Five Democrat controlled states, including several that are struggling to meet their long-term pension obligations, are planning to introduce new state-run retirement options.
California, Oregon, Illinois, Maryland, and Connecticut plan to mandate employers to either offer a retirement plan to workers or connect them to a retirement savings plan overseen by states governments.
Robert DiMeo, co-founder and managing director of Chicago-based pension consultant DiMeo Schneider & Associates LLC, said that while the idea is intriguing, running a state-sponsored plan is no small feat.
“There are numerous challenges including the opinion of many that the government is ill-equipped to be a thought leader and to successfully implement retirement plans,” DiMeo said. “Look at the massive underfunded status of many state pension funds.”
Moody’s Investor Service announced in November that “unfunded pension liabilities for the top 50 local governments ranked by outstanding debt have more than doubled over the last decade.”
Recent data from Illinois’ Commission on Government Forecasting and Accountability showed that the state’s public pension debt has risen to $130 billion this year — a 17 percent increase from 2015.
Illinois and Connecticut, for example, are two of the states grappling with two of the largest unfunded pension liabilities.
Originally scheduled to implement its state-run retirement plan next year, Illinois is now planning to begin a pilot program in 2018 after the board overseeing the Illinois Choice program requested additional time.
DiMeo said state-run plans could, however, be considered a “cousin” of state-run 529 plans, some of which have solid performance and low expenses.
According to the Pew Charitable Trusts, more than one-third of full-time American workers lack access to 401(k) or 403 (b) plans. Furthermore, part-time employees are less likely to have the option to sign up for an employer-based program.
“I think this figure can overstate the extent of the problem of undersaving for retirement, for three reasons,” Andrew G. Biggs, resident scholar at the American Enterprise Institute, said.
Firstly, survey data tends to understate actual participating because people don’t answer accurately, Biggs said, adding that comparisons based on employer or tax data show higher retirement plan offering and participation.
“Second, many low-income or young workers shouldn’t be saving at this time, either because they will receive a Social Security benefit that replaces most of their pre-retirement earnings or because they can save when they’re older and their earnings have risen,” he said.
A third aspect to consider is that some people who don’t have a retirement plan of their own can effectively save through a spouse’s plan.
“The spouse who has a 401k can contribute enough to save for both members of a couple,” Biggs said.
Instead of requiring businesses to offer a 401(k) plan, California’s plan, signed into law by Gov. Jerry Brown, will mandate any business with more than four employees to provide a retirement savings plan requiring a 3 percent payroll deduction that the state will set aside for retirement, unless an employee chooses to opt out. This is in addition to 12.4% social security tax rate – shared equally by employee and employer.
The new deduction can be adjusted and employers are not required to contribute to the plan.
“It is an ambitious step that is part of a growing national movement aimed at protecting millions of Americans who are on track to retire into poverty,” California State Controller Betty Yee said in a speech in November.
California will roll out its plan beginning with the largest employers and then gradually extend to small businesses over the span of five years.
But some of the problems created by Obamacare – decreased competition and premium hikes – could be a reality for government-sponsored retirement plans.
“I’m not outright opposed to state-run retirement plans as a way to increase access to retirement saving opportunities,” Biggs said. “But these state-run plans run the danger of displacing employer-sponsored 401(k) plans, which are a better overall saving vehicle because they have higher contribution limits and generally offer an employer match, which the state-run plans do not.”
To make it easier for small businesses to offer retirement plans to employees, Biggs said state-run plans need to take place alongside efforts to expand access to employer-sponsored plans.
Another point of concern is that some states have “moved quickly” to enact retirement plans, but now must catch up on the administrative side, and find a cost-effective way of administering plans.
“There are dangers on that end, given that state and local government employee pensions have sometimes faced problems with ‘pay to play’,” Biggs said, where a potential fund manager pays plan officials to obtain a contract which they hope to make money on.
This can result in higher fees for participants, he cautioned.
“Some states that run college-savings plans charge high fees, so that is a concern,” Biggs said.
A government-run retirement plan run at the federal level has its dangers but may be more feasible than 50 state-run plans, but a better solution would be aggressive efforts to expand employer offerings of 401(k)s and similar retirement plans, which are better overall retirement saving vehicles than the state-run auto-IRA plans, Biggs said.
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