Under the Affordable Care Act, millions of Americans lost the health insurance they liked. Now, the same could happen with their retirement savings.
In August, the U.S. Department of Labor issued a little-known rule that allows states to set up retirement plans for private sector workers. States that do so must also require employers — typically those with five or more employees — that don’t offer their own retirement plan to offer the state-based option.
Employers who provide their own retirement plan incur administrative costs as well as a fiduciary responsibility. To save money and avoid risk, most small and new businesses — and even some large companies — will forgo offering their own retirement plans and opt instead to offer the state-based option.
But a shift to state-based retirement plans will be bad news for workers and taxpayers.
State-based plans will lack important saver protections because they are not subject to the Employee Retirement Income Security Act of 1974. According to the Department of Labor, ERISA regulations ensure plans are “established and maintained in a fair and financially sound manner” and that “employers have an obligation to provide promised benefits.” Yet, the Department of Labor’s rule could shift a significant portion of Americans’ retirement savings into plans that are explicitly exempt from such requirements.
Moreover, employers are forbidden from contributing to state-based plans. Workers enrolled in these plans will lose out on the average $2,640 per year contribution employers make to each worker’s private retirement fund. Even if employers make up for lost retirement contributions through higher pay, that pay will be taxable whereas retirement contributions are tax-free.
Worse, the new rule prohibits workers from accessing or controlling their state-run accounts if the state opts to set up a defined benefit plan. Since many states will require, or at least authorize, companies to automatically enroll new employees into state-based plans, workers could unintentionally have money taken out of their paychecks and put into accounts that they can neither access nor control.
States don’t have a very good record when it comes to managing retirement funds. State and local governments have racked up nearly $5.6 trillion in unfunded pension obligations — and that’s a problem for taxpayers. For example, the retirement fund for Chicago’s public school teachers has an unfunded liability of $9 billion. As a result, for the last seven years, 89 cents of every new dollar for education in Chicago has gone to fund teachers’ pensions — leaving only 11 cents for actual education.
Politicians will find the prospect of establishing state-run private sector pensions incredibly enticing. After all, since workers can’t access or control their contributions, politicians could be free to use them to help finance states’ public sector unfunded liabilities. Moreover, politicians use private pension plans as a way to buy votes, promising excessive benefits to workers and retirees in state-based plans and then relying on future taxpayers to pick up the tab.
Americans need to save more on their own for retirement, and there is nothing wrong with states helping to facilitate greater private retirement savings. But there are serious problems with the new, government-knows-best solution that relies on regulatory favoritism and employer mandates, strips savers of important protections, prohibits employer contributions, eliminates workers’ access to and control over their savings, and allows the private-sector equivalent of public plans that have shortchanged workers and taxpayers by promising far more in benefits than they can afford to pay.
A better solution would be to allow the creation of entirely optional, state-based IRA accounts such as Indiana’s proposed Hoosier Employee Retirement Option. Indiana’s HERO plan would set up portable Roth IRAs on a completely optional basis. But since the plan does not include an employer mandate, it is not allowed under the Department of Labor’s new rule.