By Jon Vogler, senior analyst for Retirement Research
The American private retirement system has historically been voluntary. Employers first decide whether they're going to sponsor a plan and then select the plan's features. But over the last several years, focus has intensified on two criticisms of the voluntary system:
- Too many workers lack access to workplace retirement plans.
- Those who do participate aren't saving enough for retirement.
As a result, employers are increasingly considering mandatory retirement plans and mandatory plan features as a partial solution to the retirement savings crisis-in-the-making. This edition looks at this new mandatory trend in a traditionally voluntary world and explores efforts to implement this transition.
Bottom line: Workers need help
The statistics concerning coverage and accumulated retirement savings are troubling.
- By various estimates, only somewhere between 52% and 64% of private-sector workers have access to retirement plans on the job. According to the National Institute on Retirement Security, only 52% of private-sector employees between the ages of 28 and 64 had access to a retirement plan on the job by 2011 — down from 62% in 2000).1 The American Society of Pension Professionals and Actuaries, a retirement industry group, pegs private-sector access for full- and part-time workers at 64%.2
- Two-thirds of working households between the ages of 55 and 64 with at least one earner have retirement savings equal to less than their annual income, far below what they will need to maintain their standard of living in retirement.1
- Dr. Annamaria Lusardi, a professor at George Washington University, contends that 50 cents "leaks" from every dollar in retirement accounts before retirement because of withdrawals and loans.3
It's not surprising, then, that experts and politicians are calling for some sort of mandatory retirement planning at the employer level.
A not-so-new concept
Mandatory participation in plans isn't an entirely new concept for participants. Often overlooked in this discussion is that the US does have some mandates — employers must pay 6.2% of each employee's salary into Social Security, and every employee must also contribute that amount. In addition, public-sector employers such as universities and state and municipal governments have long required their employees to participate in a plan. Even employees in private-sector employment were often told they must participate in their employer's defined benefit (DB) pension plan.
But the concept of requiring private-sector employers to offer retirement plans or accounts in defined contribution (DC) or hybrid DB/DC programs is relatively new and worth examining. Provisions of the Pension Protection Act of 2006 encouraged two auto features:
- Automatic enrollment, or enrolling employees in a plan with the choice to opt out of participation.
- Automatic escalation, an automatic annual increase in the participant's contribution rate.
These features have been picking up steam, especially in the last few years.
Automatic IRAs: Savings solution?
In his 2010 budget blueprint, President Barack Obama proposed two items that would affect the voluntary nature of the private retirement system.
- First, he proposed requiring employers sponsoring 401(k) or similar DC plans to offer automatic enrollment.
- Second, he proposed requiring employers without existing retirement plans to enroll their employees in a direct-deposit individual retirement account — an auto IRA.
According to the president's budget plan, "the result will be that workers will be automatically enrolled in some form of savings vehicle when they go to work, making it easy for them to save while also allowing them to opt out if their family or individual circumstances make it particularly difficult or unwise to save."4
The theory behind automatic IRAs is based on research showing that the key to saving is to make it automatic and simple. Due to inertia, people are likely to follow the path that doesn't require affirmative election. To take advantage of that tendency, an auto IRA would be put in place when an employee is hired, with no waiting period.
In addition to the support of the Obama administration, congressional bills have promoted the automatic IRA concept as both a stand-alone measure and as part of a package. And the Treasury Department — currently shepherding the auto IRA proposal — maintains that the requirement to make these IRA plans available is critical because a voluntary system would have minimal impact and would not address the vital issue of coverage. But despite the support, the auto IRA concept hasn't yet advanced very far.
Or slippery slope?
Resistance to the auto IRA comes partially from the concern of some retirement industry representatives that this concept represents a slippery slope — in other words, one mandatory feature would inevitably lead to additional requirements, such as a mandate that employers provide matching contributions to their DC plans, something that has always been voluntary.
"Where does this stop?" asked Ed Ferrigno, vice president of the Plan Sponsor Council of America, a nonprofit that represents firms that offer 401(k)-type plans. "It's very ominous."5 Other analysts express concern that the auto IRA could present a particular challenge to smaller businesses that aren't currently using automatic payroll deduction systems.
Despite these concerns, the concept of enrollment mandates such as automatic enrollment and automatic escalation has the support of the mutual fund industry's Investment Company Institute (ICI).
"We should consider requiring all 401(k) plans to use automatic enrollment and automatic savings escalation," according to Paul Schott Stevens, ICI president and CEO. Rachel McTague, an ICI spokeswoman, said, "The institute is a strong supporter of using automatic enrollment and automatic escalation features because of their powerful positive impact on America's retirement savings habits. It is good public policy."5
USA Retirement Funds slow to gain traction
Sen. Tom Harkin, D-IA, proposed a new kind of private retirement plan in 2012. Under his Universal, Secure and Adaptable (USA) Retirement Funds proposal, employers that don't offer a workplace retirement plan with automatic enrollment and a minimum level of employer contributions would automatically withhold a portion of their employees' pay and send it to a USA Retirement Fund.
The funds would have professional asset management and allow individuals to pool their risk with other active employees and retirees. USA Retirement Fund participants would get a monthly benefit based on the total contributions made by them, or on their behalf, and investment performance over time. Employers' only obligations would be to automatically enroll employees, ensure that employee contributions are processed and make modest contributions.
An excerpt from Sen. Harkin's proposal states: "By ensuring that every American has access to a retirement plan at work and making participation automatic, we can drastically reduce the retirement income deficit and promote retirement security."6
As of this writing, Sen. Harkin's proposal as it currently stands doesn't seem to be gaining the necessary traction to be enacted into law.
Looking abroad for concepts?
Other experts have suggested copying foreign models of retirement savings plans. Many countries seem far more willing than the US to mandate painful steps for employers and workers. In Australia, for example, there is nearly universal participation among workers in a 401(k)-type retirement plan because of a governmental mandate. Employers are required to deposit at least 9% of each worker's salary into a retirement fund, and that contribution is set to rise to 12% in 2020. The requirement for mandatory employer contributions was phased in gradually.
In the US, such moves would prompt many to denounce inappropriate raids on workers' pay and expensive burdens on employers. But experts say it would be wise to study other nations' systems for ideas to strengthen America's system. For example:
- Under Chile's plan, 10% of each employee's salary is automatically deposited into a
401(k)-type retirement fund, with workers having a choice of investment options. A supplementary system tops up the retirement funds of low-income employees.
- In the Netherlands, pension laws require that workers' 401(k)-like plans be converted into lifetime annuities to ensure they do not spend down all their savings before they turn 75 or 80.
Dr. Meir Statman, finance professor at Santa Clara University, is among those calling for a mandatory plan system. In a recent article, he said that a "paternalistic" mandatory private DC savings account should be added to the current US system. He also cited other solutions, including Israel's mandatory DC retirement savings program that requires retirees to prove "sufficient resources beyond mandatory savings to sustain them in retirement" before it permits lump sum withdrawals.3
Or sticking closer to home
But, of course, there's no consensus, either about mandatory retirement savings or following another country's example.
"We do not have only a saving crisis, we have a debt crisis, meaning most people are dealing and struggling with debt," pointed out Professor Lusardi. "It ... could be detrimental to deal with these problems by mandating people to save more; in this way we take away liquidity and people will have even less to pay off debt … Mandating everybody to save may make some people worse off."3
Marci Supovitz, president of the National Association of Plan Advisors and principal at Boulay Donnelly & Supovitz Consulting Group Inc., said, "I think in a lot of ways it would be a mistake to assume that because something works in another country it will work in the US, because every country's culture is different. There's distaste in the US for mandating such things."3 She pointed out that another mandatory system on top of the one "we already have … called Social Security" would be difficult to sell.
Likewise, John A. Turner, director of the Pension Policy Center in Washington, said some foreign features might not fit American culture, such as mandated participation in the pension system as in Australia and Chile. He does not advocate such a mandate. "We're quite different from many other countries," he said. "There's an emphasis on individual freedoms and rights and responsibilities versus collectivism — although I admit we will never have high pension coverage without some form of mandate."7
The California solution
The California Secure Choice Retirement Savings Program (CSRS), which has been adopted pending the results of a feasibility study and further research, is an interesting new blend of mandatory and voluntary features. Under the program:
- Nongovernmental employers with five or more employees must make a retirement plan available to their employees.
- Employers will be able to use any employer-sponsored program available, from 401(k) plans to automatic payroll-deduction IRAs.
- If an employer with five or more employees hasn't implemented a retirement savings plan for its employees by the time the program goes into effect, the employer must automatically enroll employees in the new state-sponsored payroll-deduction retirement savings program.
- Employers are required to offer this program, but employees aren't required to use it and may opt out. Employees who opt out will automatically be re-enrolled every two years, but they can opt out again.
- Employers who don't allow for the payroll reduction will be fined $500 per eligible employee.
- Employers must withhold 3% of employees' pay and send it to the state's new CSRS Investment Board, though the board can change the withholding amount to anywhere from 2% to 4%.
- Workers' contributions are placed into tax-deferred investments with a guaranteed minimum return backed by insurance.
The state legislature will vote again on the program after research and analysis and submission to the IRS to ensure tax incentives are equal to those offered by other IRAs. The program won't start until at least 2015. Other states are debating whether to adopt similar plans.
Sens. Harkin and Mike Enzi, R-Wyo., are reportedly working on a bill that would create a federal plan similar to the California initiative.
401(k) to the rescue?
But there's another, more familiar solution at hand, according to some.
"Do you need another mandatory program, or can you work with what is already in place?" asked Joe Ready, executive vice president and director of Wells Fargo retirement and a vice president and board member of the SPARK Institute, a trade group for the retirement plan services industry. He pointed to the 401(k) plan as a solution. "If people are in the plan, and if they're participating at a decent level, and if the employer contributes, and if participants invest properly, they do OK," he said.3
Yet with successful savings dependent on that many "ifs," Mr. Ready acknowledged that work must be done to make the system effective for a broader base of the population — particularly because many employers offer no plan at all.
SPARK advocates simplifying plans so that smaller employers will participate. Also, said Mr. Ready, shared responsibility — among employee, employer and government — is necessary for the system to work better. Currently, he said, responsibility is skewed toward the employee. The increasing support in the industry for education initiatives spearheaded by the employer could potentially dovetail with a move toward shared responsibility.
Improved outcomes worth the effort
With critics pointing to sizable gaps in retirement plan coverage and inadequate account balances for sufficient monthly income in retirement, the focus is increasingly moving from voluntary to mandatory plans and mandatory plan features. In fact, a recent Mercer global study found that the US could boost the effectiveness of its retirement programs by increasing the level of mandatory contributions to DC plans or Social Security — in addition to raising the minimum pension benefit for low-income retirees and limiting access to lump sum payments or borrowing against DC account balances.1
While mandatory plans and features, in combination with universal coverage and risk sharing, may have driven improved outcomes in other countries, there is mixed reaction from political, cultural and industry perspectives about whether these imports can be overlaid successfully onto American plans. If the tradeoff for mandatory plans and features is enhanced coverage and retirement readiness, the work involved to adapt and integrate these types of changes may be worth the effort.