In his State of the Union speech, President Obama proposed a new program he calls myRA. It’s designed to help millions of Americans start building a nest egg towards retirement if they do not have a retirement account where they work. To help expedite this, President Obama has signed a memo that directs the Department of Treasury to create government-backed retirement accounts.
1. How this will work
MyRA’s are designed for low- and middle-income Americans who don’t have access to retirement plans sponsored by their employers. This means about half of all American workers and part-time workers. President Obama has said that the White House will “aggressively” encourage employers to offer the program to their employees. The good news for these employers is that they won’t have to either administer the program or contribute to their workers’ accounts. myRAs will initially be offered through a pilot program to workers whose employers sign up by the end of this year. All workers will be eligible to invest in one of these accounts, even those who want to supplement an existing 401(k) plan – assuming these people have a household income below $191,000 a year.
Here’s a brief video of President Obama explaining his new program.
Like a Roth IRA
myRAs will work much like a traditional Roth IRA. In other words, savers will be investing after-tax money and will then withdraw it tax-free when they retire. However, unlike traditional Roth IRAs, the money invested in these accounts will be only in government savings bonds. In addition, the US Government will back them so that savers can never lose their principal investment.
2. What happens if you switch jobs
If you invest in a myRA and switch jobs, you will be able to take the account with you and contribute to it from a new job or even multiple part-time jobs. You will be allowed to withdraw money from your account at any time and without a penalty. However, if you were to withdraw the interest you earned in your account before you reached age 59 1/2, you would get hit with a tax and possibly a penalty – just as you would with a Roth IRA.
Small saver problems
The problem with small saver programs is that the cost of administering them often actually eats up the savers’ principle. Experts in this area have said that a myRA should help with small saver plans because employers won’t be administering them and employees won’t see their savings eaten up by administrative costs.
3. How much you can invest
Your initial investment in a myRA can be as little as $25 and you can then contribute as little five dollars per paycheck through an automatic payroll deduction. You can also contribute as much as $5500 a year just as you would with a traditional Roth IRA account.
4. The $15,000 max
One restriction to a myIRA is that once your account reaches $15,000 or has been open for 30 years, you will be required to roll it over into a private sector IRA. But you will still be able to continue contributing.
5. What returns to expect
You can expect your myRA to return something on your investment but it won’t be much. The White House has said that these accounts will earn the same rate as the Thrift Saving Plan’s Investment Fund that is offered to government workers. This fund earned about 1.5% last year and had an average return of 3.6% between the years 2003 and 2012.
6. You may not have enough to retire
For the sake of an example let’s say that you contribute $100 a month to your myRA with a 2% return on your investment. This means you would have about $6,300 after five years, including the interest you would earn of $300. Project this over the course of 20 or 30 years and you can see it’s not likely that you’d have enough for a comfortable retirement. The good news is that there’s no risk as the federal government would back your account. The bad news is that, as you can see from the example given above, you would never have a huge amount of savings in your account. Will this help the savings crisis? Advocates of this plan cheer it as an important step forward. However, no one seems to think that this program alone will fix the fact that millions of Americans have very little in the way of retirement savings. Obama’s budget includes a different proposal that would automatically enroll workers in IRA accounts. Advocates have said this is a necessary step but Congress would have to approve it.
7. A better answer to retirement savings
A 401(k) plan is clearly a better way to save for retirement – if your employer offers it – especially if it will match some percentage of your contribution. Most experts say that if your employer does have a 401(k) and will match your contribution, the best thing you could do is contribute the very maximum amount each payday. The matching money your employer contributes is basically free money and what’s better than free money?
Borrow from yourself
Once you build up a balance in a 401(k) account you can borrow from it. And when you pay back the money yo’re paying it back to yourself, which certainly beats paying it back to a bank or credit union. While you will be required to pay interest on that money, you will be paying interest to yourself, which is even a better deal.
Paying back the loan
If you borrow money from your 401(k) you need to pay it back within five years unless you used the money to buy a residence. In this case, you may have a significantly longer period of time to pay back the loan. If you didn’t use the money to buy a house and don’t pay back the loan within five years, the money will be treated as ordinary income and you will be taxed on it and may have to pay a penalty. If you leave your employer before you pay back the money, you will be required to pay it back within 60 days or again, it will be treated as ordinary income.. There are two other important benefits to borrowing money from a 401(k). The first is that it doesn’t require a credit check. After all, you’re really not borrowing money. You are tapping your retirement account, which is your own money. And second, the application fees should be very minimal – if there are actually any.
Unfortunately, there are some serious drawbacks to borrowing money from a 401(k) account. The first is that during the timeframe of the loan – whether it’s two or five years – the money you’ve taken out isn’t earning a return. This means you’ve lost all investment growth on the money. When you do pay it back, it comes out of your paycheck so that a $100 payment would reduce your take-home pay by $100. To make matters worse, you pay back the money with after-tax dollars. Finally, when you do reach retirement and begin withdrawing from your 401(k), you will be required to pay taxes on the money. And after you reach 70 1/2, there is a required minimum distribution (RMD), meaning you will be required to withdraw a certain amount of money every year and pay taxes on it accordingly – whether you want to or not.
In summary, a myRA could help you save for retirement. However it alone won’t be enough to assure you of a decent life. If your employer doesn’t offer a 401(k) and if you don’t have a standard IRA, should sign up for a myRA but then augment it with either a standard IRA or Roth IRA. Otherwise, you may find that like many Americans, you will never be able to really retire but will have to keep working – maybe at least part time – until you die.