Automatic for the people
US money managers could receive an estimated $100bn (€73bn) over five years to invest on behalf of the 78m workers who do not have a pension - 50% of US employees - if a proposal by the White House is approved by the Congress.
The boost to assets under management would come from the Obama-Biden Middle Class Agenda, announced in January. Its retirement security section wants to establish automatic individual retirement accounts (IRAs) requiring employers who do not offer a retirement plan to enrol their employees in a direct-deposit IRA, unless the employee opts out. The plan aims to boost retirement saving through such measures as greater tax credits, more transparency of 401(k) fees, unbiased financial advice to workers, the promotion of annuities and better designed target-date funds.
It is, however, the automatic IRA that has attracted most attention due to the impact it may have on the US pension industry, and because it may become law sooner than the proposed health reform. The plan also has bipartisan support - something similar was in the 2008 Republican presidential candidate John McCain’s manifesto, and the liberal critics of Obama claim that the automatic IRA has the same roots as former president George Bush’s idea of a partial privatisation of social security.
Actually, both initiatives have in common the brains of pensions expert David John, senior research fellow of the Heritage Foundation, a conservative think-tank based in Washington, DC. John had the idea of diverting a small proportion of social security into private individual accounts, which Bush was not able to push ahead. In 2006 John joined forces with J Mark Iwry, a pension expert with the Brookings Institution - a more progressive think-tank. Together they came up with the automatic IRA, in John’s words “a ‘third way’ to promote retirement self-reliance”.
Obama has also proposed establishing a deficit reduction commission that could look into entitlement problems, including social security’s risk of bankruptcy. This has attracted liberal criticism: “We could see social security cut by a small percentage, while simultaneously a small percentage of pay is deducted and invested in the private sector. And suddenly Bush’s wildest dreams have come true,” wrote James Ridgeway, one of Obama’s liberal critics.
Few details of the automatic IRA have been revealed. John and Iwry’s original ‘retirement security project’ calls for the creation of a special type of ‘safe’ bond - called an R-bond - which would collect the new savings until they reach a $5,000 threshold. When the threshold is reached the money would roll over into one of a small number of target-date investment options which are based on index funds to keep risk and cost low. Employees can decide for themselves how their savings should be invested.
The automatic default option could solve the problem of poor individual investment decisions, but the public is concerned about ‘nudging’ people into the stock market after Wall Street proved so volatile recently.
One obstacle to the implementation of the automatic IRAs may come from the economy. Even though Obama’s plan would expand savers’ credit, which would match 50% of the first $1,000 of contributions by families earning up to $65,000, there might be few workers with a spare $1,000 to invest.
On the other hand, small businesses may have problems paying the administrative cost of signing employees up for automatic IRAs.
A provision in Obama’s retirement security plans to promote annuities could also have a significant impact on the US pension industry. The plan says: “Promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income, reducing the risks that retirees will outlive their savings or that their retirees’ living standards will be eroded by investment losses or inflation.”
Annuities are not popular in the US because they are difficult to understand, although the proportion of annuities being sold is increasing. According to a Beacon Research Fixed Annuity Premium study, in the first three quarters of last year US sales of fixed annuities were estimated to be $84.5bn, 16% up on the same period in 2008. That meant $2bn just for bank holding companies that sold annuities, according to the Michael White-ABIA Bank Annuity Fee Income Report.