In Great Britain, standard nomenclature for describing retirement plans is to refer to them as pension “schemes.” The word “scheme” in the British context is in no way derogatory and conveys no sense of skullduggery the way it does in this country.
A new California law intended to increase employees’ voluntary retirement savings sounds good on paper, but the success of the state-run “Secure Choice” program will hinge on practical reality -- or rather, “the devil will be in the details.”
Employers with five or more workers who currently offer no retirement plan will be required to set up automatic per-pay-period voluntary retirement plan deposits, except where an employee signs a waiver opting out of the plan. In today’s 401(k) world, this concept has been around for years and is referred to as “negative enrollment.”
It works. People who have money saved for them by default will shrug it off and accept it rather than sign a form saying they do not agree to have, say, 3 percent of each paycheck socked away in a retirement plan.
What we know about human behavior is that people will agonize over something and wind up doing nothing. Retirement plan paperwork can gather dust, and a pen used to sign up for a disciplined savings program might as well weigh 50 pounds. But major forces in the traditional 401(k) business, such as Fidelity, learned long ago that automatic enrollment increases plan participation by almost 50 percent. It’s a behavioral economics trick that works.
While the California program will apply to companies of all sizes that do not currently offer 401(k) plans, it is rare that companies of more than 25 people don’t already do so. So this law will be aimed at small (under 25 employee) companies that, by the way, employ roughly 90 percent of all workers nationwide -- though for our purposes we can exclude companies with under five people.
A further advantage is that these plans will have no requirement to adhere to complicated IRS and Labor Department legislation. Current laws that force employers to make matching contributions or otherwise limit what highly compensated employees and owners can contribute will not be applicable to Secure Choice.
As for investment selection, there will initially be just one -- a government bond fund. Within three years, there will be other investment choices that involve common stocks but whose downside will be protected, in part, by a side fund or “reserve account.” So here is where the proposed scheme threatens to run up on the rocks.
Any effort to guarantee results -- or even minimize them to a limited extent -- opens the door to victimization on the part of financial organizations who make the promise. The cost of buying protection against the downside is always much higher than the value of the protection itself. This is why variable annuities that “always promise to give at least your money back” are such a rip-off -- and such a feeding trough for companies that sell them.
To see the state of California wading into what could be a quagmire of complicated decision-making -- conducted by self-interested financial service companies and a board of political appointees -- doesn’t strike me as being a value-added proposition. Taxpayer startup costs are reputed to be roughly $89 million, which would be recovered as the fund accumulates $3 billion in the first year and $28 billion by year six. Dream on.
Furthermore, here’s a simple example of how things can go wrong: Today, a major financial organization had set up dozens of 401(k) plans with a negative enrollment feature -- and then was found to have failed to monitor whether the money was actually being automatically deposited for employees who didn’t waive out. It hadn’t been, so people who assumed they had 3 percent or more automatically contributed have nothing. The law is clear that an employer is liable and has to contribute what should have been deposited by default into the plan by the negative-electing employee -- plus interest Wait until similar glitches strike this noble experiment.
Assuming that all goes well, it’s good for everyone to be saving more. An unintended consequence, moreover, may be small employers with no plan could be prompted to adopt a conventional off-the-shelf private plan. They would argue that the hassle factor and expense of these plans is less burdensome than dealing with the Secure Choice mandate with its questionable investments and costs to participants.
Don’t get me wrong. I wish this program well and hope that 10 years out we don’t look back at what turned out to be what we refer to as a “scheme” in this country.