This post was originally published on Zócalo Public Square.
More than 6 million private sector workers in California may be about to enroll in a retirement plan—whether they like it or not.
Legislation signed last fall by Governor Jerry Brown would establish a retirement account for all workers at firms that have five or more employees and don’t already provide a retirement savings plan. The reason for the legislation, known as the California Secure Choice Retirement Savings Program, is that more than 6 million private sector workers in California lack access to an employer-sponsored retirement plan. Some of these workers may be saving on their own, but many aren’t saving at all—greatly increasing the risk that they’ll spend their retirement in poverty.
Consequently, a full third of California’s near-retirees are expected to rely almost exclusively on Social Security benefits in their old age. Seniors in this position are more likely to turn to adult children for support or seek out assistance from other safety net programs. Social Security is a crucial program that has reduced the poverty rate among the elderly dramatically; still, its benefits were never designed to be the sole source of income for our parents and grandparents.
This year, the new retirement plan will be subject to a market analysis to assess its feasibility as a self-sustaining program and to evaluate the specifics of its design. If all goes according to plan, by 2014, those 6 million Californians could slowly but surely get on the path towards being able to retire in dignity at a reasonable age.
An important feature of California Secure Choice is that workers are supposed to be automatically enrolled in the program. The idea is that people will save more if inertia works in their favor. Automatic enrollment, in tandem with default contributions, spares workers from taking the initiative to sign up, fill out paperwork, or make investment decisions. The new plan will take 3 percent of each paycheck.
Many conservatives in California have condemned the plan as intrusive and costly. But, while the plan isn’t perfect, it’s necessary. Many of the attacks on it are based not on its real faults but on misunderstandings of what it would do.
The primary misunderstanding is about the plan’s funding. Some Californians fear that the program will become just the latest burden on taxpayers, much like the state pension funds CalPERS and CalSTRS, which are notoriously underfunded. But California Secure Choice is designed to impose no new costs on the state. Unlike the state’s traditional pension programs, the new plan is set up so workers’ account balances derive entirely from their own contributions, and a guaranteed rate of return will be backed by private insurance. Using private insurance means that, should the fund lose money, neither the state nor participating employers will have to pay up. The tradeoff is that the return on workers’ contributions will likely be modest, since it will be offset by the cost of insurance, but workers are protected against losing money, and taxpayers won’t be on the hook if the fund’s investments underperform.
Now to the real problem: While 3 percent contributions are a great start, a contribution level this low over an entire career—particularly for lower-wage workers—is unlikely to yield a substantial nest egg.
So what can be done? One policy that could strengthen the program is “automatic escalation,” or an automatic increase of the percentage of income workers contribute each year or with each pay raise. These incremental increases help workers save more without even realizing it.
Another possibility would be to limit the option of a guaranteed rate of return to older workers—those who can least afford to take a risk—while permitting younger participants to make riskier investments that could result in higher returns. This approach would also cut insurance costs.
Of course, retirement savings are only one piece of the financial security puzzle. Last year, Americans took out $70 billion from their retirement accounts in early withdrawals, mostly just to pay for everyday expenses. Since families need savings both for the present and the future, another kind of automatic savings plan—workplace emergency savings programs—could help workers save for short-term purposes.
Whatever approach we take, however, automatic savings plans like the California Secure Choice Retirement Savings Program should be part of the picture. They have the potential to democratize retirement and give all Californians a supplement to Social Security. A secure retirement shouldn’t be a privilege of the wealthy.