Is California about to set the country's retirement saving system on its ear?
The state has often set trends for the country in areas ranging from the environment to food and popular culture. Now, California is moving toward launching an innovative new approach to retirement saving that addresses two key problems facing Americans: the lack of workplace pension programs among small businesses and the structural shortcomings of 401(k) plans.
The state's legislature recently passed a bill laying the groundwork for the California Secure Choice Retirement Savings Program (SCP) - a government-sponsored retirement-savings vehicle that would be offered to employees of every California company that doesn't have a workplace retirement plan.
Employees would contribute through payroll deductions to SCP accounts; the plan's investments would be professionally managed, and would be geared to produce conservative returns tied to Treasury bond rates. At retirement, the individual account would be converted to a pension-style annuity.
The plan is still a long way from implementation. It faces opposition from the California business community on concerns about the cost of implementing payroll deduction systems and potential legal liability issues for employers. The mere fact that California lawmakers decided to push forward with the plan at all underscores growing worry in policy circles about the nation's looming retirement savings gap and the need to do something about it.
Just 42 percent of private sector workers age 25-64 have any pension coverage in their current job, according to a new report by the Center for Retirement Research at Boston College. And for many workers who do have 401(k) accounts, performance is hampered by high fees and bad asset allocation decisions.
The problem is most acute among low- and middle-income workers, and those who work for small companies. In California, for example, 55 percent of companies with 50 to 99 employees have no retirement plan, and 67 percent of companies with 10 to 49 workers don't have a plan. In Washington, the Obama Administration has been pushing the Auto-IRA as a national solution, a plan that would require employers with more than 10 employees and no pension coverage to contribute three percent of the worker's salary into an IRA that benefits from various tax credits. The Administration also has proposed a set of policy changes aimed at encouraging use of commercial annuities alongside workplace accounts as a way of improving guaranteed income in retirement.
And last month, Senator Tom Harkin (D-Iowa) proposed a mandatory cash-balance defined-benefit program for employers who do not offer a minimum level of retirement benefit via automatic payroll deduction.
None of these ideas are going anywhere in the current Washington climate. So some retirement policy advocates have been working to convince states to sign onto ideas resembling the Harkin plan. So far, plans similar to California's have been proposed or discussed in 11 states, in addition to California. Some states have passed small scale plans but California is the only one to approve a broad pension scheme that could grow to cover millions of workers.
In California, the SCP legislation, called Senate Bill 1234, is set to be signed by Gov. Jerry Brown. The bill authorizes study of regulatory and legal questions that need to be resolved before the plan can go forward via additional legislation. Following that legislation, a state-run board would be created to oversee the SCP, with a third party handling administration and assuming fiduciary duty. That could be a financial services company, or the California Public Employees' Retirement System (CalPERS).
Employers who don't have their own retirement plans would be required to enroll workers in an IRA account via payroll deductions, although workers could opt out if they choose. Employers wouldn't be providing matching contributions, and the accounts would have a guaranteed minimum 3 percent annual return.
The accounts would be portable, following workers from job to job. And at retirement, the cash balances would be converted to lifetime annuities.
The SCP has the potential to grow into a very large plan. Six million Californians work for companies without workplace plans, according to Dan Reeves, chief of staff for California state senator Kevin de León, the bill's sponsor. Reeves thinks the SCP's opt-out feature would enroll around 5 million in the first year.
"We know payroll deductions are vital to saving for retirement, and we think the opt-out feature would scale this up very quickly," he says.A key question is how the SCP would be treated under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Service code. Before the SCP could go forward, the state will need affirmation from the Department of Labor that the plan is exempt from ERISA, since it utilizes IRA accounts and is not an employer plan. And the IRS would have to sign off on the use of pre-tax payroll contributions.
"The business community doesn't believe you can devise a mandatory employer-implemented plan that is both exempt from ERISA and accepts pre-tax contributions," says Marc Burgat, vice president of government relations at the California Chamber of Commerce. Reeves say implementation is at least three years away. But if the SCP does get off the ground and proves successful, it could set off a wave of innovative pension programs in other states.
Here's hoping that's not just "California Dreamin'".