Nobody plans to be broke when they retire, but American culture promotes consumption over thrift, and saving for retirement is particularly difficult for low-income workers. With Social Security so deeply underfunded that skinnier benefits and heftier taxes seem likely in the coming decade, the reluctance of many workers to save for their retirement is a mounting challenge that many states are taking upon themselves by prodding private-sector employers to provide retirement savings plans.
But as it’s said about leading a horse to water that won’t drink, most states’ workforce retirement savings schemes have yet to attract widespread participation and market penetration. They are a step in the right direction, but most still fall short of moving the needle when it comes to assuring meaningful retirement income security.
Sixteen states now have or are in the process of implementing programs that seek to lure employees into saving for their own retirement to reduce those workers’ future dependence on state and federal welfare and income-support programs when they retire. For a dozen of those states, it’s a “stick-first, carrot-second” approach: Their legislatures have passed laws that require most employers to offer a payroll-savings option to their workers. They then have (or intend to) set up their own state-sponsored savings plans, typically partnering with one or more financial services firms as platform administrators.
The idea, and the goal, is to make it easier for employers to offer a voluntary payroll-deduction system with a tax-advantaged retirement investment account. This enables employee enrollment to be semi-automatic unless the worker opts out. Participants are typically allowed to customize their savings rate and investment preferences.
The savings shortfall is nontrivial. Nationally, an estimated 56 million workers cannot or do not access a payroll retirement savings option at their workplace — about half of the private-sector workforce. Research shows that payroll-deduction plans are the easiest and most successful way for employees to put aside some money for their own retirement. Indeed, according to research by AARP, employees are 15 times more likely to save through payroll deduction — and 20 times more likely if enrollment is automatic.
So far, so good. But participation and the quality and cost of the investment options is spotty in many state plans, and the vast majority of states have not followed the lead of the early adopters. The pioneers in this nascent multistate effort have most often been Democratic-controlled states with strong union presence, so there is a tinge of partisan bias to the adoption pattern so far. Some GOP state legislators will instinctively oppose these employer-level mandates as anti-business coercion.
The backbones of the investment platforms are also inconsistent, as many states have followed a Roth IRA structure while others use a traditional IRA or 401(k) as the plan centerpiece. Absent a uniform federal framework and more statewide systems, similar to what’s evolved with college-savings 529 plans, it’s hard for the workplace retirement plan industry to target and optimize economies of scale that would reduce costs and fee drag, while promoting “portable” savings — those that can be transferred to a successor employer’s program. As a result, many of the states’ chosen plan administrators are boutique companies relatively unknown in the big-league retirement investment industry.
Just because these states now require a workplace retirement plan, and offer one that they’ve created, does not mean that the business will flow to them. Employers have many options already in the private sector, and employees can always put their money elsewhere at any time. Not everybody in the private sector wants the state’s income tax collectors to be privy to their payroll and paychecks, as some might fear in a big brother state. And to be realistic, there are many lower-income workers who need every penny from today’s wages just to cover rent, groceries and car payments.
In the spirit of constructive criticism, as a former CEO of a defined-contribution retirement plan administration and investment company, I can offer some insights to state officials, legislators and their policy organizations, and point out that — to their credit — a few states are already implementing several of my five suggestions for plan structure and strategy:
1. Lobby the feds. Retirement savings sufficiency is a national goal, and the states should start pressing Congress to enact an enabling statute within or similar to the 529 college-savings law. There’s already precedent for moving the 529 concept beyond college savings: A federal law called ABLE, which permits tax-free savings for people with disabilities, was added to Section 529 of the tax code back in 2014.
Adoption and portability will be enhanced if these retirement savings programs follow a pattern similar to 529 plans. A Roth IRA model for the investment vehicle should be a standard feature, as most younger and lower-income workers are likely to have lower tax rates today than later in life when they can always then open a traditional IRA account, and the math for congressional authorizations is scored better with the Roth IRA structure where tax expenditures are conveniently overlooked by the budget wonks after 10 years. Of course, employees who instead prefer immediate tax deferrals can instead open an individual IRA.
The federal law can also establish unique conditions for tax-free withdrawal before age 62 that could be limited to narrowly defined hardships like uninsured natural disaster casualty losses and major medical expenses and not other life-stage events like college tuition and home purchases that are favored elsewhere in the tax code.
Without busting the federal budget, some modest new tax incentives would make the state-sponsored plans attractive to private-sector employers and employees, just as the states’ 529 plans are for college savers. Lower-income participants in these programs are already eligible for the little-known federal Savers Credit, which clearly needs more publicity. Annual contributions could be limited to, say, $5,000, and counted toward existing IRA and defined-contribution plan limits, to focus the benefit on rank-and-file employees and not highly paid executives. Ideally, a federal authorization should require states to put skin in the game and make payouts from these accounts income tax-free at the state level. Notably, Hawaii has a particularly generous contribution-matching provision on the books for its early-bird participants.
A safe harbor in federal law could also relieve the states and their concessionaires of any regulatory and fiduciary worries about offering a cost-effective but limited target-date investment menu as the standard, lowest-fee option. Larger states could even build their own target-date fund family by leveraging their pension funds and custodian banks to “unitize” a family of low-fee investment trusts for these programs. Gaining a broad congressional exemption from retail securities laws and regulations would be extremely helpful to the states in this regard. A federal law can also provide an antitrust shield for intra-industry cooperation in reducing processing costs across the state-sponsored platforms.
To promote vendor competition and lower fees, federal law could also extend the corporate income tax exemption enjoyed by nonprofit systems like TIAA-CREF and MissionSquare in the educational and municipal marketplaces if they secure and serve a state-level franchise through competitive selection — as long as that tax advantage translates into superior, lower pricing. (Disclosure: I suggest this without any biases for or against my former employer, known then as ICMA-RC, or its competitor, Fidelity Investments, where I had also previously worked.)
To level the playing field for those who dislike single-state monopolies, federal law can provide clear authority for any state and its chosen plan administrator to offer its program to employers in other states. Employers could then choose from competing state plans, where the home-state advantage is not truly compelling. The 529 marketplace has proven that cross-state marketing enhances competition and makes the state franchises more attractive to the private-sector bidders.
2. Leverage professional association networking. The National Association of State Treasurers (NAST) sponsors an effective College Savings Plans Network and an ABLE network of treasurers, plan administrators and private companies that provides record-keeping and investment vehicles. The private sector’s Society of Professional Asset Managers and Recordkeepers (known as the SPARK Institute), with expert leaders from more than 80 prominent member companies, can provide invaluable insights on ways to reduce costs and offer simple, efficient investment options that optimize the value of these savings accounts so that processing and investment fees don’t eat up the income.
These two national organizations can also provide invaluable insights into the legislative landscape on Capitol Hill, strategies to get a bill enacted and pitfalls to avoid when promoting their cause in Congress. They could also work with the Employee Benefit Research Institute, AARP the Ad Council and other advocates of retirement savings plans to produce a national marketing campaign as more states sign on. The U.S. Chamber of Commerce could also help, by encouraging company participation. It’s just not as simple as “build it and they will come,” as any public-sector plan enrollment rep will tell you.
3. Go for simplified, low-cost investments. Less is more at the incubation stage. One of the mistakes made by some of the plans out there today is that they have tried too hard to make a wide spectrum of investments available. Although freedom of choice from a big menu sounds desirable, the fact is that most employees are novices and poor investors, and there is a high cost to operate complex record-keeping systems that facilitate multiple investment options and play-the-market trading in a retirement saving plan where the amounts invested by individuals are small potatoes.
The costs of plan administration can be cut dramatically by making just one simple, age-based target-date index-fund family the default option, and charging appropriately higher a la carte fees to those employees who want to invest in other options. Industry experts tell me that the cost of payroll-savings retirement plan record-keeping will be reduced dramatically by defaulting to target-date funds, when coupled with electronic statements. First-timers should just “set it and forget it.”
4. Use a single provider. To avoid appearances of favoritism, one or more of the states have allowed employers and even employees in the plans they offer to also pick from a menu of service providers and their investment options. Although such platforms and “marketplaces” appear to avoid favoritism, they are grossly inefficient and ineffective. Anybody with integrity and experience in the retirement industry will tell you that the dinosaur multivendor model common in the public school marketplace is a costly, inefficient and obsolete way of running those 403(b) retirement plans.
If an employer really, really wants to offer multiple vendors, that’s their decision. But a state-sponsored-and-selected option is best operated by a single record-keeper chosen through fair competition based on cost, capability and product efficiency, without political meddling. A state-sponsored system can issue a fair request for proposal for a winner-take-all franchise. Otherwise, sales representatives from competing firms would have to vie with each other to win employee clients, and those duplicative marketing and enrollment expenses, plus the diseconomies of scale, are notoriously costly — at the ultimate expense of the plan participants whose lifetime investment returns are burdened by higher fees.
All state-sponsored vendors should also be required to retain small individual account balances above $1,000 indefinitely, and not purge them as cash distributions when employees leave a job, as most 401(k) plans do with their idle participant accounts below $5,000. In such cases, the administrator can be directed to transfer all inactive investments to its default target-date fund. After all, some day those idle acorns, if not spent elsewhere, will add up to something for lower-income citizens who need them when retired.
5. Auto-escalate employee contributions. Only some of the state-run plans include an automatic annual escalation of the savings rate as their default option. Again, industry research shows that the easiest and most effective way to get employees to save more as they age is by ratcheting up their savings rate each year. Those who don’t want to save more than their original rate can simply opt out, or opt back in at a later time when they feel they can afford to start saving more. There is no harm in offering this option.
These are just a few examples of ways that the well-intentioned promoters of these state-sponsored retirement savings systems can enhance their effectiveness. Collectively these strategies can potentially reduce costs for the higher-fee plans by 50 to 90 percent, according to one industry insider. For starters, I encourage them to make a few phone calls to the leaders of NAST and SPARK, who should be more than willing to share their expertise and networking experience.
Governing‘s opinion columns reflect the views of their authors and not necessarily those of Governing‘s editors or management.Nothing herein should be construed as investment advice.