Automatic Retirement Saving Inches Forward
By Ben Harris :: March 22nd, 2013
Automatic enrollment is slowly gaining steam as the choice strategy to encourage retirement saving. A bold plan in California would eventually make the practice widespread and could revolutionize the state’s saving landscape.
Last September, the California legislature approved a framework for automatically enrolling private-sector workers in a retirement savings plan. Employers with more than five workers would have to offer a workplace retirement plan, automatically enroll employees in the newly established California Secure Choice Retirement Savings Plan (SCP), or face a fine. Workers enrolled in SCP would automatically contribute 3 percent of their pay to an IRA-like account unless they opted out; like an IRA, benefits would be based on account contributions and investment returns. Employers are only required to set up the plan, not to contribute to the account, and there is no explicit cost to taxpayers.
A third-party—either a private firm or California’s pension administrator (CALPERS)—would administer the plan, investing no more than half the pooled funds in equities. (A private administrator may be the superior option given CALPERS’ recent history of fraud and mismanagement.) Annual administrative expenses would be limited to one percent of fund assets. The framework also calls for a guaranteed return, although the details have yet to be ironed out.
The plan is a long way from becoming a reality. The framework calls for further study of the plan’s feasibility and costs, and additional legislation will be needed to turn the idea into policy. In addition, the IRS and Department of Labor must still rule on the legality of some of the details.
Nonetheless, California’s plan shows exceptional promise. By utilizing automatic enrollment, which has been proven to bolster enrollment in private 401(k) plans, the plan could bring more than 6 million workers into the retirement saving universe. It takes advantage of a pooled investment strategy to lower administrative costs and ensure a balanced investment portfolio. The benefits would be progressively distributed. Workers take the accounts with them if they switch jobs. The plan is entirely self-funded with no extra cost to taxpayers. And it’s entirely voluntary; workers who do not want to contribute may opt out.
But there’s one big drawback: the guaranteed return purchased from private firms. Guaranteed returns would be great if they were free, but they’re not. Workers would have to pay private firms to guarantee the investment return, which would increase investment fees, possibly a lot. The structure of the guarantee dictates the price. Guarantees that exclusively protect against steep losses or those that “collar” the return (i.e., impose a minimum and maximum return) are less expensive. Guarantees that ensure at least a modest return are pricey. One analysis put the cost of a guaranteed 2 percent real rate of return at 29 percent of contributions.
An important new study reinforces the benefits of automatic enrollment. In a sample of Danish workers, researchers at Harvard and the University of Copenhagen found that approximately 85 percent of retirement savers are “passive” savers. Passive savers don’t respond to price subsidies like tax benefits, but will save more if automatically enrolled in a savings account. Importantly, the researchers found that under a system without automatic enrollment, 98 percent of contributions to existing retirement accounts were simply offsets to other types of saving—a finding that casts doubt on the billions of dollars in tax expenditures now devoted to encouraging retirement saving.
California’s plan faces several hurdles before enactment. But the evidence suggests that if it ever becomes policy, the plan will go a long towards increasing retirement saving.