois, Maryland, New Jersey, Oregon and Virginia) and two cities (Seattle and New York City).

How Auto-IRAs Work

Putting money in a piggybank

In states that have enacted auto-IRA programs, they are typically mandatory for certain employers. If a company has a specific number of employees (often five to 10 or more) and does not offer another qualifying retirement plan, the employer is required to automatically enroll eligible employees in the auto-IRA program for their area.

Once enrolled, the employee begins putting money away in a savings-based IRA through automatic payroll deductions, just as they would an employer-sponsored 401(k) plan. The biggest difference is that while an employer can contribute to or match an employee’s contributions into a workplace-sponsored retirement plan, the employer cannot contribute to an employee’s auto-IRA. Additionally, the employee is saving into an IRA (either Roth or traditional), which has its own contribution limits and tax rules.

Each state’s plan has its own default contribution rate, and some will automatically increase the employee’s contribution percentage each year until they’re saving a maximum amount. The employee can also choose to increase or decrease their contributions to the auto-IRA or opt out altogether.

Each state’s program is managed by an administrative committee, which determines the target-date funds, bonds and other investments chosen. Most states will also set a maximum fee threshold for the management of these funds.

Advantages of an Auto-IRA

Here are some of the benefits of state- or city-sponsored auto-IRA plans.

  • Auto-IRAs make retirement savings accessible for more employees. For employees of small businesses or companies that don’t offer retirement plans, the auto-IRA may be the best option for initiating and automating retirement savings. This allows the employee to invest in their future without researching funds or setting up their own automatic contributions.
  • Enrollment is automatic. For eligible employees of affected companies, enrollment into an auto-IRA is automatic. This eliminates much of the confusion or possible procrastination that could derail an employee’s savings efforts.
  • Payroll deduction contributions are automated and the investments are managed by an administrative team. An employee’s payroll deductions will be based off of the program’s default contribution rate, which can be changed later on. Rather than seeking out their own plan and adjusting the investment(s) regularly, employees can enjoy fully-managed funds.

Disadvantages of an Auto-IRA

Of course, there are a few disadvantages to keep in mind.

  • Not all states offer an auto-IRA. Currently, auto-IRAs are available in eight states and two major cities. Additional states have similar programs and many others are expected to develop their own programs in the future, but as of now they are limited.
  • Employers cannot contribute to the auto-IRA. An employer contribution match can be an excellent benefit and add free money to your retirement savings. With an auto-IRA, however, your employer cannot contribute or match your contributions in any way.
  • Employees may be able to find better investments and/or lower fees elsewhere. Each auto-IRA program involves its own investment options and strategy, as well as fees. While this may be the easier option for eligible employees, they may be able to find better returns and/or lower management fees on their own.
  • There may not be tax benefits. Some auto-IRAs invest into Roth IRAs while others use traditional IRAs. Depending on which applies to your program, contributions may or may not be tax-deductible.

The Bottom Line

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An auto-IRA is a sponsored program currently offered in eight states and two major cities. It aims to make retirement plans accessible to employees who are not otherwise offered retirement account options. Eligible employees are automatically enrolled in these programs at the default contribution rate. They can then utilize automatic payroll deductions to contribute to the account each month.

Tips for Retirement Planning

  • Saving for retirement often involves a multi-tiered approach, utilizing a variety of different retirement accounts and strategies. Without access to employer-sponsored plans — or the benefit of employer matched contributions — building adequate retirement savings can be difficult.
  • A qualified financial advisor can help create the retirement savings strategy that works best for you and your unique goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/Be-Art, ©iStock.com/andreswd

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