As part of his pledge to help financially strapped American households, President Barack Obama will sign an executive order creating a new, simpler way to save for retirement. He dubbed it a "MyRA" account.
In his State of the Union speech on Tuesday, the president announced the plan "that encourages folks to build a nest egg" and "guarantees a decent return with no risk of losing what you put in."
The plans offer households with no retirement savings a place to start. But they come with some serious shortcomings compared to existing individual retirement accounts.
I haven't started saving. Will these plans help?
The MyRA accounts were created for you and the millions of others who don't have an individual retirement account or work for a company that does not offer a pension or 401(k) plan. You're in good company: About 39 million households don't have such accounts, according to the Investment Company Institute.
Much has been written about how woefully under-prepared these households are for retirement, and the White House is hoping these new accounts will help people like you start to set aside a nest egg.
Great: I'm ready to start. How will these new plans help?
The White House wants to make these plans easier to set up and simpler to take with you from one job to the next. Many investment companies require a minimum of as much as $1,000 to open an account. You can open a MyRA with as little as $25.
It will also be easier for your employer to offer these accounts because the government will manage the paperwork and invest the money, saving companies the cost of hiring a plan sponsor. But unlike pensions or 401(k)s, employers won't have to make contributions to your MyRA.
That also means if you change jobs, you won't have to roll over your MyRA to your new employer's plan or keep up with accounts managed by former employers. But once your MyRA balance reaches $15,000, you'll have to roll it over into a privately managed IRA.
Are these better than IRA and 401(k) accounts?
Not really. Technically, these plans are going to fall under the rules for a Roth IRA, which means you'll pay tax on your contributions before you deposit the money into your MyRA. That means you'll lose the tax advantage of a traditional IRA. The original idea behind those tax rules was to let you shield income from the IRS during your peak earning years and then pay tax when you withdraw the money in retirement, often at a lower rate because your income is lower. You won't get that tax break with a MyRA
How else would they differ from traditional IRA and 401(k) accounts?
One of the main selling points, according to the White House, is that your principal would be preserved: "The account balance would never go down." But that's true for any saver who invests retirement savings into U.S. Treasurys. Like all bonds, you get all your money back if you hold onto it until it matures.
The problem with that strategy is that you'll give up a substantial return. Since the Federal Reserve collapsed interest rates to save the financial system five years ago, the return on short-term Treasury bonds hasn't even kept up with inflation.
With a MyRa account, your money will be invested in the Government Securities Investment Fund available to federal workers. That fund has an average annual return for the past three years of 2.24 percent. As of December, the average annual inflation rate for consumer prices over the past three years was 2.07 percent.
But a MyRA will help me get started. I just don't have the discipline to keep my hands off the money without those IRA withdrawal penalties.
Then you're going to have a hard time building a MyRA balance.
If you take money out of an existing IRA or 401(k) before you turn 59-1/2, you'll usually have to pay taxes on the money—along with a 10 percent penalty.
There are some notable exceptions, including withdrawals for college expenses, a new house or certain medical expenses. It's not exactly a "lock box" but the penalties are there to help you stick with your savings plan.
That won't be the case for the MyRA accounts. According to preliminary details offered up by the White House, "contributions can be withdrawn tax-free at any time."
Well, we all need to save more for retirement. The president's proposals can't hurt, right?
The MyRA account offers a solid, entry-level plan to get people started. Unfortunately, the president has made a separate proposal that could crimp retirement savings for those further up the income ladder.
The White House has said the tax advantage that underpins all retirement savings has been too generous for those with lots of wealth to set aside during their working years. So he's calling on Congress to scale back tax breaks for wealthy households when they sock away money in a tax advantaged retirement account.
According to the White House, some two-thirds of tax benefits for retirement saving go to the top 20 percent of the income ladder, and one-third goes to the top 5 percent.
Obama wants to limit the tax benefits to those top earners to 28 percent of what they set aside. And he's proposing a cap on tax preferred savings accounts of $3.2 million, which the White House thinks is all anyone needs "to fund a reasonable pension in retirement."