A new idea in California could wrest retirement away from the financial industry and guarantee income for generations at risk
There is a long-running idea in American life that all trends start on the west coast and move east. When it comes to the subject of retirement planning, let’s hope that’s true.
The do-it-yourself revolution in retirement savings has left the United States on the verge of a crisis; 30 years of mismanaged money is finally taking its toll on the young and old. The Center for Retirement Research at Boston College claims the US has a $6.6tn deficit in retirement financing, and a substantial minority of Baby Boomers and a majority of Gen-Xers risk a serious decline in their living standards the day they stop working.
Kevin de Leon thinks it should be different. He’s the California state legislator who took on the financial services sector by promoting what is now called the California Secure Choice Retirement Savings Program, shepherding it through the legislative process and getting Governor Jerry Brown’s approval last fall. He’s now in the beginning stages of realizing the plan.
De Leon’s initiative would automatically deduct 3% for retirement savings from workers’ pay at firms with at least five employees and no 401k already in place. The money would be pooled and managed in a newly established entity. Participants would get a 3% return, which is very modest. An insurance policy would underwrite the plan, so taxpayers would not be financially liable if the plan loses money. At retirement, the account balance will be turned into an annuity.
What the plan does is provide a kind of pension – from their own earnings – for people who don’t work at big, established firms that have big corporate infrastructure. Very often, these are people without the luxury of retirement planning, or the access to good financial advice. In de Leon’s words:
“It’s right for lower income and middle income to have access to retirement security.”
It’s in some ways a pension for all of us: something Americans tell pollsters time and time again they would prefer over a defined contribution plan. So why aren’t others jumping on the bandwagon?
Some have made moves but still kept one foot on the ground, or have been unable to bring others with them. Senator Tom Harkin, for instance, has pushed similar legislation on the federal level for several years. But progress has been all but impossible, in large part because the powerful financial services industry earns billions managing our funds.
The age of do-it-yourself retirement might not have been good for you and me, but it was terrific for the banks, insurance companies, retirement plan providers and most everyone who peddles financial products. Estimates on industry earnings range widely: it may make between $89bn for 401k fees alone, according to Bloomberg magazine, all the way up to $500bn for all retirement assets, as estimated by retirement reform advocate and professor at the New School for Social Research Teresa Ghilarducci.
De Leon’s plan is a direct competitor to this money management model, and – this must worry Wall Street – he may have the better argument.
The benefits of pensions and professionally managed funds like the upcoming California retirement plan are myriad. They can invest for the long run, since they are investing for millions of people and, therefore, won’t fully cash out on an investment when one member retires. Unlike in a 401k or Individual Retirement Account, investments are not controlled by the individual investor, who may or may not understand the first thing about stocks and bonds, and who might be taking advice from a spurious guru on television.
These plans are also not dependent on the success of individual portfolio managers at big mutual funds, many of whom start out young and inexperienced and are handed millions of dollars to train with. All too many – even veterans – have a black thumb when it comes to making investment decisions.
These California-style plans invest directly, avoiding middlemen and their layers of mutual fund and annuity expenses that have so enriched the banks and insurance companies.
Finally, because they manage money for so many people, these plans can achieve lower costs by economy of scale. As a result of all this, they offer enrollees overall greater returns than they offer those investing for personal accounts.
Not surprisingly, the financial services industry came out swinging against the new initiative.
So what comes next for California? Getting the bill passed wasn’t easy and there’s a chance de Leon’s plan will die in the long process of being implemented. Beginning later this fall, the commission will need to raise the estimated $500,000 to $1m in private funds to complete a study of the initiative’s viability.
After that’s done, the legislature needs to approve the concept again – something, no doubt, the financial services industry once again will try to stop. All the relevant parties in Washington, which is to say the Department of Labor and tax authorities, also need to sign off that the plan does not conflict with federal law.
Don’t get me wrong: the California plan is not a perfect solution for our retirement woes – not even close. It doesn’t allow for employer matches like a 401k, or, for that matter, Britain’s National Employment Savings Trust (Nest).
The California plan leaves the pool of freelance workers out, though de Leon says they will be able to participate in time.
Finally, asking people to invest 3% of their individual salaries does not come close to the 15% many experts claim we need to save to ensure a decent income in our later years.
This is what the California plan has going for it: it’s a guarantee, which is by definition an improvement over the status quo. Hopefully President Obama, who is expected to make a speech on Americans and retirement security at the end of the month, is paying attention.