November 4, 2016
In a bold move to help millions of residents avoid poverty in their golden years, California recently created a state-sponsored retirement savings plan designed to encourage private-sector workers to build nest eggs.
California is the latest state to address what could become a national crisis as the baby boom generation marches into old age. Countless studies have pointed to an enormous shortfall in retirement savings nationwide, with the average account for those between 55 and 64 hovering around $100,000 – an amount that would produce just $300 a month in income if annuitized.
Median savings for households in that age bracket is between $10,000 and $20,000, and 41 percent of those nearing retirement have saved nothing at all.
Millions of households face two unsavory choices: keep working past 65 or try living on Social Security.
Unlike previous generations, the clear majority of private sector workers today can’t count on pensions to help cover retirement costs. Tax-advantaged retirement savings accounts like IRAs, Roth IRAs and 401(k)s have been available for a generation, but large numbers of workers don’t use them or take premature distributions and suffer high tax consequences.
A lot of Americans realize how poorly they’ve prepared for their post-working years yet they won’t, or can’t do much about it. Many don’t know how to set financial goals and save, or can’t afford to. Without pensions or savings, and with only a modest income from Social Security, retirement for many will mean living hand-to-mouth with financial catastrophe looming one medical bill away.
The California Secure Choice Program: How It Works
That reality motivated California in 2012 to begin planning what would become the California Secure Choice Program, signed into law in late 2016. Unless workers opt out of the program, it will compel employers to automatically withhold up to 5% of an employee’s wages, money that is transferrable to the state for investment in a publicly administered version of an individual retirement account.
Secure Choice is expected to carry lower investor fees and higher returns than conventional tax-advantaged retirement savings plans administered by profit-conscious investment firms.
The financial services industry lobbied against Secured Choice, concerned that competition from such state-sponsored plans could drive down the fees they collect for administering IRA and 401(k) plans.
Critics also have argued that Secure Choice would unfairly compete against financial planning companies and would create expectations that the state would cover workers’ investments if they suffered in an economic downturn.
One other objection — that companies that collect the contributions might be held liable under federal law for problems related to the plan — was addressed in 2016 when the U.S. Department of Labor adopted rules to regulate state-managed accounts. The rules hold businesses blameless if they merely collect wages and send them to a state-managed fund.
The California plan initially will invest workers’ contributions to Treasury funds, but expects to later branch out into other investments. It targets the roughly 55% of private-sector employees in the state who don’t have access to a workplace retirement plan. It would automatically set up accounts for 6.8 million workers, diverting 3% of their incomes into the program.
California Retirement Plan Could Set Example for Other States
The contentious effort to pass the law is significant for several reasons. California is the nation’s most populous state and is often on the legislative cutting edge. Nearly one in eight Americans live there, and its importance as a media center means its policies get broad exposure in other parts of the country. If the California plan works, supporters say, it might serve as a template for federal legislation.
Several states, including Illinois, Maryland, Connecticut and Oregon, preceded California in enacting similar programs, and two others – Washington and New Jersey – have created non-mandatory plans that allow workers to shop options in particular marketplaces.
New York might be one of the next states to join the movement. That would be significant because it is the second most populous state with a plan that would include as many as 3.6 million employees.
The plans work like automatic Roth IRAs and are designed for California employers with more than five workers that lack their own retirement plans. Workers’ contributions are pooled in large funds and initially get invested conservatively in government securities. California will build its fund in conjunction with the U.S. Treasury, which will guarantee the investments up to $15,000. When accounts grow larger, they get transferred to private providers.
There is concern whether the California law, which takes effect Jan. 1, 2017, will sufficiently address the looming retirement savings problem. It will do little to help those who hope to retire soon but might set the groundwork to better protect future generations. At least that’s what it backers hope.
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