Until recently, the “three-legged stool” was the reigning metaphor for achieving retirement security. Workers could anticipate being supported as they aged by a combination of Social Security benefits, private pension income, and personal savings. This model no longer holds. Traditional pensions have almost disappeared from the private workforce, personal savings are low, and Social Security benefits face political and actuarial threats. The new model relies on defined contribution (“DC”) plans like the 401(k). Unlike yesterday’s pensions, also known as defined benefit (“DB”) plans, which based monthly benefits for life on earnings and time served, DC plans derive their value from employee and employer contributions, which are governed by a set of tax rules and limits.
Unfortunately, roughly half the private workforce does not have access to these DC plans because their employers choose not to offer one. Still, for many with access, their accumulated assets will not adequately replace their incomes. Without policy changes, the transition to a 401(k)-based system is on its way to becoming a failed social experiment.
The state of California has recently embarked on crafting a response. In September 2012, the state legislature passed Senate Bill 1234, which created the California Secure Choice Retirement Savings Program. California Secure Choice (“CSC”) would establish automatic retirement accounts for all workers in the private sector who do not otherwise have access to a workplace retirement plan. In California, over six million workers fall into this category. The new program is aimed at reducing disparities in retirement saving and shoring up the three-legged stool. Some of its key features include:
- Automatic Enrollment and Contributions – All workers at firms of five or more employees will be automatically enrolled in the program, with the option to opt-out. Participants’ default contribution to their accounts will be 3% of each paycheck, though they can adjust this contribution level at any time.
- Portability – CSC accounts will be fully portable, which means that workers can move from job to job while maintaining their accounts. This feature reduces the likelihood that workers will cash out these accounts and have to start from scratch during a career change.
- Pooled Investments - CSC relies on a pooled investment structure to leverage economies of scale, reduce insurance and management costs, and increase efficiency.
- Self-Financing – The program is designed to be self-financing, with all administrative costs paid from workers’ contributions. There should be no new costs for the state, and employers are tasked solely with providing their workers with the information packet about the program and enabling contributions through their existing payroll structures.
- Guaranteed Rate of Return - A unique feature of CSC that sets it apart from other universal account proposals is its guaranteed rate of return, which would be made possible through the use of private insurance. Although the level of the guarantee will be modest, this provision ensures that workers can feel confident that any contributions they make will grow over time.
This issue brief explores the inequities and shortcomings of the current retirement system; outlines the effort in California to reduce these inequities through universal accounts; and offers additional policy considerations for both the California initiative and the national retirement savings framework.
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