State-Run Auto IRA Programs Are Now Active in CA, CO, CT, IL, MD, OR, and VA
Call me old fashioned, but I’m a fan of government that works to serve the people that it is elected to serve, in part, by recognizing significant gaps that capitalism has left behind, and at least giving a fighting effort to fill them.
One of the largest such gaps in our country right now is with lackluster retirement savings and voluntary retirement saving participation rates. With defined benefit pensions going extinct in recent decades (just 15% of private industry employees now have access to one), voluntary employer 401Ks have left a big hole in retirement savings. 27% of all workers and 56% of part-time workers do not have access to any retirement plan through their employers, leaving tens of millions of Americans without access to an employer-sponsored retirement plan. And 23% of those who do have access are not participating. As a result, the average retirement savings per American to supplement Social Security is lagging far behind where it needs to be.
So when news broke last year that state governments were launching solutions to try to help fill the gap in the lack of retirement plans offered by employers, I was pretty excited about what that meant for workers.
With California, the country’s most populous state, making the leap (along with Colorado, Connecticut, Illinois, Maryland, Oregon, and Virginia) with a state-sponsored IRA program called CalSavers, now I am not so excited. Let’s single out CalSavers to show why.
What is CalSavers, and How Does it Work?
CalSavers is an IRA initiative legislated by the State of California that requires employers that don’t already offer an employer-sponsored retirement plan to offer employees access to a state-sponsored CalSavers IRA, in an effort to fill the gap of employers not offering retirement plans and lack of voluntary participation by employees. Employers pay nothing for their involvement in the plan.
Employers have 30 days to let CalSavers know when they’ve hired a new employee. Once CalSavers is notified, the new employee is immediately sent information on the plan. From that point, the employee has a few different choices:
- Choose their contribution rate (employees can also choose to auto-increase the savings rate by 1% each year, until 8%).
- Do nothing and be auto-enrolled to contribute 5% of their income (employees can later opt-out at any time).
- Opt out within 30 days.
For workers that contribute, those contributions are automatically deducted from payroll to a Roth IRA. Employee investment options include:
- a capital preservation fund (money market fund, in this case): State Street Institutional U.S. Government Money Market Fund (GVMXX)
- a U.S. grade investment bond fund: State Street Aggregate Bond Index Fund (SSFEX)
- global equity funds (U.S. S&P 500 via State Street Equity 500 Index Fund and non-US equity via State Street Global All Cap Equity ex-US Index Fund)
- target retirement date funds: various State Street Target Retirement Income Funds, based on target retirement date
- an environmental, social, and governance fund that tracks the Calvert US Large-Cap Core Responsible Index (CSXRX)
The first $1,000 in contributions for each member will be invested in a a money market fund for capital preservation.
Auto enrollment with opt-out, automatic payroll deductions, and no costs to employers. Not a bad framework! So, what’s not to like?
What I Don’t Like About CalSavers (& the Other New State IRA Plans)
I applaud these states for doing something to address this problem. And this could be considered a first step in the right direction. The problem is not the attempt, it’s that they didn’t go nearly far enough. There are 3 ways in which I think these new offerings are inadequate.
First, instead of offering Roth IRAs to employees that do not have access to 401Ks, why not actually offer them 401Ks? The 2024 annual maximum 401K contribution is $23,000, while the maximum IRA contribution is $7,000. Sure, most wouldn’t contribute more than $7,000, but why set the bar low? I’ve outlined, at length, why I think Roth IRAs are overrated.
Second, 401Ks often result in employer 401K matching contributions, and employer-sponsored SIMPLE IRAs require it. Roth IRAs do not. CalSavers, and its peers, do not even have the option of voluntary employer-matching funds or contributions. And in letting employers off the hook for more robust plans with matching fund options, workers lose out.
The third – and I think the most egregious offense – is the fees. I don’t know who Ascensus is, but the state of California chose them to manage the plan. And as a result, employees will be charged significant asset-based fees of approximately 0.825% to 0.95%, depending on investment choice. These management fees are much higher than if the employees were to start their own plans and buy index funds through Vanguard, Fidelity, or other discount brokers. Meanwhile, employers pay nothing. With the number of participants expected, I am shocked the state was not able to negotiate a better deal than that.
To put it bluntly, laggard employers with no skin in the retirement savings game were let off the hook entirely with these offerings and still have no skin in the game.
If you are reading this article and find yourself in the group of workers in California that have the option of contributing to CalSavers, I would suggest:
- Finding a better employer who offers a pension or 401K, so that your employer actually is contributing to your retirement.
- If that’s not a short-term option, start up your own IRA at a discount broker like Vanguard, Fidelity, or Schwab and pay significantly lower fees than you will through CalSavers. Just make sure you are regularly contributing to it.
I’m singling out California here – but their plan was nearly identical to the plans from a few other states – right down to the website design. Oregon’s was the first and it looks like other 2 states simply created a carbon copy. Most have a similar structure, Roth IRAs only, lack of employer incentive or requirement to contribute, and high management fees. Connecticut is an outlier, with low fee investment options from Fidelity, Schwab, and Vanguard. A message to all states – if you’re going to go down this path (as you should), don’t stop at half measure solutions with expensive fees because your are afraid of industry and political blow-back. You can do better – and the workers in your state deserve it.
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This isn’t really a benefit at all.
You mentioned this but anyone eligible for this plan could instead get an IRA through Vanguard or another firm. A superior IRA with lower expense fees. 401Ks are a legitimate employer benefit since most people don’t have access to them, or anything like them, without their employer giving them one. But this isn’t a 401K! Unfortunately, I’m willing to guess some misinformed employees won’t know the difference and assume their company has their back, is offering them a retirement plan, and see no reason to look towards greener pastures (with actual retirement plans).
It may be zero benefit to informed investors, but there is an impact here for lesser informed workers. There is something to be said for reducing friction in encouraging people to save and invest and auto-enrollment is the least frictional form of encouragement. The auto-enrollment is the best part of these programs. The rest leaves a lot to be desired.