States Try to Save Retirement While Washington Waits

An ambitious effort to close one of the biggest gaps in the American system of retirement saving is under way in California. Governor Jerry Brown, a Democrat, is expected to sign into law a program that will provide retirement-savings coverage to the estimated 7.5 million small-business employees in the state who lack workplace plans. The California Secure Choice program will require small-business employers to auto-enroll their workers in an IRA.

The move by the most populous state in the country adds critical mass to a state-level movement to improve retirement security for workers who lack employer plans. “It will be a watershed moment,” says Sarah Mysiewicz Gill, a senior legislative representative at AARP. “States keep an eye on California’s innovation, and this will spur more to go ahead with their own savings plans.”

Some 30 states are considering or developing savings programs to cover their small-business employees, according to the Georgetown Center for Retirement Initiatives. Washington and Oregon are set to launch programs in 2017, while Connecticut, Illinois, Massachusetts, New Jersey and Maryland have enacted legislation to set up plans.

Backers of the initiative include retiree advocates, financial-services companies that manage retirement plans and state officials who want to get ahead of the potential expense of supporting an impoverished aging population. But many small-businesses organizations, which fear the costs and complexity of new regulations, have resisted the notion of a mandate.

Access to an employer plan is the single most critical factor in retirement security, studies show. Without a nudge from an employer and the convenience of payroll deduction, most people simply never get around to putting away money for retirement. In recent years, many companies have boosted 401(k) participation by automatically enrolling new employees and pointing them toward an age-appropriate investment.

Some 90% of workers with an employer plan are saving for retirement vs. just 20% of those without one, according to the Employee Benefit Research Institute. “Having 401(k) auto-enrollment and default contributions is essential in overcoming inertia and making savings happen,” says Harvard public-policy professor Brigitte Madrian, an expert on behavioral finance.

But at any given time, only about half of U.S. private-sector workers participate in a 401(k) or other employer plan, typically those employed by large or midsize companies, the Boston College Center for Retirement Research reports. The other some 55 million employees work for small businesses, which typically do not provide a retirement benefit, or freelance or are self-employed.

Granted, most Americans, even those with 401(k)s, are falling short in their retirement savings. Take the millions of boomers heading into retirement or already there. Half of all households headed by those 55 and older have no retirement savings, a recent GAO study found. Among those who do have some savings, the median amount was just $148,000 for households ages 65 to 74, which is worth $649 a month in annuity income.

Struggling retirees are likely to end up tapping local safety-net programs, which is why many states are attempting to build their own plans. But a state-by-state approach to retirement saving has drawbacks. A patchwork of plans would lack economies of scale, which would make it difficult to keep fees low and deliver higher returns to savers. “I’m delighted that states are taking the initiative,” says economist Alicia Munnell, director of the Boston College Center for Retirement Research. “But it’s silly to have 50 different retirement plans instead of a national auto-IRA plan.”

States don’t have much choice, Munnell notes, since a national plan has been stalled in D.C. for years. A federal auto-IRA, which would require employers without workplace plans to enroll workers in an IRA, was first proposed in 2006 with bipartisan congressional backing. Yet the measures failed to pass. An auto-IRA plan was included in President Barack Obama’s State of the Union speeches in 2015 and this year but never got traction. Obama instead launched the myRA, a federal starter-IRA plan that workers can choose voluntarily.

Still, the growing momentum of state savings plans may spur Washington to finally take action. “There’s surprisingly broad agreement in Congress that we need to pass a new retirement bill,” says Melissa Kahn, a retirement-policy strategist with investment firm State Street Global Advisors. “We’ve reached a tipping point, with more boomers retiring without enough savings, a lower return environment and the push from the states.”

Indeed, the Senate Finance Committee unanimously approved legislation recently that would allow small employers to band together to create so-called open multiple employer plans, which would give their 401(k)s greater economies of scale. “Helping small businesses is a goal shared by both political parties,” says Jamie Kalamarides, senior vice president at Prudential Retirement.

It’s far from clear whether the bill will be passed in Congress’s lame-duck session. And even if that happens, broader reforms are needed, retirement experts say. The last major federal retirement legislation, the Pension Protection Act, was passed a decade ago. That bill gave the O.K. for 401(k) plans to use auto-enrollment, auto-escalation of contributions and broadly diversified portfolios as default investments. But it has not helped workers who lack 401(k)s. “Today more people are working for smaller employers or startups, many of them are younger and earning lower incomes, and the big issue is helping them save even small amounts,” says Diane Oakley, executive director of the National Institute on Retirement Security.

A flurry of proposals to set up new national savings plans have emerged this year. One of the most comprehensive was offered by the Bipartisan Policy Center, which is led by former Republican and Democratic Senators as well as economists and academics. The recommendations include a proposal that would encourage employers that do not offer a retirement benefit to connect their workers with an outside firm that offers retirement accounts.

Financial-services companies, employers and benefit experts are also proposing retirement reforms. A plan devised by State Street Global Advisors would mandate employers to auto-enroll workers into a 401(k). To cushion this requirement, small-business owners would receive tax incentives and options to sign up with open multiple employer plans that would ease reporting requirements. The Brookings Institution, the American Academy of Actuaries and the ERISA Industry Committee, a group representing the benefit plans of the U.S.’s largest employers, have also suggested retirement-plan changes.

But real progress on comprehensive reforms will wait until after a new President takes office. Whoever wins will also face the challenge of fixing Social Security, which remains the most important source of income for retirees. About 25% of Americans 65 or older rely on the program for at least 90% of their income. The trust-fund reserves are projected to run out of money in 2034, according to the latest annual report from Social Security’s board of trustees. After that, Social Security can continue to pay about 75% of its scheduled benefits.

All the more reason to hope state savings plans move forward and push Washington to act. “Historically in the U.S. we don’t make major policy moves without states first experimenting on their own,” says New School economics professor Teresa Ghilarducci, who notes that before Social Security was enacted in the 1930s, some 30 states set up old-age pensions. More recently, health care reform in Massachusetts set the stage for the Affordable Care Act. Perhaps states will end up leading the way in retirement saving too.

Wang is an editor at large at Money magazine