New California Retirement Plan for Private-Sector Jobs

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A new California state board, Secure Choice, last week recommended that the automatic enrollment of millions of private-sector workers in a new state-run retirement savings plan begin with a safe investment: U.S. Treasury bonds for the first three years.

The board would then have time to develop options for riskier higher-yielding investments that could be protected against losses, possibly though insurance or pooling investments and eventually building a large reserve that could offset market downturns.

Several states are working on savings plans for private-sector workers with employers that do not offer a retirement plan — an estimated 6.8 million in California, who are 55 percent of workers ages 18 to 64 and earn a median wage of $23,000.

A payroll deduction is said to be a proven way to sharply increase savings. Deductions would begin at 3 or 5 percent of pay, perhaps escalating to 10 percent as years on the job increase. Workers automatically enrolled in the new state-run plan could opt out.

Employers with five or more employees but no retirement plan (typically a tax-deferred 401(k) investment plan available from many firms) would be required to offer the state savings plan. Business groups are worried about potential costs and liability.

Senate President Pro Tempore Kevin de Leon, D-Los Angeles, after four years of trying, obtained legislation (SB 1234 in 2012) authorizing a study of a state-run savings plan for private-sector workers with tight constraints:

A legal and market analysis not paid for by the state, exemption from federal retirement law, IRS tax deferral, and a self-sustaining plan with no employer liability or state liability for benefit payments.

Half of the $1 million raised by the nine-member Secure Choice board chaired by state Treasurer John Chiang came from the Laura and John Arnold Foundation, often vilified by public employee unions for promoting public pension reform.

De Leon credits President Obama for Labor department guidelines that create a “safe harbor” for state-run plans from the federal retirement law, ERISA, which would be a burden for employers.

The board approved extending the legal contract of K&L Gates to work with two other state savings plans, Oregon and Illinois, on obtaining a Securities and Exchange Commission exemption from registering under federal securities laws.

The estimated Secure Choice startup cost is $129 million if the payroll deduction is 3 percent of pay. Consultants say a startup loan from the state could be paid off without exceeding the cap on administrative expenses: 1 percent of total assets.

Last week, as the Secure Choice board voted unanimously to recommend legislation approving a cautious start with bonds and the flexibility to add more sophisticated options later, one of the issues was protection against investment losses.

State Controller Betty Yee, a board member, asked about De Leon’s vision with his original legislation for an insurance-like “cash balance” plan, a minimum guaranteed investment return that prevents losses.

The Overture Financial consultants who did the feasibility study, Nari Rhee and Mohammed Baki, told her a guaranteed return during the early years of savings could take half of the potential return, but might work in the years before retirement.

“Legislation should allow flexibility to the board to add insurance,” said Baki. “It’s really a matter of how much is accumulated on the average account in that last 15 years.”

Overture had recommended that the board choose one of two options: a traditional tax-deferred IRA like a 401(k) individual investment plan or an innovative pooled IRA that could build a reserve to offset investment losses.

At board hearings on the two options in Los Angeles and Oakland, a large union with members in the public and private sectors, SEIU, used news conferences and emotional personal testimony to urge the board to choose the pooled IRA.

Workers would have a “variable-rate savings bond,” going up or down with investment earnings. Annual earnings over 10 percent would go into a reserve, which in two decades might be large enough to offset losses like those in the recent financial crisis.

A powerful political force at the Capitol, the Labor Coalition of public employee unions including SEIU that represents more than one million members, sent the Secure Choice board a letter opposing the traditional IRA option.

The coalition said it’s too much like the 401(k)-style plans “anti-pension advocates propose for new public employees.” The coalition prefers the more pension-like pooled IRA, but notes difficulties with cost, implementation and SEC clearance.

A third option mentioned by the coalition is roughly similar to the recommendation adopted by the Secure Choice board: pooled investments, risk sharing with the smoothing of gains and losses, and some investment options for workers.

De Leon’s bill drew on proposals from academic research and the National Conference on Public Employee Retirement Systems, said a report last month by the Center for Retirement Research at Boston College.

“The NCPERS plan reflected the recognition by public employees that the quality of their own retirement coverage could be at risk if their counterparts in the private sector lack access to a retirement system,” said the report by Alicia Munnell and others.

A letter to the Secure Choice board from the Securities Industry and Financial Markets Association said the Overture study found that “71 percent of uncovered workers” are already saving for retirement.

The association said a state-run plan would be “simply adding a new savings vehicle to an already robust market,” not filling a coverage gap that mainly results from the severe economic stresses on workers.

A coalition of 21 business groups, including the California Chamber of Commerce and the California restaurant and retailers associations, said in a letter that it lifted its opposition to the De Leon bill to allow a feasibility study.

But the business coalition still has a long list of detailed concerns, among them potential employer liability, hidden employer costs, employer and employee education about the plan, enforcement, recordkeeping, and changes in employee payroll deductions.

“The coalition also notes that simple, cost effective private market solutions may be available and yet have not been explored,” said the business coalition. “Perhaps there is a better path to addressing the ‘retirement crisis.’”

At a news conference last week, De Leon said he was interested in the reserve fund, but does not want to “let the perfect get in the way of the good.” He said the Secure Choice board’s financial background will help it collaborate with the Legislature and the governor’s office.

“What we come up with today may not be the product that we will have in two to four years,” De Leon said.