State-Run Plans Will Struggle Without Aggressive Plan Design

All told, about half of the 50 U.S. states are actively considering ways to provide payroll deferral retirement savings programs to private-sector workers whose employers opt not to deliver the benefit, including a handful of states that have already taken steps to launch these plans.

As a senior vice president in charge of government and religious markets for TIAA, Rich Hiller is frequently called on to discuss the efforts these states are making. He points to a handful of states in particular—California, Illinois, Oregon, Wyoming, Connecticut and Washington—which seem to be furthest along in the effort and which offer some important food for thought. 

“These states get a lot of attention because they are at different stages of actually rolling out plans to the private workforce,” Hiller tells PLANADVISER. “They make a great series of case studies for what may work and what may not work to boost retirement savings overall in this country. Unfortunately, the first thing to note is that I don’t believe these plans are going to prove to be a windfall in new retirement assets, either for the workers or for firms like TIAA and other private market providers, as some have speculated.”

This is largely because Hiller doesn’t see the plans catching on like wildfire the way some in the Department of Labor (DOL) and the various state legislatures anticipate. Like other financial industry practitioners and commentators, he feels there is little reason to believe that these plans will be more popular than the individual retirement account (IRA) offerings most workers can already access today. 

“Of course, the big difference is that these programs may be mandatory, or at least they may force the worker to proactively opt-out of saving,” Hiller explains. “They may also be built in a way that makes them lower cost compared to private market IRAs, which could lead to greater uptake than we currently see with IRAs. In the end, however, the ultimate key to success for these programs, as with the defined contribution (DC) plans already existing out there, will be features like auto-enrollment and auto-escalation.”

Some states seem to be falling into the trap of believing that simply getting folks saving a little bit is a positive step towards retirement readiness. “So, for example, we have Illinois moving ahead on a plan to do auto-enrollment at 3% of salary in an IRA-like account,” Hiller explains. “In Colorado and Connecticut, we see them considering being a little more aggressive, with a 5% and 6% auto-enrollmen,t respectively, but I don’t think you can argue that any one of those is a sufficient deferral for real retirement readiness.”

Hiller goes on the explain that these programs will be at a further disadvantage compared with many employer-sponsored DC plans because very few states, if any, seem to be willing to offer up matching contributions on deferrals to these new retirement programs. “Unfortunately, I don’t expect many states to end up with a matching contribution,” Hiller adds. “There are just far too many other budget constraints that governments are feeling right now to make that a likely possibility.”

NEXT: DOL guidance still unfolding 

Hiller goes on to predict that, while there may be opportunity for the private sector to support governments as they roll out these plans, “any initial accounts will be small and will likely grow slowly, given the low auto-deferral rates and fairly conservative plan designs that are being proposed.” He also expects firms to be more than a little intimidated by the prospect of having 50-different approaches to delivering these benefits, “which would make it very hard to support the programs efficiently.”

Another aspect slowing up the overall progress of the private sector and the state governments moving to implement these plans is that the DOL is still in the process of updating its regulatory stance on how these plans will relate to the Employee Retirement Income Security Act (ERISA). It was just last November that the DOL proposed a new set of rules and guidance for how it would like to see these plans come into being—and as Hiller observes, it's pretty clear that most states do not want their programs to fall under the ERISA umbrella. 

That late-2015 action from the DOL included Interpretive Bulletin 2015-02, which sets forth the department's current view concerning the application of ERISA to “certain state laws designed to expand the retirement savings options available to private sector workers through ERISA-covered retirement plans.” The Department separately released a proposed forward-looking regulation describing safe-harbor conditions it would like to set up for states and employers “to avoid creation of ERISA-covered plans as a result of state laws that require private sector employers to implement in their workplaces state-administered payroll deduction individual retirement account (IRA) programs, commonly referred to as auto-IRAs.”

Considering the pending regulatory change, Hiller expects states, employers and private market providers will all have to be very cautious as they work together to roll out any new offerings. 

“This is unfortunate to some degree because we know that it is the most aggressive plan designs that are going to be needed to get people to real retirement readiness,” Hiller concludes. “We would all like to see more plan designs that promote lifetime income and speak the language of income replacement and protection.”