How state Auto-IRA legislation may affect employers
Several states are considering adopting legislation that would require private (that is, non-governmental) employers that do not provide a retirement plan for their employees to adopt some sort of retirement program – typically, an ‘auto-IRA.’ These proposals generally do not cover employers who already have a plan. But, depending on how they deal with uncovered groups and uncovered employees (e.g., part-time or seasonal employees) and minimum standards for ‘what is a plan,’ they may wind up applying even to large plan sponsors.
In this article we review three such initiatives – the National Conference on Public Employee Retirement Systems (NCPERS) Secure Choice Pension (SCP) proposal, the California Secure Choice Retirement Savings Trust Act and the Illinois Secure Choice Savings Program Act. Since the state legislation is still un-implemented (the Illinois bill has only passed the Illinois Senate) and vague on many details, we generally focus only on issues that directly affect employers.
Many of the state proposals have names like ‘California Secure Choice,’ ‘Illinois Secure Choice,’ ‘Maryland Secure Choice,’ etc., reflecting roots in the National Conference on Public Employee Retirement Systems (NCPERS) ‘Secure Choice Pension’ proposal. Most of these state proposals differ significantly from the NCPERS SCP, but given the role of NCPERS and of individual state pension administrators in moving these proposals, it is worth briefly considering the NCPERS proposal.
Generally, the NCPERS Secure Choice Pension would –
Cover employees of private employers that do not maintain a retirement plan.
Provide a cash balance benefit – a 6% pay credit and interest credits based on the yield on 10 year Treasury bills plus 2%. (The current yield on 10 year Treasuries is around 2.5%, equaling an interest crediting rate of around 4.5%.)
Pay benefits in the form of a life or joint and survivor annuity. The SCP would take a ‘variable annuity’ approach to the amount of the benefit – that is, positive/negative experience could in certain circumstances result in an increase/decrease in the benefit.
Be funded by employers.
NCPERS contemplates that the SCP would be generally subject to ERISA (with some tweaks) and (apparently) would be qualified under Tax Code section 401(a).
The NCPERS SCP is very clearly intended to leverage the skill and ‘buying power’ of state pension funds:
Although the SCP would be a separate trust and have a separate administrative board, the assets of each SCP generally would be invested in tandem with the assets of one or more designated state retirement systems identified in the enabling legislation, particularly at the onset of the SCP.
We note that, perhaps understandably, the NCPERS has a view of public pension funds that not all would share:
Public pension plans stand out as a potential model. Such plans have a successful track record of performance in delivering adequate benefits in a sustainable and efficient manner.
We’re going to look at two state proposals – the California Secure Choice Retirement Savings Trust Act, which was signed into law in September 2012, and the Illinois Secure Choice Savings Program Act, which passed the Illinois Senate in April 2014.
State legislation is very much a work in progress. The bill enacted by the California legislature is vague on a number of key issues and its implementation is contingent on a number of factors. The Illinois law is marginally more definite (with respect to, e.g., investment options), but it has only passed the Illinois Senate. We are going to briefly describe the basic features of these state proposals and consider their effect on employers. We are not going to go into detail on the benefit structure/investment options/payout options/etc. (all of which are, to some extent, moving targets).
Basic features of state proposals
While both these state legislative efforts have ‘Secure Choice’ in their titles, they differ radically from the NCPERS Secure Choice Pension. The California and Illinois programs –
Are employee-funded IRA arrangements – not employer-funded cash balance plans.
Adopt an automatic enrollment/opt out rule similar to federal auto-IRA proposals, with a default contribution rate of 3%.
Do not appear to anticipate any required employer funding.
Cannot be implemented if they are covered by ERISA.
So these states have rejected the basic cash balance design of the NCPERS SCP proposal in favor of an auto-IRA approach. What they have kept is the idea of leveraging the state pension infrastructure to provide scale and “an efficient product to enrollees by pooling investment funds.”
Effect on employers
For employers trying to determine whether and how this push for state legislated retirement programs will affect them we would identify the following features of this legislation:
Both the California and Illinois proposals are mandatory. If the employer is covered it must provide an auto-IRA arrangement.
Employers covered by the mandate. The California proposal covers all employers with 5 or more employees “that do not offer an employer sponsored retirement plan or automatic enrollment payroll deduction IRA.” The Illinois proposal covers all employers that have: (1) 25 or more employees; (2) been in business for at least 2 years; and (3) “not offered a qualified retirement plan, including, but not limited to, a plan qualified under Section 401(a), Section 401(k), Section 403(a), Section 403(b), Section 408(k), Section 408(p), or Section 457(b) of the Internal Revenue Code of 1986 in the preceding 2 years.”
We assume our readers are at companies that already maintain a retirement plan. So, on a superficial reading, they would be exempt from the mandate in this legislation. There are in this connection, however, issues that have been raised in federal auto-IRA legislation but have not, so far, been fully addressed at the state level:
What sort of employer retirement plans avoid application of the mandatory auto-IRA rule? Senator Harkin’s (D-IA) USA Retirement Funds and some federal auto-IRA proposals have set minimum standards for what sort of employer plans get employers out of the mandate. The California and Illinois proposals don’t address this issue in any detail. Current language would seem to allow employers to avoid the mandate with even the simplest retirement program. But as more attention is focused on this issue, that approach may change.
How do you treat ‘uncovered’ groups? Is it sufficient, to avoid application of this legislation, to have, say, a 401(k) plan for location A, even though there is no plan at location B?
How do you treat ‘uncovered’ employees? Both proposals define ‘employee’ broadly – there are no exceptions for, e.g., part-time or seasonal employees. Must these employees be covered by the state plan? Right now, it’s unclear.
Obligations of a covered employer. At least in California and Illinois, if the current proposals were adopted, generally all covered employers would have to do is set up a payroll deduction facility and administer an automatic enrollment program.
Federal policy issues
One way to think about the state retirement plan initiatives is that advocates of auto-IRA have given up on getting action at the federal level and have turned to the states to implement a program to cover the ‘75 million American workers’ not covered by an employer-sponsored retirement program. In that regard, it’s worth considering the following:
Revenue impact. One of the main reasons (perhaps the main reason) auto-IRA proposals have not gotten anywhere in Congress is not left vs. right issues but budget issues and revenue loss. Of course, auto-IRA doesn’t change the tax structure, it simply gets more workers to save. But that results in more tax deductions/exclusions and reduced revenues. An end run (via the states) around Congress on this issue will, in the states that adopt auto-IRA, have the same result: reduced federal revenues. That may force some sort of Congressional action. If these state programs catch on, it’s not inconceivable that, to make up lost revenues, Congress will look at reducing tax benefits for retirement savings – perhaps along the lines of the Administration’s and Congressman Dave Camp’s (R-MI) proposals to cap retirement savings deductions/exclusions for high earners.
Preemption. One nagging question is whether these state programs are unenforceable because of ERISA’s broad preemption provision. This is a technical issue, and we’re not going to review the substance of it here. We note, however, that both the California and Illinois proposals are conditioned on ERISA not applying, and their IRA-based structure is designed to avoid application. In this regard, any state attempt to set ‘minimum standards’ for retirement plans (i.e., minimum standards for the kind of plan that gets you out of an auto-IRA mandate) may well raise preemption issues. So, if states are determined to avoid ERISA coverage, they may also avoid setting such minimum standards.
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It’s understandable that some employers may ask: wasn’t ERISA supposed to federalize retirement policy? The perceived problem of 75 million ‘uncovered’ workers and Congressional inaction has inspired advocates of auto-IRA to get creative – to find state legislatures that are willing to act. Depending on how it is drafted, this legislation may or may not create issues for sponsors that already have a retirement plan. In that sense, the devil may (as they say) be in the details of each state’s law.
This effort is in the very early stages. But it looks like we are likely to get something definite – probably out of California – relatively soon. As these proposals become law and are implemented, we will cover them in more detail.