State-run IRA nears fruition after long road
More than four years in the making, California’s effort to create a state-run retirement plan for private-sector workers whose employers don’t offer one is suddenly on the fast track to fruition, despite concerns about participant fees and possible legal liabilities for companies.
The program, originally called Secure Choice, has been renamed CalSavers. Any employer with at least five employees in California that doesn’t offer a retirement plan would have to enroll them in a payroll-deduction IRA, although workers could opt out.
At a “milestone meeting” last week, the Secure Choice investment board approved final regulations and authorized its staff to
search for a company to administer the program, said Katie Selenski, executive director of CalSavers.
The staff posted the regulations last Friday and plans to file them with the state’s Office of Administrative Law within a month. Under an expedited review process known as emergency rulemaking, the public will have just 10 business days from the filing date to comment.
“Assuming there is no contest or protest that warrants a pause, the regulations would be in effect after the 10-day period,” Selenski said. She said a pilot program could begin this fall. A phased introduction, starting with larger employers, would begin early next year.
Christin Evans, owner of Booksmith on Haight Street, is excited about the plan. “We have employees just out of college or high school, and they’re not able to really think about establishing a retirement plan,” she said. “They are typically struggling to pay rent and meet their basic needs. This tries to address a culture of saving” for low-wage and small-business workers. “I have employees who are quite excited about this possibility,” she said. “It’s also a benefit to me. They are less likely to move on to employers who have richer benefits.”
California will be the third state to create an auto-IRA. Oregon started one last year, and Illinois will before the end of the year.
“Study after study shows that people are significantly more likely to save for retirement if they have a plan offered through their employer. States are looking at these programs as a way to offer high-quality, low-cost retirement plans to all those employees who don’t have access today,” said Peg Creonte, a senior vice president with Ascensus, the company running the Oregon and Illinois programs.
Participation in Oregon’s nascent plan is running around 70 percent, she said.
The CalSavers regulations say that any private-sector employer that had an average of five or more workers (full- or part-time) in California the previous calendar year and doesn’t offer a “qualified” retirement plan must enroll them in CalSavers, unless the worker opts out. A qualified plan is one governed by the Employee Retirement Income Security Act, the federal law that protects workers in private-sector pension plans, including 401(k)s.
Self-employed workers could opt into the program. California companies could not enroll out-of-state employees.
Workers who stay in CalSavers would have 5 percent of each paycheck automatically deposited into a Roth IRA. Each year, their contribution rate would go up 1 percentage point until it hit 8 percent. That’s the default; but workers could contribute a different amount or open a regular IRA instead of a Roth.
The CalSavers account would be subject to the same complex rules that govern all IRAs. Workers could not contribute more than $5,500 a year ($6,500 when they are 50 or older). If their income, including a spouse’s salary, exceeds certain limits, they could not contribute to a Roth IRA and could not make a tax-deductible contribution to a regular IRA, although they could make an after-tax contribution.
In 401(k) plans, there are no income limits and the annual contribution limits are much higher — $18,500 (or $24,500 for those 50 or over).
Workers who opt out or drop out of CalSavers could get back in only once a year during an open-enrollment period in the fall.
Employers could not make a matching contribution, as they can with 401(k) plans. They could have no involvement other than passing along information to employees and setting up the payroll deduction. Everything else would be handled by a company called a third-party administrator.
The CalSavers staff is planning to issue a request for proposals from potential administrators. The request asks them to bid on five investment options: a target-date or riskbased fund, a global stock index fund, a global bond index fund, a socially conscious fund and a capital preservation fund.
Under the default setting, the first $1,000 of a worker’s contribution would go into the capital preservation fund, and after that, the money would go into the target-date or riskbased fund, unless the employee chose different investments.
One big question is fees. By law, participants must bear all costs including administration and fund fees. After six years of operation, fees would be capped at 1 percent of assets, but until then there would be no limit. The program is borrowing money from the general fund to get started, but participants must repay that loan.
In Oregon, fees are about 1 percent of assets, $104 per year on a $10,000 balance. In Illinois fees are capped at 0.75 percent. Those fees are much higher than average for large 401(k) plans, but lower than average for very small plans, according to BrightScope data.
CalSavers expects to have lower fees than Illinois, given the “vast size of our target market, approximately 7 million workers,” Selenski said.
The Investment Co. Institute, which represents mutual funds, has long argued that California cannot operate the plan under a 1 percent fee cap, which could result in a bailout by the state.
The other big question is a legal one. The 2012 and 2016 state laws that created Secure Choice said it could not go forward if it would be subject to the federal retirement security law. Under this law, employers who sponsor plans are fiduciaries; they choose investments and can be sued by participants. Many large employers have been sued over excessive 401(k) fees.
In August 2016, the U.S. Department of Labor issued a ruling that said state-run autoIRAs would be exempt from that act if they followed certain rules, including very limited involvement by employers and no matching contributions. The following May, President Trump signed a resolution that overturned the Obama-era rule.
Nevertheless, the state forged ahead with its plan after getting an opinion from law firm K&L Gates that said the program as envisioned would not be subject to the federal law, known as ERISA.
A court, however, could decide that these plans are governed by the federal law.
The California Chamber of Commerce dropped its opposition to the plan, but still has concerns about employer exposure to liability, said Marti Fisher, the chamber’s policy advocate.
“If ERISA were to apply, employers could be at risk for considerable liability, the extent of which is unknown because this type of program has never been done before,” the chamber said in January.
For Mark Herbert, California director of the Small Business Majority, that’s not a concern. Polling by his organization and AARP found that two-thirds of small business owners in California support a state retirement-savings program. For small companies, the main barriers to offering a retirement plan are cost, administrative complexity and fiduciary liability under the federal law. “CalSavers solves for all three,” he said.