It’s been a couple weeks since the State of the Union address at which Mr. Obama, announced (among other things) a new retirement savings plan called the “myRA”. The myRA is a cutesy play on words referencing the traditional term for the commonly known retirement savings vehicle called the IRA (which FYI, actually stands for Individual Retirement “Arrangement” – not “Account”). In listening to the speech, the myRA was by far the most interesting thing Mr. Obama had to say – but that’s a topic best left for another forum.
So what is the myRA and should your family be interested or enthused about it? The short answer is: probably not. That being said, I believe investors / retirement savers should at least be aware of the basics around this new type of account and use it as forum for a refresher on the legacy IRA vehicles you usually can (and should) take advantage of as you plan for your retirement.
First, let’s dig into the details on the myRA. In short: this is a simplified Roth IRA with limited investment options and very low minimum requirements to open and fund the account. It has its advantages and disadvantages, which I detail below:
Roth-like IRA: This means savers contribute after-tax money and the contributions grow without tax implications on withdrawal. In addition, there are no penalties as investments are withdrawn. This type of structure makes sense from a tax standpoint given it appears the government is targeting people with low assets and low income who probably pay little to no income taxes. Thus, providing a tax deduction would probably not makes sense for folks who pay minimal income taxes anyway and would not benefit from the tax deduction.
Low investment minimums: This is the main advantage as it takes only $25 to open an account. In addition, savers can contribution as little as $5 at a time. This contrasts with traditional accounts which typically have minimums of $1,000 or even $3,000 to open an account.
No Fees: As a proponent of low-cost, passive investments I think this is a nice advantage. However, there’s a caveat. I usually recommend a portfolio of low cost investments, not no cost. To operate this program, there is, of course, costs involved as I firmly believe there’s “no free lunches” so somebody is paying the freight on this. When the government is involved, that “somebody” is almost always taxpayers (a.k.a. you and I).
Transferable: Once the account reaches a balance of $15,000, the owner can move to private sector Roth IRA managed by any private custodian (Schwab, Vanguard, Fidelity, etc.) where the saver would have more investment options. In addition, this account is not tied to any employer so the account owner does not have to worry about losing the accrued value when switching jobs.
No employer match: Unlike a 401(k), there no matching contribution from the employer which for the 401(k) is a tremendous advantage that I almost always advise all my client to leverage to the full extent.
Limited, Low-Growth Investment Option: People using these accounts can only use G Fund securities (Government Securities Investment fund) which are essentially government bonds. These are low-growth, low-interest, low-volatility securities (as most federal government bonds are) but returned only an average of 3.61% per year from 2002 – 2012 according to the Wall Street Journal (versus 7.53% per year the last 10 years for Vanguard’s Stock Market ETF (Ticker: VTI)). While the principle of the account is “safe” (to the extent the government doesn’t default) this investment does not provide the higher growth that most young savers need to take advantage of when their investment horizon is still relatively long (20+ years).
People with a 401(k) Cannot Participate: Access to this program is only for those who do not have access to 401(k) plans with their employer. I get the sense that the reason is, this program was developed is based on the Administration’s assumption that only “the rich” have access to 401(k)’s and that high-income earners get most of the tax breaks. But, according to the Bureau of Labor Statistics, 68% of people have access to retirement plans through their employer. In addition, according to a study by ASPPA (American Society of Pension Professionals and Actuaries) 80% of 401(k) participants make less than $100,000 per year and households making more than $200,000 accrue only about 17% of the tax benefits. So as a natural cynic when it comes to government programs, I get the impression this initiative is more about political theatre than practical, common-sense problem solving.
So how is this different from the legacy IRAs (rollover, traditional, Roth)? A detailed explanation of existing IRAs warrants its own dedicated article due to the complexities. This is by no means a comprehensive explanation but the basics are as follow:
Traditional IRA Deductibility Rules (for 2014): The degree of deductibility depends on whether the tax payer or the married couple is already covered by a qualified retirement plan. If they are not, then they can take the full deduction regardless of income. If they are covered, then the deductibility of the contribution declines as income increases. For a single person, they lose full deductibility if their Modified AGI (adjusted gross income) is $70,000+. For Married Filing Jointly with both spouses covered by a plan, they lose all their deductibility if Modified AGI is $116,000+. Of course, these funds are taxable at withdrawal and could be subject to penalties if taken before you are 59 1/2.
Traditional IRA Contribution Limits (for 2014): Individuals under the age of 50 can contribute up to $5,500 per year in these accounts and can deduct these contributions subject to the aforementioned deductibility rules. At age 50 and over, individuals can add an additional $1,000 “catch up” contribution.
Income Phase Out for Roth IRA (2014): If taxpayers make too much money, you can’t contribute to a Roth IRA. For married filing jointly, this range starts at $181,000 (MAGI) and completely phases out at $191,000. For single taxpayers, this range is $114,000 – $129,000. These are “after-tax” contributions (i.e. no tax deduction) but the withdrawals are not taxed. As far as contribution limits, the Roth has the same constraints ($5,500 plus $1,000 “catch up” if 50 or older) as the traditional IRA.
Investment Options: This is where IRAs shine. Single or married couples can open an account with any custodian and choose from a variety of investment options including my favorites: low-cost index funds.
To wrap up: Overall, the myRA is a decent, albeit underwhelming idea to the extent it gets people started saving for their future, which is always a good thing. But do we need a new government program for that? Probably not, but when has that ever stopped a politician?