Frustrated States Push to Fill Small-Business Retirement Gap

A new game of chicken is underway between states and the federal government and, so far, it appears the states are winning.

This time, the fight is about how best to shore up the country's retirement system.

At the federal level, Sen. Tom Harkin, D-Iowa, has advanced legislation to deliver retirement plan access to more than 50 million Americans in the private sector without a plan. Sen. Marco Rubio, R-Fla., raised the hacklesof many in his party earlier this year when he suggested those without an employee-sponsored plan be allowed to enroll in the federal Thrift Savings Plan, which is available to members of Congress.

Neither proposal has seen much traction, largely because of partisan battles in Congress. Rather than sit idly by, state lawmakers across the country are pushing retirement security to the front burner.

According to the Pension Rights Center's website, 17 states are at some stage of legislating state-administered plans that hope to deliver retirement plan access to the country's smallest employers.

Among them, Maryland, Connecticut and Illinois have either set up a commission to study creation of statewide retirement programs or taken early steps to create such programs.

Nebraska has held hearings examining the state of its private-sector employees' retirement readiness. Indiana is moving forward, too, as are Arizona, Colorado, Minnesota, Ohio, Oregon and Vermont.

In a recent blog post, Invesco Consulting senior analyst Jon Vogler provided a snapshot of the latest three state initiatives:

In Connecticut, a panel is evaluating whether state-run automatic individual retirement accounts or other retirement programs could help increase savings. The panel is expected to issue an interim report by May.

In Illinois, legislation has been introduced that would require employers who have 25 or more employees but don't offer a retirement plan to automatically enroll workers in a Roth IRA with a 3 percent payroll deduction.

In Maryland, a retirement program task force was established after a lawmaker wrote a bill requiring employers with at least five employees who don't offer a retirement plan to establish an automatic 3 percent payroll deduction into a retirement plan.

Furthest along in these efforts is California. In September of 2012, Gov. Jerry Brown signed the Secure Choice Retirement Savings Trust Act into law. Eventually, it will require all businesses with five or more employees that don't currently offer an employer-sponsored plan to enroll their workers in a plan based on the IRA model.

The law is designed to place as little responsibility on employers as possible. Their primary requirement would be to use payroll-deduction systems to see that about 3% of employees' compensation is deferred to the state plan. Employers would assume no fiduciary liability for the plans' performance.

What may be most concerning to the financial services industry is that the new California funds would be managed by CalPERS, the state employee pension fund in California.

Former Minnesota governor and Republican presidential candidate Tim Pawlenty, who now runs the Financial Services Roundtable, recently called California's and other states' efforts an "existential threat" to the financial service industry.

Tonnie Wybensinger, VP for government affairs at the Washington D.C.-based organization, says whether the retirement system is, in fact, "broken" is up for debate.

"There's no doubt that Americans aren't saving enough," said Wybensinger. "(But) there's also no doubt that employer-sponsored plans have been beneficial to the country's middle class. 401(k)s have brought middle-income earners into the investment class."

She says that the Roundtable's lobbying efforts focus on the question of choice.

"We very much are advocates for simplifying 401(k) implementation to make it easier for small employers to offer plans. But we're also for options," she explained. "That's what we feel the state plans don't offer. Saving for retirement shouldn't be a static process. Peoples' needs change throughout the course of their careers. The state plans offer limited options. And there is no aspect of them that brings the option of advisory services to employees."

On the other hand, even a limited option is arguably better than no option at all.

Data varies, but according to Sharholder 401(k), a provider of plans to small businesses, only 24 percent of employers with fewer than 50 employees sponsor a retirement plan.

U.S. Census data shows that 19.6 million Americans work for companies with fewer than 20 workers.

Wybensinger says that the Financial Services Roundtable is initiating a new campaign to address small employers' concerns over the cost, and risk, of implementing 401(k) plans.

"We believe the benefits far outweigh the costs," added Wybensinger. "It's incumbent upon industry to show all employers why."

Just trying to keep the lights on

Charles Nelson partially agrees with the Financial Services Roundtable.

As president of Great-West Retirement Services, he recognizes a need for regulatory change, but sees the movement to create state-run retirement plans as regressive. The Denver-based retirement arm of Great-West Life and Annuity Insurance Co. is now the second-largest retirement plan record-keeper in terms of participant accounts.

The problem, according to Nelson, is that the benefits of offering a plan may not outweigh the costs to small businesses.

"When you are talking about small businesses — and I mean those with fewer than 25 or 30 employees — the costs of establishing a plan are real and prohibitive," Nelson said in an interview with BenefitsPro.com, a sister site to ThinkAdvisor.

"In many cases these businesses are just trying to keep the lights on. They are trying to meet payroll, energy costs, and if they can manage to do so, add jobs. Just to establish a plan, that's an expense a lot of small businesses simply can't afford," explained Nelson.

It can cost a small business anywhere from $2,000 to $4,000 just to start a plan. That's not accounting for any matching costs, or ongoing administration costs, such as Form 5500 filings.

"That may not seem like a lot, but when a small business is struggling to pay its bills, it is," Nelson said.

That said, Nelson also foresees a world where the costs to start a plan are a fraction of what they are now. In fact, he thinks it could be done for several hundred dollars, maximum.

To get there, Nelson says the answer could be most efficiently delivered via the Employee Retirement Income Security Act, not new initiatives at the state level.

"Under ERISA, the cost of establishing a plan for small employers means you have to meet the law's requirements when it comes to establishing a plan document. Then there have to be coverage tests. And non-discrimination tests," said Nelson.

"When you are spreading those costs over a plan with only a few employees, it becomes expensive quickly," he said.

That's why Nelson is calling for new, clear safe harbors, tailored specifically for small businesses from the Department of Labor. Without that, Great-West and other record-keepers have their hands tied, Nelson said.

An existential threat?

Unlike Gov. Pawlenty, Vogler isn't worried about the financial services industry falling apart if a few states start to deliver private-sector retirement options to small businesses.

"I think states are looking at the issue, and they are looking at the current state of Congress, and the states think they are in a better position to address the issue," he said.

Vogler certainly isn't holding his breath for action from Congress.

"Beyond Sen. Harkin's, there are bills that have been proposed to expand coverage, eligibility, even to simplify ERISA's nondiscrimination provisions. But in today's climate, with midterms on the horizon, it's just not realistic to expect Congress to take the initiative," he said.

Which, of course, is the fact of life spurring the states to take action.

"The financial services industry believes that they are better capable of addressing the problem. The states don't necessarily disagree. What they are saying is the private sector isn't addressing the problem. So, some states have assumed the initiative," Vogler said.

Vogler thinks that states would be willing to take cues from Congress, but Congress isn't giving them.

Ideological differences are likely to keep the issue of retirement reform stalled at the federal level, Vogler said.

"The reality is that conservative politicians don't think government should be involved in creating what they feel is a private-sector solution."

The conservative playbook also asserts that the U.S. Constitution gives states precedent over Washington on a lot of matters. ERISA, of course, gives the federal powers precedence on the question of retirement security.

Legal arguments aside, more state legislatures are becoming aware of the retirement security issue within their borders.

For better or worse, more are setting out to do something about it.

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