Disruptive Innovation: Three Proposals That May Change Your Retirement Business
Part I: Automatic IRAs
By Thomas Rowley
Director, Retirement Business Strategy
This is the first of a three-part series examining how retirement-related regulatory proposals could potentially affect plan consultants, field associates and financial advisors by altering their business models. The series includes discussion of automatic IRAs, revision of the definition of "fiduciary" and the changing 401(k).
"Disruptive innovation" is the term used to describe innovations that change a product or service in ways the market doesn't anticipate — typically by first designing for a different set of consumers in the new market and later by lowering prices in the existing market. Disruptive innovation is now favored over "disruptive technology" because it's the changing application — rather than the technology itself — that disrupts the market.
Here's an example. The automobile was a technological innovation, but it didn't disrupt the market because early automobiles were expensive luxury items. But mass-produced Ford Model Ts put autos within economic reach, disrupting the horse-drawn vehicles market. The innovation of mass production, not necessarily the automobile, changed the transportation market.
Change looms in retirement marketplace
The retirement marketplace could potentially experience similar transformational disruption as Congress, the Department of Labor and other regulatory bodies begin to “innovate” revisions in retirement regulations. Among the multitude of proposals put forward, several fit particularly well into the disruptive innovation category. Automatic IRAs are one change that could significantly alter your business model over time.
How automatic IRAs work
Automatic IRAs offer employees who aren't covered by an employer-sponsored retirement plan the opportunity to save through payroll deposits. The idea has been proposed previously by:
- Sen. John Kerry, D-MA, and former Sen. Jeff Bingaman, D-NM, in 2011.
- Rep. Richard Neal, D-MA, in 2012.
- Most notably, President Barack Obama, who endorsed the idea in his budget for fiscal 2013.
Under the federal version of the automatic IRA concept, employers would be required to use their payroll system to channel employee money to an IRA if the employer:
- Has more than 10 employees.
- Has been in business for at least two years.
- Doesn’t sponsor another retirement plan.
Employers with existing retirement plans are exempt from the legislation, which could affect an estimated 40% of the US workforce.
Why should automatic IRAs be on your radar?
Last year California Gov. Jerry Brown signed into law The California Secure Choice Savings Trust Act (SB 1234), which is similar to the often-proposed federal version of automatic IRAs. Here’s a quick overview of the California law:
- All nongovernmental California employers with five or more employees would be required to make "workplace retirement savings" available to employees. Workplace retirement savings may be any type of employer-sponsored program — 401(k), SEP-IRA, SIMPLE IRA, defined benefit plan — but if no plan is chosen, the employer would default to The California Secure Choice Retirement Savings Program.
- These employers would be required to automatically enroll employees, withhold 3% of their pay and forward these IRA contributions to a state-run program for investment. Employers have no other responsibilities.
- Although automatically enrolled employees may opt out, those who do will be re-enrolled every two years. But they can always opt out again.
- The IRA accounts would have a guaranteed rate of return, declared at the beginning of each year. Distributions are to be made as lifetime income, based on accumulated account balance at retirement.
- The value of the accounts and the lifetime income payments won’t be guaranteed by the state. Instead, the program must privately insure the risks associated with the program’s guarantees.
The next step for The California Secure Choice Savings Trust Act is to obtain funding for a market study to determine if the automatic IRA program can be self-sustaining. The program would proceed to the design phase only if it's viable. Then legislative approval would be required before enactment. Assuming that funding, determination of self-sustaining viability and legislative approval happen, the program would affect all California employers within one year of enactment.
How could automatic IRAs affect your business?
The potential for California’s bellwether program to become reality raises a number of questions for the retirement industry:
- Will California's IRA "innovation" become the model?
- Would it lead employers to adopt default automatic IRAs and drop defined contribution (DC) retirement plans, much the same way a generation of employers replaced defined benefit plans with less costly DC plans?
- Could employees take a lump-sum distribution from their automatic IRAs?
More to the point for those in the retirement industry, would increasing participation by 40 million employees into IRAs help your business? Or would it force a change in your business model to accommodate this disruptive innovation in the industry?