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News & Press: CalAdvisor Newsletter

California Unveils Blueprint for Payroll-Deduction IRA

Friday, February 12, 2016   (0 Comments)
Posted by: SF Chronicle
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The board created to design a state-sponsored retirement plan for private sector workers in California unveiled a blueprint for such a plan on Wednesday.

The plan was authorized by a bill passed by the Legislature in 2012. The goal was to create a simple retirement plan for the estimated 55 percent of California workers whose employers don’t offer one. Employers with five or more workers in California that don’t offer a plan would be required to automatically enroll their workers in the state-sponsored plan, although workers could opt out.

SB1234 created the Secure Choice Retirement Savings Investment Board to set the wheels in motion. The nine-member board hired Overture Financial of New York to conduct a financial feasibility study, market analysis and design such a program. Overture delivered its final report to the board Monday, and the board made it public Wednesday. It will hold public hearings on the plan March 1 in Los Angeles and March 3 in Oakland. On March 28, it will make recommendations to the Legislature, which would have to pass another bill implementing the plan.

About half of states are considering setting up their own retirement plans that would be similar, in some respects, to state-sponsored 529 college savings plans. California is one of six states that have passed laws to begin crafting retirement plans.

Under Overture’s plan, an employer with at least five California employees that did not offer a retirement plan would have to automatically enroll workers in a state-sponsored Roth IRA, unless they opt out. There would be no waiting period to enroll in this Secure Choice IRA.

Contributions would come directly out of workers’ paychecks. Employers could not provide matching contributions as they can with 401(k) and other defined contribution plans.

The default contribution rate would be 5 percent of pay, escalating by one percentage point each year until it reached 10 percent, but “only if this can be coordinated by the recordkeeper, without any need for employers to track employee hire dates,” the 518-page report said.

The initial default investment vehicle would be “a diversified portfolio with long-term growth potential and the choice to opt into a low-risk investment.” The diversified portfolio would be similar to target date funds that become more conservative — by investing less in stocks and more in bonds — as an employee get closer to retirement. The state could set up its own proprietary funds or use ones offered by fund companies.

As with all IRAs, contributions would be limited to $5,500 a year, or $6,500 for employees age 50 or older. With a 401(k) plan, the contribution limits is $18,000, or $24,000 for those 50 or older.

As with all Roth IRAs, employees would not get a tax deduction for money they put in, but the money would grow tax free. But here, the rules start to diverge.

With a regular Roth IRA, investors can withdraw the amount they contributed at any time, for any reason, without paying tax or a penalty. Earnings on the account can also be withdrawn at any time and will also be tax free if the investor is at least 59½ years old and the account is at least five years old. If those two requirements are not met, the earnings portion of the withdrawal will be subject to income tax and a 10 percent penalty.

However, to discourage employees from raiding their IRA before retirement, the Overture plan would “limit preretirement withdrawals to hardship.” It does not elaborate on what constitutes a hardship, and the report’s author did not return requests for comment. The board’s acting director, Christina Elliott, declined to comment on the report.

Still, the report does say, “survey and focus group responses indicate that a significant share of eligible workers would be disinclined to participate if they cannot access their funds in emergencies.”

The report says that participants’ fees would not exceed 1 percent of invested assets and could decline after the first five years of operation.

While a 1 percent fee is not exorbitant, it’s no bargain either.

Federal employees participating in the government’s Thrift Savings Plan paid 0.29 percent in fees last year. Investors in California’s Scholarshare 529 college savings plan pay fees ranging from nothing (on the guaranteed option) to 0.59 of a percentage point.

The new myRA account, a Roth IRA for beginning investors, charges no fees, but it’s invested entirely in a government bond and must be transferred to a financial institution once it hits $15,000.

The report estimates that the new plan would cost the state $73 million in the first year and break even by the fourth year.

The state’s Secure Choice IRA is supposed to be easy as pie for employers. In fact, the plan could not go forward if it would be treated as an employee benefit plan under the federal Employee Retirement Income Security Act.

In November, the U.S. Labor Department issued a proposal that said state-sponsored auto-enrollment IRAs would not fall under that act, as long as employees could opt out and employers “are minimally involved. For instance, employers would make the automatic deductions from employee paychecks, but the employees and states would retain control of the program and IRA accounts.” That proposal would still need to be made final before California could implement its plan.

Although many Americans, especially lower-income workers, are woefully unprepared for retirement, it’s not clear that another retirement plan is the answer. Workers without an employer plan can already contribute to a regular or Roth IRA, or the new myRA. Many financial institutions will automatically deduct contributions from a worker’s paycheck or checking account. But setting it up requires effort on the part of the employee. Boosters say auto-enrollment is the key to getting more workers to save on a regular basis.

But “no matter how simple they say it’s going to be, I think it’s another burden on a small business,” said Ed Slott, who makes a living explaining IRAs to financial advisers.

“It reminds of the time they came out with the Simple IRA,” which was designed for small businesses. “It turns out to be the most complex of all the IRAs,” Slott said.

“They are trying every which way to get people to save for retirement. The idea in theory is good.” But even with minimal involvement, employers would still have to deal with employees who want to participate one week but not the next, who leave the company, who take money out and get hit with a penalty and who lose money and wonder why. “And I’m sure there will be penalties from the states and potential lawsuits if something isn’t filed on time.”

Indeed, the report suggest instituting “an easy way for employees to report noncomplying employers to the state.”

Kathleen Pender is a San Francisco Chronicle columnist. E-mail: kpender@sfchronicle.com Twitter: @kathpender


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