States aim to fill pension gaps with "auto IRAs"
With a push from AARP, a small but growing number of states are legislating "automatic IRAs" for the employees of their smaller businesses that don't offer a pension or 401(k).
Currently, an estimated 55 million Americans -- about half the workforce -- have no employer-sponsored retirement plan to supplement Social Security, said Sarah Myseiewicz Gill, AARP senior legislative representative. But if plans like Maryland's new auto-IRA, which mandates the automatic enrollment of any employee who works 30 hours or more for a company with at least 10 employees, were adopted nationwide, as many as 37.5 million Americans could be included, she said.
Many of those people could open IRAs on their own initiative, "but we know only 5 percent will do that, and those numbers haven't moved over the last three decades," she said.
Yet as these bills wind their way through statehouses, they're also getting major pushback from financial service firms because the auto-IRAs would typically be invested by state-administered agencies that might compete with private-sector retirement plan vendors and investment managers. Employers, which would be required to deduct the contributions from their employees' paychecks and forward them to the state, are also expressing concerns about that role.
The American Council of Life Insurers has been the biggest and most vocal opponent. But in California, the Securities Industry and Financial Markets Association is part of a group of 36 trade and business organizations led by the California Chamber of Commerce that's opposing a proposed auto-IRA. They want it amended to address a variety of concerns, including potential employer liability, said Marti Fisher, the Chamber's policy advocate.
California's proposed plan has been in the works since 2012 and may be finalized by August, when its legislative session ends.
In New York, an auto-IRA bill was working its way through the Assembly during the closing days of the current session. However, the Business Council of New York filed a comment in opposition, noting that none of its members had "asked for the creation of this type of program with another employer mandate." (The bill didn't pass.)
Connecticut and Maryland enacted auto-IRA laws in May. Illinois was the first in 2014, followed by Oregon in 2015, and both are scheduled to start enrollments in June 2017. This year, at least 14 other states have either commissioned studies or considered bills on what are also known as "work and save" or "secure choice" retirement plans, including Vermont, Iowa, Colorado, Georgia, Louisiana and Hawaii.
Even New York City is getting into the act. Mayor Bill de Blasio is calling for a local auto-IRA law for businesses with at least 10 employees and no retirement plan. (Under the New York State bill, the threshold would have been 25 employees.)
In January, Governor Chris Christie of New Jersey vetoed an auto-IRA with the suggestion that the legislature consider an alternative favored by the insurance industry and adopted by Washington in 2015. That would be a state-sponsored online "marketplace" where small employers can shop for plans, but enrollment will be voluntary and not mandatory. The investment offerings on the platform will come from existing vendors without the state getting involved in setting up or selecting investments. The legislature quickly passed that alternative.
Connecticut ended up with a hybrid. It includes an auto-IRA, but "the governor requested we do a marketplace also," said Joe Aresimowicz, the majority leader in the Connecticut House of Representatives and the plan's leading proponent. Under the plan, which will become operational on Jan. 1, 2018, employers with five or more employees will auto-enroll their workers, and the money will go into Roth IRAs.
A newly formed Connecticut Retirement Security Authority will select a group of vendors, but employers will also be able to go to a Website and shop for other investment options.
The key premise of an auto-IRA is that if employees have to opt out rather than opt in, they're more likely to save for retirement. In 2006, the federal Pension Protection Act green-lighted auto-enrollment in 401(k)s.
"The results have been stunningly good," according to congressional testimony in 2012 by David C. John, the senior strategy adviser at the AARP Public Policy Institute and the deputy director of the Retirement Security Project at the Brookings Institution. "With automatic features, enrollment in 401(k)-type accounts has grown to average over 80 percent of eligible employees."
But Congress didn't seem inclined to carry that concept a step further when John and a colleague proposed a national auto-IRA. So by 2008, they had started talking to the states, starting with California and Washington, John said.
Major differences distinguish these state-sponsored auto-IRAs and the national "myRA" retirement accounts that President Obama authorized in 2014. The first is that while employers can offer a myRA, it's not mandatory. And myRA has only one investment option -- a specific type of Treasury bond. Also, once the account's balance reaches $15,000, people are required to roll it over to a regular IRA at a financial firm.
MyRA is "certainly a tool in the toolbox, but it's not the be all and end all," said AARP's Gill.
"The state plans are pretty modest, but they're a recognition that we're facing a huge retirement income crisis in this country" said Karen Friedman, the executive vice president and policy director at the Pension Rights Center. "Since Congress is paralyzed and not likely to do anything big or new to address this problem, the states have jumped in," she said.
The estimates of retirement savings are alarming. A 2013 study by the National Institute on Retirement Security described them as being "dangerously low," with a projected national deficit in the range of $6.8 trillion to $14 trillion, "depending on the household assets counted."
It found that "four out of five working families" had less than a year's income saved toward retirement. AARP says about 21 percent of people age 65 or older depend on Social Security for 90 percent or more of their income, while another 24 percent get at least half of their income from Social Security.
Usually, auto-IRAs have a default contribution rate of 3 percent, which employees can lower or raise, and their money will be forwarded to a state agency for investment. For instance, in Illinois, the default investment will be a life-cycle fund, which will be invested according to a person's age, becoming more conservative over time as a person grows older and nears retirement. A seven-member board will add other options over time.
Since none of these plans are operational yet, no one knows how many people will opt out. Also, auto-IRAs, have no matching contribution from an employer, which is the main benefit of a 401(k). And since most are structured as Roth IRAs, which are funded with aftertax dollars, there's no tax deferral like a traditional IRA.
There's also no way of knowing how low-income or younger individuals -- key targets in this push -- will react to having their paychecks nicked today in favor of a retirement that may be decades away.
Some might opt out, conceded Senator Daniel Biss of Illinois, the main proponent of that state's plan. But of those who stay in, he believes "very, very few will be disappointed about their decision 10 years later" when they're "surprised to have the beginnings of a nest egg."