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The ambiguity of federal regulations has raised concern about how states can proceed legally to increase retirement savings.
A recent analysis by Pew found that about 42 percent of full-time, year-round American workers—some 30 million people—do not have access to an employer-sponsored retirement plan. To address this, many states are eyeing new ways to increase opportunities for private sector workers to save for retirement while also reducing the fiscal burden of elderly poverty. But the ambiguity of federal regulations has raised many questions about how states can proceed legally to increase retirement savings.
After a directive from President Barack Obama, the U.S. Department of Labor in November 2015 issued a proposed rule, accompanied by what is known as an interpretive bulletin, to help states navigate the complex legal landscape so they can offer or encourage state-based plans. Although the agency has done much to clarify the regulatory framework for states, some of the new detail in these publications is likely to raise questions among state policymakers.
The rule clarifies that state-sponsored plans can be exempt from the federal Employee Retirement Income Security Act of 1974 (ERISA), which sets federal standards for most retirement plans, if they meet certain requirements. ERISA provides strong consumer protections, spelling out legal obligations for employers that sponsor plans, rules on participation and benefits, and the rights of workers and spouses, for example. Under ERISA plans, such as 401(k) accounts, both employers and employees can contribute to retirement savings, and contribution limits are higher than for non-ERISA plans such as individual retirement accounts.
Lawmakers in many states have expressed wariness about the perceived legal complexities involved in complying with ERISA and are considering alternative approaches such as those discussed in the proposed rule. Illinois and Oregon, for example, recently enacted state-sponsored savings plans that were designed to avoid ERISA. These plans automatically enroll workers in an IRA but allow them to opt out of making contributions. The proposed rule would put these plans on firmer legal ground by clarifying that they indeed are not subject to ERISA.
At the same time, some of the requirements in the proposed rule for these non-ERISA plans have raised questions among those seeking to implement state-sponsored retirement programs. First, the Labor Department requires that employers covered under the law automatically enroll their employees, who must have the right not to participate. That’s because a non-ERISA state plan is not permitted to provide employers with control over employee participation or contributions. This has led to questions, however, about the possible administrative costs of such a mandate, especially for small businesses.
Second, unlike in most retirement plans, the DOL rules require that participating employees have the ability to withdraw or transfer funds at any time without penalty. That raises the issue of what is known as leakage, or money leaving the plan before retirement.
Additionally, the proposed rule clarifies that employers cannot make matching or incentive contributions to employee accounts. It also makes clear that it is the states, as plan sponsors, that have fiduciary responsibility for the plans, rather than employers. A fiduciary, for example, has legal liability for discretionary decisions over investment selection and management. What is less clear is whether a state can appoint independent entities to serve as fiduciaries and run the programs, thereby alleviating taxpayer responsibility for any issues that arise.
In the interpretive bulletin that accompanied the proposed rule, the Labor Department also seeks to clarify how states could operate plans within ERISA. It lays out three possible approaches. Under the first, already taken by the states of Washington and New Jersey, a state could create an online marketplace that allows retirement plan providers to offer employers a range of options, including ERISA-qualified plans. Under this approach, the state does not sponsor plans and does not have to take on the fiduciary responsibility; employers can choose whether to adopt plans.
The second approach allowed under the guidance is for states to offer a state-sponsored “prototype” plan—essentially a standard plan with customizable features that employers could choose over traditional plans already available in the market. Under this approach, employers would be the plan sponsors while the state would provide basic administrative services.
The final option outlined by the Labor Department would allow states to create an “open” multiple-employer plan (MEP). MEPs already exist, but the agency has previously required that they be available only to similar types of employers—for example, those within a specific industry. An open MEP would allow all employers within a state to join a state-sponsored ERISA-qualified plan. That possibility could increase the use of MEPs by employers.
States today have a tremendous opportunity to make it easier for private sector workers to save for retirement, but the many policy choices available to states and employers—and the accompanying requirements—can lead to conflicts between competing objectives. States offer or promote these plans for a number of reasons, including increasing retirement savings, reducing poverty among retirees, and limiting state expenditures on social programs. States also want to maximize program effectiveness, minimize burdens on employers, and manage their legal risk.
The Labor Department’s guidance clarifies some of the choices that states can make in trying to boost retirement savings through the use of non-ERISA payroll contribution plans, like those being enacted in Illinois and Oregon. These plans could help many people save more, but states considering these options will want to evaluate how they would affect smaller employers in particular. Although many policymakers support these plans because more workers would be able to save and employer obligations would be less significant than under ERISA plans, others may be more resistant, because employers would be required to participate and would still face some administrative burdens.
Sponsoring an ERISA retirement plan—whether as a prototype or a MEP—could provide more flexibility and less political risk, but employer and employee participation might be considerably lower. States that consider these options would also need to evaluate how they will market ERISA retirement savings programs to make them appealing to businesses and workers.
The comment period on the proposed rule ended Jan. 19, and the Labor Department is expected to issue a final version later this year.