With private-sector pensions largely fading from memory and concerns about Social Security surfacing regularly in the news cycle, retirement is on many Americans’ minds.
It is also on the minds of state legislators, who are well aware that retirees without sufficient nest eggs may come to rely on the state itself for safety net services when their savings fall short. On the theory that prevention is often cheaper than a cure, several states have begun considering programs to make sure private sector workers are saving for retirement effectively – or at all.
Millions of Americans have scant or no retirement savings. About half of private-sector workers have no access to a 401(k) or pension plan through their job, and few have taken active steps to open an IRA or other savings vehicle on their own. Only about 5 percent of workers without a workplace plan opened a personal retirement account, Forbes recently reported. According to the U.S. Government Accountability Office, about half of households 55 and older have no personal retirement savings, instead relying entirely on Social Security. Among workers younger than 55, the proportion with no savings is around 31 percent.
The numbers also suggest that access through the workplace is a huge determining factor between workers with at least some retirement savings and none. Of the private-sector workers who did not participate in a workplace retirement savings program, 84 percent either were not eligible for the existing program or worked for an employer who did not offer one. In other words, most workers who could participate in workplace programs did. Participation rates were even higher for plans that were set up as payroll deductions with automatic enrollment, asking workers to opt out rather than opt in.
The federal government has recognized the problem of workers who are not saving due to lack of access and has attempted to address the issue through its “myRA” program. The program is designed to fill gaps for private sector workers by offering the program through employers, with a very low minimum investment thresholds and no maximum age for opening an account. While myRAs do not offer an employer match mechanism, they are fee-free until the account balance reaches $15,000, at which point the saver must roll it over into a regular private IRA. As with many federal initiatives, however, development was slow; myRAs were announced in early 2014, but only became broadly available this November.
In the meantime, some state legislatures decided to take a more proactive approach. President Obama officially praised such state action this summer during the White House Conference on Aging. But the roots of state-mandated employee retirement plans go all the way back to 2012, when Massachusetts passed the first, limited attempt to create a state-run solution to the private sector problem. That law created a state-run 401(k) program for employees of small nonprofits.
While each of the state plans is unique, the plans are generally designed somewhat similarly to state-run 529 college savings plans. Rather than increasing state obligations, especially when many states have already overcommitted to public sector workers, the idea is that the state will create and oversee a program to let nongovernment workers save for themselves. These programs generally do not guarantee an employer match, though some allow employers to voluntarily offer one. Employees may typically choose between only a few low-fee funds, if the worker gets any investment choice at all. Yet while the plans have major disadvantages compared to many existing employer 401(k)s, the theory goes that they are still much better than not saving at all.
The first state to pass wide-reaching legislation was California, whose “Secure Choice” plan has served as a model for several other states, including Illinois and Connecticut. The plan was established through legislation in 2012, but has not yet been implemented. First, the nine-member Secure Choice Retirement Savings Investment Board is conducting a legal and market analysis to determine whether the program can realistically be self-sustaining. The board also must attempt to determine whether the program will qualify for advantaged federal tax treatment and will comply with the Employee Retirement Income Security Act of 1974, better known as ERISA.
Assuming the California plan goes forward, any employer with five or more employees will be required to participate unless the employer offers an alternate retirement plan. Participating employers will automatically enroll workers in a 3 percent payroll deduction earmarked for the state-run program. Individuals will be able to change this percentage or opt out completely if they wish. Assets in the program will be pooled and professionally managed, with a privately underwritten guarantee, theoretically leaving neither the state nor the employer on the hook.
Illinois’ plan is very similar, and is similarly under review, though it has a set implementation date of June 2017. Employers must have 25 or more employees, rather than five, and the employer must have been in business for at least two years in order to be affected by the law. Employees in Illinois also have the option to choose among a small menu of investment options offered by the Illinois Secure Choice Savings Board, though contributions will still be pooled and professionally managed.
Connecticut’s plan, also based on California’s, adds another feature: a guaranteed rate of return, backed by insurance. The plan also includes survivor benefits, and allows retirees to draw their benefits as either an annuity or a lump sum.
Not every state’s plan is built on the California model, however. Washington’s plan, set to roll out in early 2017, applies to businesses with fewer than 100 employees. Instead of offering a state-run asset pool, it will give employers access to a privately run digital portal to connect workers with existing private-sector offerings that meet certain standards regarding asset types and administrative fees. Through the portal, employers will be able to match up to 3 percent of employee contributions. And, unlike California’s plan, participation is completely voluntary, though the state is considering offering financial incentives to small employers for participation.
At this writing, 24 states and New York City have passed or are discussing mandated retirement plans for the private sector. Besides the states mentioned above, Minnesota, Oregon, Vermont and Virginia have passed some version of their own. Utah passed legislation “strongly urging” the state’s small business community to work with the legislature to develop a plan for workplace retirement saving, but no such plan is yet in place. The New York City Council created a Retirement Security Study Group earlier this year, charged with developing affordable savings options for employees without access to retirement plans through their employers.
The major question for now is whether these plans will solve the problem of private workers with no retirement savings. According to an analysis by the Employee Benefit Research Institute, expanded auto-enrollment in workplace IRAs could help modestly. The group calculates the chance of a “successful” retirement, characterized as one in which an individual has enough income to cover routine expenses and health care needs, would increase by 8.4 percent for employees in their late thirties if workers maintained the widely suggested 3 percent contribution level. If employees increased their contributions to 6 percent, their chances of a successful retirement increase to 15 percent better than workers who do not participate. State plans, while unlikely to fix the entire retirement savings problem alone, are certainly better than having private sector workers save nothing at all from this perspective.
The AARP Public Policy Institute also did an analysis of state-mandated retirement plans. The organization generally supports these plans, but emphasizes the need for robust consumer protections, such as an independent board of trustees to oversee pooled assets and a formal dispute resolution process. For plans where private vendors compete with the state-administered plans or, as in Washington state, participate in a state-run marketplace, the institute also stressed the need for formal standards to make sure consumers are choosing among robust and trustworthy options.
Supporters of state-run plans emphasize that pooled assets can create economies of scale, including lower fees and costs than individuals can expect to pay as individual investors. Assuming the pooled assets are actively managed, such professional oversight will also prevent individual investors from falling into errors to which they might otherwise be prone. In theory, a pooled fund could also distribute risk and reward by age, allowing a plan to guarantee a minimum return, such as return of capital or some other minimum threshold.
Yet there are those who oppose such plans, for a variety of reasons. Considering that many states already face fiscal strains, often largely tied to pension promises to public sector workers, some observers are wary of the state taking on more retirement responsibilities. Even if the plans are designed to be ultimately self-sustaining, they will inevitably incur start-up and administration costs. And, since no one can know the future, it is possible that initially strong plans might eventually falter, leaving states on the hook to at least some degree. After all, if the state is overseeing the plan, the risk of administrative or fiduciary mistakes could come back to haunt state governments in some way – whether political, fiscal or both.
Some opponents have also been wary of potential conflicts between federal and state law. The Labor Department recently removed one major hurdle, however; the department recently proposed a rule that would exempt states from ERISA regulations to the extent necessary to create state-backed IRAs, as long as participation in such plans was voluntary and workers could opt out. This step is a major factor in the likelihood these plans will move forward, since in the past courts have generally struck down state laws that they found to intrude on ERISA’s domain.
Even though ERISA is no longer as great a concern, other federal laws may still come into play. Depending on how they are structured, state plans could come into conflict with other Labor Department regulations, such as the existing rules about payroll deduction IRAs, or Treasury Department rules. State lawmakers will need to tread carefully in creating their programs.
As these plans come closer to fruition, there are also some administrative questions that remain unanswered. For instance, if workers move between states, will they be forced to roll over their state IRA into a private account? If not, will savings be transferrable to the plan in the employee’s new state, presuming one exists? Some companies wary of an increased compliance burden and private providers of retirement plans have also criticized the state-run plans for obvious reasons.
Despite these concerns, it is still too early to say how these plans will work if and when they take effect. For now, employers and employees alike will simply need to keep an eye on their state’s legislation and see what develops.