While more than half of the states in the Union are considering legislation to address retirement savings shortfalls, the most aggressive initiatives to date have been passed by decidedly “blue” states.
California, Illinois, Connecticut, Maryland, and Oregon have passed legislation that mandates participation in state-sponsored and administered individual retirement accounts for employees of businesses that don’t sponsor a retirement plan.
Those plans, which create mandates for participation that include businesses with as few as five employees, are modeled from a policy proposal with conservative roots that was embraced by Republican presidential candidate Sen. John McCain, R- AZ, in 2008.
“The idea behind the state initiatives is very much a product of conservative thought,” said David John, a senior policy advisor at the AARP Public Policy Institute, the organization’s non-partisan inhouse think tank.
Before joining AARP, John spent more than 14 years as a senior research fellow at the Heritage Foundation, a conservative think tank.
Early in 2006, Heritage published a working paper, co-authored by David John and Mark Iwry, then a fellow at the left-of-center Brookings Institution who most recently served as a senior advisor to the Treasury Secretary on retirement and health care policy.
The paper—“Pursing Universal Retirement Security Through Automatic IRAs”—proposed what its authors called “an ambitious but practical set of retirement savings initiatives” to expand access to retirement savings plans in the private sector.
The theory behind the automatic IRAs envisioned by the two retirement policy experts was premised on the higher savings and participation rates seen in 401(k) plans with an automatic enrollment feature.
John and Iwry were proposing a road map for federal policy. But the policies being embraced at the state level are virtually indistinguishable from their model for automatic IRAs.
Their automatic IRAs would be built on diversified, low-cost investment alternatives; participating employers would be relieved of fiduciary obligations under the Employee Retirement Income Security Act; payroll deductions would be remitted to a collective retirement account; the option would be designed to promote further adoption of 401(k) plans among small businesses, and not as a competitive alternative to the private market; and management and record-keeping responsibilities would be contracted to private sector providers.
John and Iwry stopped short of explicitly recommending mandates. Their proposal seems to prefer tax incentives as carrots for employer participation, but they do raise the question of whether simply creating a new auto IRA and allowing employers the option would be enough to motivate employer adoption.
To date, much of the legislation at the state level automatically enrolls employees in qualified businesses.
A safe harbor issued by the Labor Department last August says states can mandate employer participation, so long as workers are allowed to opt-out of the plans.
And that’s fine with John, who has been a strong advocate for the state-run initiatives and the Labor Department’s safe harbor, along with his policy team at AARP.
“The question is not ‘why’ states should be doing this, but ‘why not’,” said John. “This is the right thing to do from a variety of perspectives. Yes, it will create security for more workers. But it is also the right thing from the viewpoint of the state taxpayer. If we continue as we are now, the cost of state-funded subsistence programs for low-income retirees will climb substantially.”
The Labor Department’s safe harbor is being challenged by Congressional Republicans under the Congressional Review Act, which gives lawmakers a limited window to block recently issued regulations.
Critics raise a range of concerns over the safe harbor, which has been described as a regulatory loophole by some Republicans.
From John’s perspective, all of those concerns “are without merit.”
One criticism suggests that leaving states to administer a new automatic IRA would be a fool’s errand, given the systemic underfunding of pubic defined benefit pension plans in so many states.
But the comparison of auto IRA programs and state-sponsored pensions is inept, says John. “It’s like saying pineapples and pine cones are the same thing because they have the same syllable.”
John and other advocates of state-sponsored IRAs point to the success of the 529 college savings market. Those plans are sponsored by states and managed by providers in the private sector. “That market proves states can manage auto IRAs,” says John.
Other critics fear cash-strapped states will ultimately be tempted to use savings in collective IRA accounts as a source of revenue to patch budget holes.
“IRAs are private property,” notes John. “If there were ever a hint that states would require investments in state bonds, people would move to a private-sector provider. It is the individuals’ money, and it can’t be used in a way they disapprove of.”
Another key complaint that is expected be aired on the Senate floor—the House has already passed a resolution to block Labor’s safe harbor—is the idea that state-administered auto IRAs deprive savers of consumer protections, because they will not be subject to the Employee Retirement Income Security Act, which holds employer sponsors of retirement plans to a fiduciary standard.
By writing a fiduciary rule, which requires all advisors on IRAs and 401(k) plans in the private sector to be fiduciaries, and then crafting a safe harbor for state-sponsored IRAs that relieves them of ERISAs fiduciary protections, the Obama Labor Department committed the crime of contradiction, say critics of state-administered plans.
But John thinks that argument is a red herring. “The safe harbor protects employers from liability—that is all it does. It doesn’t deprive consumer of ERISA’s protections, because it targets workers that don’t have access to ERISA-qualified plans.
Employers overwhelmingly support state-administered options, says John, pointing to a Pew Charitable Trust survey.
John says those employers that do sponsor 401(k) plans won’t be tempted to drop the option if their state offers an auto IRA option.
For one, employers benefit from the tax treatment of 401(k) plans. And the considerably higher savings limits on 401(k)s means employers would shoot themselves in the foot by moving to an auto IRA.
“That would be like inviting your managers and higher-level employers to go find another job,” said John. “Only an employer that wants to go out of business would do that.”