With retirement savings dwindling President Obama has proposed as part of the 2011 budget proposal for workers to be automatically enrolled in individual retirement accounts.

The proposal would automatically deduct up to 3% of an employee’s salary straight from their paycheck and invest it in Roth IRAs, unless the employee chose to opt out, or chose to invest in a traditional IRA. This plan would be for employees who don’t have other types of pensions or retirement savings plans, about 80 million workers in all.

With the Auto IRA, employees would still have the opportunity to opt out of the program, but most don’t. The National Council of La Raza, the largest national Hispanic civil rights and advocacy organization in the United States, published a report in December revealing that when employees are automatically enrolled in retirement accounts, their savings rates jump to 80% from 20%.

This is especially important at a time when savings rates have tumbled. Last month Cogent Research released its 2010 Investor Brandscape report, which showed that the proportion of investors that hold a 401(k) plan has gone down significantly.

As of October, she said, only 59% of investors’ surveyed hold an employee-sponsored retirement account, down from 70% in October 2008. At the same time, younger investors are more likely to start their own businesses or freelance and aren’t necessarily working in traditional full-time jobs that offer employee-sponsored retirement plans. In addition, high unemployment is also cutting into contributions.

Employers with more than 10 employees, who have been in business for at least two years, would be required to participate in the automatic-IRA program.

David John, a senior fellow at the Heritage Foundation and managing director at the Retirement Security Project, said when he helped to write the proposal for the auto-IRA four years ago, he was open to auto-enrolling employees in either a traditional or Roth IRA. But “it turns out that the Roth is actually better for moderate and lower income workers because they may or may not have the sufficient tax liability to take full advantage of the deductibility of the traditional IRA,” John said in a phone interview on Tuesday.

The reality, he said, is for most families who earn around $35,000, they don’t owe much tax anyway so they don’t get much benefit from the traditional IRA given the fact that when they withdraw they would have to pay income tax on that money. On the other hand, he said, if they take a Roth when they retire they end up with tax-free income.

John said the auto-IRA isn’t only for new savers, but also for rollover savers who have lost their jobs and taken new jobs at smaller companies. The proposal would allow them to rollover their 401(k) into an auto-IRA and continue to save. Freelancers would also have the opportunity to enroll if they were part of an independent group which sponsored an auto-IRA program.  

“For better or worse the traditional pension system is disappearing,” he said. “Unless you’re a career minimum wage worker social security doesn’t provide a level of income that’s sufficient. So either we can make it easier for people to save for retirement from the day they start to work until the day they retire or we’ll have millions of Americans who are poverty stricken in retirement.”

David Wray, president of the Profit Sharing/401k Council of America, a Chicago-based association of providers of 401(k)s and other profit-sharing plans, ssaid in an interview in December that auto-enrollment only works when the participant views the plan as aligned with their own goals. Just having a default, auto-enrollment retirement savings plan is not sufficient. If it’s not coupled with “an aggressive education effort where the company goes and explains to participants in advance how important it is to save and why it is in their best interest,” Wray said.
When participants don’t understand why they should enroll, or in some cases, don’t even know they are enrolled in retirement savings plans, the result can be ineffective and costly.

Nonetheless, Obama has made auto-IRA and retirement savings an important focus of his administration and even mentioned it in his State of the Union address.