States face a costly future if their citizens fail to save enough for retirement.
By Anna Petrini
Most Americans are not saving enough for retirement. The problem is especially severe among small-business employees, low-income workers and communities of color. On the brink of a national retirement security crisis, state lawmakers are stepping into the breach with a spectrum of innovative solutions.
Retirement planning experts have traditionally used the analogy of a three-legged stool to describe the common sources of retirement income: Social Security, employer-provided pensions and individual savings. But the stool has grown wobbly for many workers, particularly in the private sector. For one, fewer employers offer traditional pensions, which puts the onus on workers to save more themselves. Another issue is changing demographics—people are simply living longer and need to save more money as a result. A third concern: Just how secure is Social Security?
As state officials stare down the prospect of mounting costs if their citizens retire into poverty, they’re looking carefully at how to boost retirement savings. Should they create and facilitate new retirement savings programs for private sector workers or encourage participation in existing plans?
One important consideration is how to take full advantage of the options the private financial services market already offers. It’s a balancing act as legislators try to promote employee savings, limit burdens for employers, and manage legal and financial risks for their states.
“The bottom line is that, by most reasonable metrics, about half the population is not on a path toward a secure retirement,” says Illinois Senator Daniel Biss (D). “And that differentiates this issue from almost any other in our discourse. We have very justified anxiety about costs of health care, about costs of college, about affordability of housing, about a whole variety of standard bread-and-butter middle-class issues. These anxieties are important and these problems are severe and require solutions. I don’t think any of them have the situation where the median family is in serious trouble in the way that we see happening across the country on retirement. … It’s an opportunity to help people on a scale that I think we rarely encounter as policymakers.”
The Scope of a Looming Crisis
Roughly 10,000 baby boomers turn 65 each day. And less than a quarter of them, along with members of Generation X, feel confident they have enough savings to last throughout their retirement years, according to research from the Insured Retirement Institute. Another report, from the National Institute on Retirement Security, found that 3 in 4 Americans are highly anxious about their retirement outlook. The level of concern was consistent across gender, generational and economic lines.
Senator Todd Weiler (R) of Utah notes that not only do a lot of people retire with little savings, many retire with more debt than savings. “As a Republican, this alarms me because I know that if someone retires with insufficient funds, they’re going to be looking to the government as a safety net.”
These fears are not misplaced. According to AARP, half of American households risk financial insecurity in retirement, leaving them unable to afford basics like food, medicine and utilities. Many who have remained solidly middle class throughout their working lives may face financial hardship in their senior years.
About 80 percent of workers between ages 25 and 34, and 48 percent of workers age 45 or older, have less than $25,000 in total savings and investments, according to the Employee Benefits Research Institute’s 2014 Retirement Confidence Survey. Moreover, nearly one-third of households age 55 and older lacked either a traditional defined benefit pension plan or defined contribution retirement savings—like 401(k)s or individual retirement accounts (IRAs)—in 2013. That leaves Social Security as their main or only source of retirement income. Questions about its long-term solvency aside, Social Security was never designed to serve as a retiree’s sole source of income.
State, local and federal policymakers want to ensure that, after a lifetime of hard work, retirees can maintain a dignified standard of living. And it’s going to cost taxpayers down the road if people reach old age without sufficient resources.
Numerous factors are driving the retirement security crisis, from shifting demographics and structural changes in the American workforce to limited financial literacy.
While retirement ages tick up slowly, they are not keeping pace with increasing life expectancies. As a result, Americans have to finance retirement over a longer period of time. They may invest too conservatively, yielding insufficient returns to guarantee a comfortable retirement. Likewise, consumer debt, large or unanticipated expenses, and inflation can all threaten long-term savings. Few workers are sophisticated financial experts; indeed, many lack basic knowledge about personal finance. Even the most determined savers may find the complexities of today’s financial markets difficult to navigate.
Workers are 15 times more likely to save if they have access to a payroll deduction savings plan through their employers, according to one report. But 68 million Americans don’t have access to a retirement savings program at work, the U.S. Department of Labor estimated in 2015. The likelihood of having a workplace retirement plan varies considerably by geography and employer size, not to mention worker earnings, education, race and ethnicity. Those with lower rates of access to on-the-job savings include small-business employees; part-time, temporary and seasonal employees; members of minority groups; and people with low to moderate incomes. Offering such plans may carry costs or burdens that small employers, in particular, are reluctant or unable to bear.
A Spectrum of State Solutions
Since 2012, lawmakers in at least 39 states have introduced legislation to study or create some type of state-sponsored retirement savings program for nongovernmental workers. Task forces in Minnesota, New Mexico, New York and Virginia are examining whether a state role in increasing retirement savings is appropriate and if it would save taxpayer money.
New Jersey and Washington are creating online marketplaces, where small businesses and individuals can comparison-shop for savings plans from financial services providers. These online clearinghouses will be voluntary for employers and employees and are favored by many in the financial industry. Washington plans to roll out its marketplace later this year.
“Washington residents have a significant gap between their actual retirement savings and the amount financial planners recommend,” says Senator Joe Fain (R), who served on the Financial Institutions and Insurance Committee when the Small Business Retirement Marketplace bill was passed by the Legislature in 2015. “More than 1.5 million Washington employees do not have access to retirement savings plans at work. Making it easier for people, especially small-business employees, to access retirement plans creates a more financially secure future.”
Taking a different tack, lawmakers in California, Connecticut, Illinois, Maryland and Oregon have adopted legislation to create state-sponsored retirement savings programs featuring IRAs that receive automatic deposits from workers’ paychecks. These “Secure Choice” programs, as they’re sometimes known as, require employers of a certain size to offer their employees a way to save for retirement at work. Employers who don’t want to sponsor their own retirement savings plans can use the state IRA. It is voluntary for workers, who decide how much to put away and how to invest it. Employers don’t contribute. Secure Choice programs are run via public-private partnership, and employee funds are pooled and professionally invested by the financial industry.
A third approach involves the state aggregating employers who elect to participate to offer a 401(k)-style retirement plan. In January, a study committee in Vermont recommended that the state design one of these voluntary multiple employer plans.
In a final variation, Massachusetts is experimenting with a voluntary 401(k) plan for employees of small nonprofits.
The various plan structures and features have tradeoffs. A voluntary marketplace, for example, is an attractive option in part because it capitalizes on existing retirement plan products and services and could be less disruptive for providers. But it may not yield enough participation to generate significant increases in coverage to make the plan self-sustaining.
Policymakers face a host of tough questions. What is the best way to reach those on the financial fringes—low-income, minority or gig-economy workers? How can states encourage adequate retirement savings without demanding too much of cash-strapped workers, who have little set aside for emergencies. Could employers drop existing plans to send workers into state-sponsored alternatives? Will employees save less as a result? Will small account balances make plan administration inefficient? What is the right type and number of investment options? How many is too many when it comes to ease of use? And what is the appropriate state role for enhancing financial literacy and general investment education?
Another layer of complexity for state lawmakers and regulators, financial services firms and other stakeholders is the constantly shifting matrix of federal law.
Recent Federal Developments
Following failures of pension plans during the 1960s, Congress passed the Employee Retirement Income Security Act in 1974 as a framework of consumer protections for employer-provided retirement, health and welfare plans. It generally doesn’t cover public sector employers, religious institutions or IRAs set up by individuals.
Known as ERISA, the act provides important consumer protections for private sector employees. It also carries regulatory burdens for their employers, who must comply with stringent reporting and disclosure rules, and it imposes fiduciary responsibilities on retirement plan sponsors and providers.
States exploring retirement security legislation have faced uncertainty about the broad federal pre-emption provisions contained in ERISA. In 2016, the U.S. Department of Labor issued several pieces of guidance on how states can address retirement insecurity, including a final regulation meant to provide clarity for states interested in sponsoring auto-IRA plans, such as the Secure Choice model mentioned above. The department followed up with a rule aimed at certain cities and local governments that want to set up similar programs.
The rule for state-sponsored plans provides a limited safe harbor exemption from ERISA if a program meets certain requirements. Among them, employees must be allowed to opt out, and employers, who cannot make contributions themselves, must play a limited administrative role. The rule also requires certain employee protections.
Some members of the financial services industry expressed concern that the regulation creates an uneven playing field in the retirement plan marketplace. Under current Labor Department regulations, private providers cannot offer similar savings arrangements with the types of auto-enrollment and auto-escalation features the department’s recent actions would permit for state-facilitated plans. Other industry concerns relate to unintended consequences, like reduced economies of scale and less incentive for innovation among private providers.
Using the Congressional Review Act, which permits federal lawmakers to roll back regulations from the last months of the previous administration, Republicans moved swiftly during the first weeks of the new session to repeal the Labor Department rules that green-lit state and locally sponsored auto-IRA plans. Citing an unwarranted pre-emption of state innovation, NCSL joined a bipartisan group of state treasurers and other groups in opposing the state rule rollback. As the number of workers who lack sufficient retirement savings grows, the strain on public finances means states need the flexibility to develop creative solutions, NCSL said in letters to the House and Senate in February. President Donald Trump signed the resolution nullifying the rule for municipalities, and as this magazine went to press, he appeared likely to sign the resolution invalidating the state rule as well.
Meanwhile, federal legislation authorizing private retirement providers to offer pooled plans to all employers within a state met with strong bipartisan support when it passed the Senate Finance Committee in 2016 and is expected to be revived in 2017.
Even with uncertainty about the federal legislative and regulatory landscape, and a contentious political climate, some state leaders have vowed to forge ahead with retirement security efforts.
“There is nothing more powerful for financial literacy than when a person opens up that quarterly statement and sees the power of compound interest over time,” says California Senate President Kevin de León (D). “We are creating a generation of new savers throughout the country who will rely less on government. Whether you are a Republican or a Democrat, you will pay the consequences in state budgets when you have to subsidize those who live in poverty as senior citizens.
“Retirement insecurity is a bipartisan issue. It’s an American issue.”
Anna Petrini is a policy specialist in NCSL’s Strategic Initiatives Program.
BY THE NUMBERS
63 — The average age at which Americans retire
$42,797 — The amount the average 50-year-old has saved
$73,857 — The median income of householders age 45 to 54 in 2015
$62,802 — The median income of householders age 55 to 64 in 2015
$38,515 — The median income of householders age 65 and older in 2015
18 years — The average length of retirement
$1,360 — The average monthly Social Security retirement benefit
20% — Portion of Americans who tap into their 401(k) assets early, either through a loan or withdrawal
97 years — The age 30% of today’s 50-year-old women and 19% of 50-year-old men will live to
Sources: U.S. Census Bureau, Kaiser