It’s hardly news that private sector employees’ retirement accounts took a serious hit in the 2008 financial crisis. In addition, availability of retirement plans in the workplace has declined and small employers have opted not to participate in the private pension system to a greater extent than large employers. To California’s credit, the state’s government is trying to do something about this, but will it work?
Background – California’s Proposed Solution
California’s Legislature is currently considering the California Secure Choice Retirement Savings Act, which would create a public retirement savings plan for private sector workers who do not have access to employer-sponsored retirement savings plans. Employees would have to contribute (3% in the first year) unless they opt out and employers would be allowed to contribute. The plan, including contribution limits, would be modeled after an IRA with interest tied to 30-year Treasuries. All employers (with 5+ employees) that do not already offer a retirement savings plan would be required to arrange for their employees’ participation, but employers’ day-to-day involvement is intended to be minimal.
Hurdle 1 – Would the plan be preempted by ERISA? ERISA generally preempts state laws that “relate to” private sector employee retirement or welfare plans which makes California’s efforts in this area problematic. Is California’s plan a “plan” under ERISA, or merely a payroll practice? Will the plan be “sponsored” by the private employers in the manner that an ERISA plan is “sponsored”?
Certainly, proponents of the California plan have taken steps to avoid ERISA preemption. For example, recent amendments specify that employer contributions would only be allowed if they would not cause the plan to be treated as an employee benefit pension plan under ERISA. Also, the plan’s IRA-like structure and minimal employer involvement are most likely intended to have the plan avoid ERISA preemption. Proponents argue employers’ involvement would constitute only a payroll practice, rather than a retirement “plan” under ERISA. Opponents argue that although the plan takes steps to eliminate an employer’s liability and responsibility, employers will have added operational costs associated with answering questions, collecting forms, and transferring contributions to the plan and these ongoing operational costs and activities make the arrangement employer-sponsored, subjecting the plan to ERISA.
Hurdle 2 – Would contributions be tax deferred? The legislation describes the employees’ accounts as modeled after a traditional IRA, but without in fact creating an IRA or creating an ERISA plan. Therefore, it is unclear how participating employees could enjoy the federal tax benefits associated with typical deferral arrangements.
Hurdle 3 – Would the state be liable for funding shortfalls? Perhaps most alarming for California taxpayers, opponents argue that the state will ultimately be liable in the event of a funding shortfall. The plan is structured to shield the state from liability by having private firms manage the portfolio, purchasing insurance for any funding shortfalls, and notifying employees that the program is not guaranteed by the state. However, opponents argue that the cost of insurance to cover market risk, longevity risk, benefit guarantees set by the plan, and risks regarding administration would be prohibitively high, if this type of insurance even exists. And even with this insurance, plan participants would most likely still look to the state (or their employers) if the insurer go under.
What happens if the plan is successful? Wouldn’t a state like California be awfully tempted to find a way to access those funds, particularly in light of its funding shortfall for public pensions? If the bill does make it through the California Legislature, it will likely prompt other states to move on similar legislation. In the event this legislation does pass, lawsuits regarding the described issues undoubtedly will follow.
What are your thoughts?
We thank our Summer Associate, Anne Jumpe, for her help in preparing this post.