In 2012, Senator Harkin (D-IA), Chairman of the Senate Health, Education, Labor and Pensions Committee, released his USA Retirement Funds proposal. The proposal addresses a number of issues that remain current, e.g., coverage, 401(k) participation by low wage employees and the efficiency of the current 401(k) system.
Senator Harkin is retiring from the Senate in 2014, and this proposal is widely considered his ‘legacy’ contribution to the ongoing search (by some, at least) for a better retirement plan paradigm. His proposal is both interesting in itself and as a resource of ideas for improvements to the current system.
At this point, the proposal exists only in summary form — no bill has been introduced. So our discussion of it will necessarily be a little short on specifics. You can read the proposal here: http://www.harkin.senate.gov/documents/pdf/5011b69191eb4.pdf.
In this article we summarize the proposal and provide a (preliminary) evaluation of it.
The USA Retirement Funds proposal would, generally, provide for automatic participation (default in/opt out) of employees not covered under a current defined benefit plan or defined contribution plan (with automatic enrollment and a match) in a new USA Retirement Funds system – a system of collective trusts providing (generally) a DC-type benefit payable as an annuity at retirement. Here are the details:
1. Coverage. The program would generally cover all employees of employers that do not maintain a DB plan or a DC plan with automatic enrollment and a match.
Some obvious issues: What about young or short service employees? Non-covered groups? Part-time and seasonal employees? We assume the general bias would be towards ‘covering the uncovered,’ so we would expect that a USA Retirement Funds arrangement would generally have to be set up for these employees (unless they are already covered under a current plan).
2. Automatic enrollment. The program would default employees into the program at a specified contribution rate. It’s not clear what that rate would be. We would assume it would be at least 3% of pay; and we would assume that backers of the proposal are at least considering an automatic escalation proposal. Employees would at all times have the right to increase, decrease or opt out of contributions.
It’s unclear whether any employer contribution would be required. The proposal summary does say that employers would be obligated to “make modest contributions,” but there is no direct discussion of this issue.
‘Low-wage’ workers would get a refundable tax credit, which would be contributed to the fund. As we understand it, as in 401(k) plans, contributions would be excludable from income or subject to ‘Roth’ rules.
3. Investment. Contributions would be paid into a USA Retirement Fund chosen by the employer, or if none is chosen, the “‘default’ fund identified for the region, industry, or through collective bargaining.”
The USA Retirement Fund is one of the key concepts of the proposal. Similar to Australia’s superannuation funds:
One of the problems this proposal seeks to solve is the difficulty small- and medium-sized employers have in, e.g., choosing investment managers and constructing a 401(k) plan fund menu, choices that the Department of Labor is currently trying to regulate through the ERISA fiduciary rules. Under Harkin’s proposal, however, “employers would not have any fiduciary responsibilities in selecting, administering, or managing the funds.” This will certainly be an appealing feature for many employers.
4. Benefit. The benefit paid would be an annuity beginning at retirement, with survivor benefits. The amount of the benefit would be determined based on the total amount of contributions by and for the employee and investment performance over time. The calculation of the benefit is somewhat unusual:
This sort of approach is similar to the approach used, e.g., in the Netherlands ‘collective defined contribution plans.’ It presents an interesting solution to the challenge of achieving efficient investment performance while paying retirement benefit, in volatile times. In an economy that is ‘simply cyclical’ — where there is no long-term trend up or down in returns — it should work. But in the context of long-run declining returns it may be problematic.
The proposal addresses a number of issues that are being tackled separately by different groups of policymakers. The published description of the proposal acknowledges that the coverage rules – automatic/default payroll deductions for employees not covered by any plan – are “similar to the administration’s proposal to establish automatic workplace pensions.” The tax credit ‘match’ for low-wage employees is also similar to Administration Saver’s Credit proposals and to a proposal in legislation recently introduced by Congressman Neal (D-MA).
The administration of these programs, at the sponsor level, looks a lot like what is envisaged in the Administration and Neal proposals. Like advocates of those proposals, the USA Retirement Funds proposal describes this as relatively easy: “Enrolling employees in a USA Retirement Fund would utilize existing payroll withholding systems, so it would involve little, if any, additional administrative burden ….” Perhaps. But experience with 401(k) plans is that nothing is easy when you are dealing with hundreds of thousands of accounts.
USA Retirement Funds
The concept of a new sort of ‘multiple employer collective fund’ is innovative. It is a creative solution to the small- and medium-sized employer fiduciary problem. To characterize that problem in its simplest terms, there is concern at DOL and amongst participant advocates that fees in the small- and medium-sized employer market are too high, investment fund lineups are ‘sub-optimal’, and that conflicts of interest among recordkeepers, consultants and mutual fund companies are the cause. (On this issue, see, for instance, our articles Recent studies on rollovers identify emerging issues and How efficient is the 401(k) system?)
As noted, the USA Retirement Funds concept is modeled on the Australian superannuation fund program. That program seems generally to have worked. There is the possibility, if the USA Retirement Funds proposal were fully implemented, that it would cannibalize current 401(k) programs, especially in the small- and medium-sized employer market. As noted, the relief from fiduciary responsibility it promises would be welcomed by many employers (conceivably even some large ones).
This last point raises, however, an interesting ‘meta’ issue: where will these collective funds come from? Will current mutual fund providers (with their pre-built investment management infrastructure) enter this market, even if it means cannibalizing their (conceivably more profitable) mutual fund business? If not, are there enough non-mutual fund financial providers willing to create the infrastructure necessary to get these funds off the ground?
Two final questions, though, about these new funds. First, there is the possibility that a “board of trustees consisting of qualified employee, retiree, and employer representatives” may make decisions based on non-financial issues. The question is, will this ‘diverse accountability’ approach – with employee, retiree, and employer trustees – produce better results than the current system (which has its own problems) of the employer by itself or (conceivably) with a consultant?
Second, the creation of this brand new sort of investment fund – which, if successful, would control (conceivably) trillions of dollars of capital – would require the further creation of some sort of government and compliance bureaucracy to regulate it. The proposal states that “USA Retirement Funds would be subject to stringent transparency requirements and would be required to regularly provide information on investment performance, funding levels, and the projected level of retirement benefits based on contribution levels.” That, of course, brings into play its own set of politics. And it is not inconceivable that one (or more) of these funds might become insolvent, e.g., as participants en masse move their (fully portable) accounts out of an underperforming fund. Moreover regulatory compliance (however good an idea the regulations are) inevitably increases costs and creates barriers to entry for smaller providers.
Improving low-wage workers’ retirement savings, prohibiting leakage and annuities
Another ‘meta’ problem: as the proposal states, “it is nearly impossible for low-wage workers to save enough for retirement ….” The 401(k) system addresses this problem by tolerating a high level of leakage, via hardship withdrawals, loans and lump sum payouts at termination of employment. One of the really shocking statistics, in this regard, is that, according to the Government Accountability Office, IRS takes in $5 billion annually in early withdrawal penalties.
The USA Retirement Funds proposal would apparently allow none of this: the participant has to wait until retirement, at which point he or she gets an annuity. There would be a refundable tax credit ‘match’ for low-wage employees — but if the employee cannot afford to save for retirement (which requires locking up savings for 20 or 30 or 40 years), will that matter? Many employers currently provide significant matching contributions and still have employees that do not participate. Moreover, while ‘nudge’ (default contribution) policies have been very effective in encouraging participation generally, it’s an open question whether at lower income levels, where saving is much more difficult, they can really move the needle.
Finally, there is the question of cost vs. benefit. The proposal envisions (1) a new participant contribution infrastructure (albeit piggy-backed on the current payroll deduction infrastructure), (2) a new investment management infrastructure with accompanying bureaucracy, (3) a significant increase in tax-favored retirement savings (without which the entire project would be a failure) and a resulting increased tax expenditure, and (4) refundable tax credits, another, likely very costly, tax expenditure. Will the benefit – in additional retirement savings and (conceivably) a more efficient (i.e., less costly) investment management paradigm – be worth it? Possibly, but it’s not yet clear that it will.
The proposal is, however, a significant contribution to the current debate over what is the optimal retirement savings paradigm. And we would single out the idea of a new type of investment fund, the selection of which would relieve employers of “virtually all” fiduciary liability, as a particularly intriguing idea.
We will continue to follow this issue as it develops.