We’ve said it before and we’ll say it again-- retirement is largely going to be funded by the individual rather than an employer. What does this mean for the 27% of workers 1 who don’t have access to an employer-sponsored defined contribution plan?
In 2016, the Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) released a final rule that provided a safe harbor for state payroll deduction individual retirement accounts (IRAs) from the Employee Retirement Income Security Act of 1974 (ERISA) coverage. This change offered protection for workers’ rights by ensuring employees are notified and given sufficient time to opt out of participation.2 Congress overrode the DOL’s action in 2017, repealed the rule, and made it easier for state-run plans to exist.
ERISA contains three titles:
- Title I: Minimum standards for eligibility, vesting, funding, reporting, disclosure, and fiduciary standards
- Title II: Coverage under IRC § 410(b), limitations under IRC § 415, top-heavy rules under IRC § 416
- Title III: Division of responsibilities between the DOL and Internal Revenue Service (IRS)
Why might the ERISA exemption affect a state-run individual retirement account (IRA) plan?
The ERISA exemption would have permitted employers to avoid state mandates in benefit plans because they offer the savings plan under federal pension law.
Despite Congress repealing the action, California, Illinois, Maryland, Connecticut, Massachusetts, Oregon, New Jersey, and Washington State have already enacted legislation to establish a state-run defined contribution plan. All but Washington State require automatic enrollment; Washington State has voluntary participation that is limited to employers with less than 100 employees. Over 30 states have considered legislation, so it’s clear the thought is out there and gaining traction.
Why might a state plan be a good solution?
Twenty-one percent of American adults have saved $0.00 toward retirement3 and possibly face bankruptcy or poverty in retirement. A state-run IRA plan provides a retirement savings vehicle for those who do not have access to one through their employer. Now this may beg the question “Doesn’t every person in the United States have access to open their own IRA?” Yes, they do. “But if they aren’t already investing in an IRA, why would we expect to see any interest in investing in a state-run IRA plan?” Procrastination, inertia, loss aversion, and myopia are characteristics of human nature that prevent the average worker from actively researching and opening retirement accounts on their own. Rather than let those aspects of human nature prevent people from saving for retirement, most state- run plans have proposed automatically enrolling employees into a state-run IRA program. This creates a seamless and automated savings stream for participants; in essence, this starts their retirement savings plan for them.
A state plan that offers contributions via payroll deductions removes inertia and procrastination from the equation. Contributions withheld as a payroll deduction remove the temptation for an individual to spend rather than save.
Today, more and more Americans expect employers to provide retirement benefits as part of their employment package. A state-run retirement plan could close a benefits gap with minimum added cost or effort to the employer. Small business owners, who may offer limited benefits, are a prime example of where a state-run plan could be advantageous, resulting in a competitive position for employee engagement and retention.
As many of us know, retirement benefits come with their share of rules, administrative tasks, and expenses. What may interest employers to join a state-run program is that the investment and vendor selection are done for them. These programs are a “ready to go” product with minimal employer responsibility and virtually no liability. Employers simply provide information to the employees and set up payroll deductions. This, partnered with no requirement for employer matching contributions, looks like a very inviting program.
The employer is also exempt from taking on the plan sponsor role and fiduciary responsibilities that normally align with a private sector retirement plan. One aspect of using a state-run retirement program is still unknown at this time-- to what extent will these plans be relieved of the administrative ERISA requirements that employers in the private sector retirement market are required to follow? Even with unknown ERISA requirements, these plans are simple for the employer to administer. For some employers, this state-run program may be a temporary retirement plan solution until the employer can establish a stronger, more vibrant private sector retirement plan.
What issues could there be with a state retirement plan?
State-run retirement plans are in a “sprouting” stage of implementation and activity, which leads to several key questions to consider:
- Will each state have a designated board or committee which oversees the program? If so, how will they be held accountable to keep the program in the best interest of the employees and beneficiaries?
- For private sector retirement plans, the employer has a fiduciary responsibility to oversee the expenses associated with investments and any fees charged to the plan or participants. Who bears the responsibility in a state-run retirement program to select, monitor, and understand the fees? Will the plan provide employees with low cost institutional investments? Or will their investment options be high-cost retail funds?
- Employers joining these state-run plans will not incur any cost to maintain the accounts for the employees. If the employer does not pick up the tab, then is the employee paying for their state retirement account or will the state pick up some of the cost? One of the six state-run programs has determined that it will charge each IRA an annual fee of no more than 1.05%4 for investments and administration. If the participant pays for their own account, will there be a state board or committee that determines an appropriate fee for service?
- Are these state-run plans designed to provide retirement readiness? For private sector plans, participation and savings rate are two of the main factors towards retirement readiness. State- run plans have addressed participation via auto enrollment into the program and an IRA established in the employees’ name. For savings rate, the state program carries restrictions to contributions as the limits are aligned with the IRA limits of $5,5005 for 2018. If contribution limits in these state programs are 70% less than the 2018 401(k) plan limits of $18,500 and 77.4% less than the limit of $24,500 for those age 50 and above, this begs the question of how can employees save enough to retire in a state-run program? The outcome of low savings may lead to an employee being unable to retire financially and being forced to continue working. Delays of this nature may create an adverse effect to the employer, such as a larger aging employee workforce and increased healthcare costs.
What conversations should we be having with plan sponsors?
Looking through a single lens at each state’s program may not seem too concerning. Now, consider looking through multiple lenses for the employer that is a multi-state employer. Because each state designs its program, a multi-state employer may not meet the minimum requirements to be excluded from individual states’ required participation. Navigating the rules for multiple states could also add enormous complexity to benefits administration, potentially requiring separate payroll and reporting to each of the states in which employees reside.
Could there be a new focus for private sector employers of ERISA-qualified retirement plans? In a private sector retirement plan, employers may look to focus on the corporate tax deduction for employee and employer contributions. With these state-run plans in their infancy, there are no employer matching or employer contributions allowed and no corporate tax deductions. This may lessen the appeal to join the state-run plans.
As a fiduciary for the ERISA plan, should a due diligence assessment of the state plan(s) versus your current plan be performed to determine what is best for your plan participants? Employers that provide an ERISA-qualified retirement plan may be focused on new questions about cost and impact to their business. If an employer is looking at cost alone and a state-run plan is cheaper than a private sector plan, but the employees cannot save enough for retirement through the state program, are we looking through the correct lens for retirement benefits? If cost is the sole focus of the lens, then will we see a drop in private sector ERISA-qualified plans in lieu of the state-run retirement plan?
What would our ideal state plan design include?
The ideal plan design would mean umbrella plan coverage. This means that the set-up would be similar to an association type plan but without the requirement of a related association. This way, employers from all industries could choose to participate.
Ideally, the state would select one vendor to record-keep the plan. This way, participants would be free to move between employers without the added hassle of needing to meet new eligibility requirements or roll previous accounts together. Combined tracking would allow the plan to save money and avoid having to send new enrollment materials.
Contributions would be allowed on both a tax-deferred basis and/or a Roth type after-tax basis. By allowing both money types, participants would be allowed to choose which type of contribution or combination of the two is more appropriate for their specific financial situation.
From the investment front, keep it simple. Often times, people who aren’t already actively managing a retirement account of their own tend to suffer from loss aversion or even myopia. By limiting the number of investment options offered within the plan, we would reduce the fear of investing. Using an institutional share class target date fund series as the plan’s default investment keeps the participant cost down while offering an age appropriate investment strategy. By aggregating contributions across the entire state and trading on a plan level with institutional class funds, we could anticipate that the individual participant may benefit from larger buying power with cheaper share classes and lower trading costs.
“By failing to prepare, you are preparing to fail.” This famous quote by Benjamin Franklin really speaks volumes in retirement savings today. AARP research shows “workers are 15 times more likely to save for retirement if they have access to a payroll deduction savings plan at work.”6 Leaving Americans to their own devices and signing up for an IRA has put eight states in the position to implement a state-run savings program. Employers in these eight states may end up split on two sides of the coin-- those who find that a state-run plan is a great addition to the benefits package for their company versus those facing payroll challenges. Eight states are taking on the challenge and piloting state-run programs, and we will be eagerly awaiting the results of these endeavors.
1Greenwald, Lisa, et al. “The 2017 Retirement Confidence Survey: Many Workers Lack Retirement Confidence and Feel Stressed About Retirement Preparations.” Employee Benefit Research Institute.
2“US Department of Labor Announces Final Rule on State Payroll Deduction IRA Accounts.” United States Department of Labor. Retrieved on September 5, 2018, from www.dol.gov/newsroom/releases/ebsa/ebsa20160825.
3Brenoff, Ann. “11 Numbers That Will Terrify You Into Saving For Retirement Right This Minute.” The Huffington Post, TheHuffingtonPost.com, 14 May 2018. Retrieved on September 5, 2018, from www.huffingtonpost.com/entry/saving-for-retirement_us_5af1d130e4b0ab5c3d6a8a76.
4“Program Cost.” Oregonsaves. Retrieved on September 5, 2018, from saver.oregonsaves.com/home/program-details/program-cost.html.
5“Retirement Topics IRA Contribution Limits.” Internal Revenue Service. Retrieved on September 5, 2018, from www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits.
6Harvey, Catherine. “Access to Workplace Retirement Plans by Race and Ethnicity.” AARP, AARP, 27 April 2016. Retrieved on September 5, 2018, from www.aarp.org/ppi/info-2017/Access-to-Workplace-Retirement-Plans-by-Race-and-Ethnicity.html.