Wednesday, November 5, 2014

Public Retirement Plans: A Non-Solution Solution

Public Retirement Plans: A Non-Solution Solution

At least three states are actively exploring ways to increase retirement savings among private sector employees through something called “public retirement plans.”  In mid-September the Oregon Retirement Savings Task Force issued a report[1], while the California Secure Choice Retirement Savings Investment Board is seeking candidates to conduct a study, and the State of Connecticut Retirement Security Board is trying to find the funding to conduct a feasibility study. Legislation is pending in about a dozen states to create additional boards to study this issue.

Mainly Democratic State Governors, Treasurers, and Comptrollers are driving these initiatives as a response to the lack of adequate retirement savings in their states.  Here’s the concept.  Employers would be required to offer their employees automatic payroll deductions, which would be linked to a new state agency.  The agency would be empowered to administer and invest retirement accounts for the participating employees.  Employers would not be required to contribute, and the employees would receive the tax benefits usually associated with 401(K)s and IRAs.  Proponents argue that such a system would encourage more people to save, and offer a lower cost solution than the existing retirement products offered through small businesses and directly to individuals.

Businesses are wary of public retirement plans because they fear the additional costs of setting up and administering the payroll deductions.  They also see this as a potential first step toward mandatory employer contributions.  Meanwhile, Wall Street doesn’t seem thrilled about this idea either.  For example, in Connecticut, the home of many financial services firms, the industry has been dead set against it.  While the plans might attract additional pools of retirement savings, the industry seems more concerned about the potential competition.

The industry has a point.  At the moment, many small businesses and individuals pay retail fees to brokerage firms, mutual funds, and administrators for these services.  If Oregon, California, or Connecticut were to launch large investment platforms, individuals might suddenly find that they could enjoy wholesale pricing for virtually the same services.  

Whether or not you think this is a good idea, I don’t think we’ll see public retirement plans in the immediate future.  There are a host of legal issues to be sorted out with the SEC, IRS, and other federal agencies.  There are all sorts of questions about program design.  What kinds of investment options would be offered?  Should public retirement plans offer dozens of mutual fund or ETF choices like a 401(K) or college 529 plan or large common pools?  How would programs deal with the glide path as investors near retirement and seek to reduce risk?  The questions go on and on.  The financial industry has produced all sorts of answers to these questions in other contexts.  However, it’s going to take these commissions a considerable amount of time and money to make the necessary decisions and come up with a comprehensive program.  Moreover, most of the Commissions have to go back to their legislatures for authorization and money if their studies wind up recommending a particular approach to public retirement plans.

Conceptually, this is an attractive idea.  It would be like creating dozens of Vanguards all over the country.  As a big believer in low cost investing, I’d like to see more platforms that could put effective pressure on Wall Street.    While some states might have the political leadership and resources to create public retirement plans, I’d bet that this concept wouldn’t fare well in the average state. 

In my opinion, we already have a public entity that could conceivably do the job:  the Federal Thrift Investment Board, which offers retirement options to federal employees.  It is a high quality, low cost provider of investment services for employees.  However, the idea of using the Federal plan is about as likely as using Medicare as a template for all of our health insurance needs.

In the end, public retirement plans are severely flawed for a more fundamental reason than the potential for state governments to administer them poorly.   Many of the folks who have not prepared for retirement simply don’t have the wherewithal to save.  Study after study has shown that the vast majority of Americans have suffered a loss of inflation-adjusted income in the past several decades.   Setting up additional retirement savings options may be a nice idea.  However, folks have to have enough income in order to forego 3% to 6% of their take home pay.

Note: the Connecticut effort may not go much farther.  The State’s treasurer and comptroller (co-chairs of the Retirement Security Board) are locked in very tight races.  As of this morning, both races are still too close to call.


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