California Pioneers Pension for Private Workers

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Headshot of Alicia H. Munnell

is a columnist for MarketWatch and director of the Center for Retirement Research at Boston College.

California Takes First Step to Cover Private Workers Without Pensions.

The private sector has an inadequate retirement system.  It is too small and too risky.  With the decline of defined benefit pensions, most private sector workers will end up with Social Security and the balances in their 401(k) plans.  In 2010, according to the Federal Reserve’s Survey of Consumer Finances, the median 401(k)/IRA holdings for households that had a plan and were approaching retirement (age 55-64) was $120,000.  (IRA balances are included because the bulk of the assets in these accounts have been rolled over from 401(k) plans.)  Moreover, at any moment in time, only 42 percent of private sector workers have any form of employer-sponsored pension, be it defined benefit or 401(k).  Some of these individuals will pick up some coverage along the way, but a full one-third of households will have nothing but Social Security.

State and local employees have nearly universal coverage under defined benefit plans, despite some recent moves to introduce a defined contribution component.  Public employees recognize that their counterparts in the private sector may feel that public pension benefits are too generous relative to private sector benefits and, therefore, public pensions should be scaled back. 

Therefore, the future security of public sector workers hinges on private sector workers having access to a retirement system that ensures adequate retirement income.  In response, the National Conference on Public Employee Retirement Systems (NCPERS), the largest trade association of public sector funds, released a proposal in 2011 to build on the public sector infrastructure to provide a plan to uncovered workers in the private sector.  That proposal provided the impetus for recent California legislation.

Governor Brown recently signed legislation that creates a California Secure Choice Retirement Savings Trust, authorizes a major feasibility study, and seeks approval from federal regulators.  The Department of Labor must determine that the California law is not preempted by ERISA and the Internal Revenue Service needs to rule that the contributions to the retirement plan could be made on a pre-tax basis.  While the final legislation only provides for a study and requires another bill to specifically authorize such a program, it is an exciting notion that innovation may occur at the state level. 

The goal of the proposal – should it pass all the hurdles and a second bill is enacted – is to create a plan for California’s private sector employees who have no retirement coverage at work.   Eligible employees would have 3-percent of pay deducted from their earnings unless they opt out.  The state would collect their money and hand it over to professional investment managers selected by the state through a competitive bidding process.  The managers could be either private sector firms or the California Public Employees Retirement System (CalPERS).  The plan also calls for a minimum guaranteed return to be purchased in the private sector.  Since private sector firms cannot guarantee more than the riskless rate without enormous expense, the guarantee would be modest.  The whole program would be overseen by a seven-person board, consisting of the state treasurer, director of finance, comptroller, and four people appointed by the governor and the legislature.  

Although opponents have tried to link the proposed plan to public pensions – which  face serious financial challenges, especially in California – it is essentially an automatic IRA that would not cost the state a dime. 

The California proposal is important for two reasons.  First, it draws attention to the fact that the majority of private sector workers are not covered by any type of employer-sponsored plan and takes the first step to solve the problem.  Second, if finally enacted, it would be very efficient in that it uses automatic enrollment to maximize participation and professionally-managed pooled investments to minimize administrative costs and the risk of making investing mistakes. 

It is an exciting initiative.  If it works, more states may take on the retirement crisis.