California vs. the 'Retirement Tsunami'

When California State Sen. Kevin de Léon talks about his plan to help people save for retirement, he usually starts by describing his Aunt Francisca, a housekeeper. "She's north of 70 and she still cleans homes," says de Léon. Francisca can't afford to retire because she has no savings. Even with help from Social Security, she struggles to make ends meet.

"It's the story of tens of millions of Americans throughout the country," de Léon says. The Los Angeles Democrat isn't just talking about domestic workers. Nearly half of Californians are on track to retire in or near poverty, according to a University of California (Berkeley) study. A separate analysis of census data from The New School for Social Research found that three-quarters of Americans ages 50 to 64 have an average total retirement account balance of under $30,000.  

Saving for retirement has never been easy for poor and middle-class workers, and employer-sponsored retirement plans have never been universal. But the recession and slow recovery have made it hard for many Americans to make a living, let alone put money away.

A new law authored by de Léon attempts to address what he calls the coming "retirement tsunami." Signed by Gov. Jerry Brown in September 2012, the California Secure Choice Retirement Savings Program would establish automatic payroll contributions into retirement accounts for 6.3 million Californians whose employers don't sponsor a pension plan or a 401(k). Legislators in left-leaning states such as Connecticut and Illinois have put forward similar proposals, as has U.S. Sen. Tom Harkin (D-Iowa). 

The California program aims to create an effortless savings vehicle for an underserved population. Three-quarters of eligible workers make less than $46,420 per year, putting them into a demographic that relies heavily on Social Security in retirement. The new law won't end reliance on Social Security, but it could provide workers with additional financial security.  

The program is designed to be privately run and managed, ideally at no cost to the state. Advocates like de Léon argue that its structure combines portability--one of the best features of 401(k)s and Individual Retirement Accounts--with professional management of pooled funds--one of the best features of traditional pension plans. The new system would deduct an automatic 3 percent contribution from the paychecks of eligible employees, unless they chose to opt out. Workers with unconventional employment arrangements--like housecleaners--could opt in. And businesses with more than five employees that fail to allow payroll deduction would pay a penalty of $500 per eligible employee.

The contributions would be saved in individual, IRA-type accounts, but the accounts would be managed collectively as an estimated $6.6 billion fund. To protect workers against stock-market crashes, no more than 50 percent would be invested in equities. "Looking at what happened in 2008, 2009--we can't have that happen for this population," says Lisa Chin, de León's legislative director.

Additional protections include a reserve fund that could be drawn from during years of slow growth, and private insurance, to guarantee account-holders a rate of return. The guarantee would likely be tied to the 30-year Treasury bond rate, which is currently about 3 percent.

"Automatic enrollment is great because the evidence we have so far--which comes from large companies that have traditional 401(k) plans--is that participation rates are extremely high," says Brigitte Madrian, professor at the Harvard John F. Kennedy School of Government. Automatic enrollment and payroll deduction are powerful tools that help people save, she says, because people don't tend to miss money they don't see.

Large, pooled funds are cheaper to manage than hundreds of individual accounts--and that lowers fees that account-holders have to pay, says Nari Rhee, manager of research at the National Institute on Retirement Security. Pension funds also tend to have higher returns, because they're professionally managed, invest over the long term, and spread market risk across a range of people of different ages and income levels.

De León insists that the savings program isn't a new entitlement. But California's existing pension obligations loomed over his bill. The measure didn't get a single Republican vote in the Legislature, and even many Democrats were skeptical. "It's one of the most dangerous pieces of legislation I've ever seen," Democratic State Sen. Ted Lieu, told The Sacramento Bee. The California Department of Finance Analysis, also opposed the bill, saying it could create a new "multibillion-dollar liability."

The California Chamber of Commerce argued that the plan was unnecessary, as any worker with taxable income and a bank account can open an IRA. De León counters that if the current system was working, there wouldn't be so many Californians who lack retirement savings plans.

Still, implementation of the new law will be slow, partly in order to address concerns about liability and cost. Many of the details of the program--like how retirees will be able to access their money-- will be determined by a yet-to-be appointed board. The board must raise private money to pay for a market analysis of the program to find out what tweaks are needed to smooth implementation. 

Despite language in the bill freeing the state of all liability, it is unclear what responsibilities the state will have under federal law to ensure benefit payments. The final program must be submitted to the Internal Revenue Service and the Department of Labor to make sure the individual accounts qualify for the same tax treatment as IRAs, and that they doesn't constitute an employer benefit plan. If the plan passes both assessments, it will be resubmitted to the state legislature for authorization.

Enrollment won't begin until 2015, at the earliest. It could be years before de Léon finds out if the new program helps workers like his aunt Francisca--or if, for those with little income to put aside for retirement, the only way to ensure financial security in old age is to keep on working.