While it’s not surprising that over half of Americans are currently not on track for retirement, it’s still unsettling. Roughly 50% of Americans don’t have access to a 401(k) plan or similar plan through their employer. Even fewer have a pension. The COVID-19 pandemic and growing concerns around inflation aren’t helping the situation either.
The good news is that 14 states and two cities across our nation have enacted legislation to create retirement savings programs.
California, Oregon, Illinois, Massachusetts and Washington have successfully launched their programs, and Connecticut recently rolled out a “soft” pilot on November 1, 2021. The other seven states and two cities’ programs are currently under development and plan to launch over the next two to three years. They include Colorado, Maine, Maryland, New Jersey, New York, Virginia, New Mexico, Vermont, New York City and Seattle.
Social Security provides the most important source of retirement income in the United States. The second-most important income source comes from savings in employer-sponsored retirement plans, yet many Americans don’t have access to one. State-run retirement programs will help alleviate the retirement savings crisis because they provide a tax-advantaged way to save for people without employer plans.
Who in the U.S. doesn’t have an employer-sponsored plan? Research shows low-income workers and workers in firms with fewer than 100 employees tend to have less access to a workplace retirement plan than those with high-wages and large firms. Black and Latino workers in particular have negatively been impacted because of this trend.
The state-run programs may positively impact employees in lower wage jobs who end up relying the most on Social Security for retirement income. A model conducted by The Pew Charitable Trusts indicates that Hispanics would be able to delay claiming Social Security benefits for one year or more by using their state-run retirement savings. Having the option and ability to delay Social Security can mean claiming significantly more monthly income in retirement.
State Plans Will Impact Clients
It’s important for advisors to understand and keep up with the development of state-run programs because it will most likely impact their clients or potential clients. Many of the state-run programs to date are created as individual retirement accounts (IRAs) subject to the annual IRA contribution limits set by the IRS. That means an individual can contribute a total of $6,000 across all traditional IRAs and Roth IRAs per year. Those over the age of 50 are allowed a catch-up contribution of $1,000. Individuals over the age of 50 could potentially save $7,000 per year in a traditional or Roth IRA.
For clients who are already maxing out their IRAs, advisors must ensure these individuals don’t accidentally contribute more than they are allowed through the state-run retirement plan. And, for those who are either not saving at all or the maximum amount, it gives us an opportunity to share what is possible.
While currently, 83% of the workforce between the ages of 45 to 54 have some retirement assets built up, only 40% of this population are on track for retirement. Saving is important, but financial planners understand that accumulating assets is only a piece of the retirement puzzle. Advisors have an opportunity to work with individuals, understand their goals, and give advice in the person’s best interest to help get them on track for retirement. Through a combination of state-run programs and financial planning, we have an opportunity to create a retirement-ready nation.
Here are two key things to know about the nation’s state-facilitated retirement programs:
• There are currently three model programs.
Although each state-facilitated retirement program has a unique set of stipulations and requirements, all current programs tend to fall under one of three models: 1) auto-IRA, 2) marketplace or 3) multiple-employer plans (also known as MEPs).
Auto-IRAs, or automatic enrollment IRAs, are leading the way, with 69% of state-run programs using that model. Another 13% are marketplace programs that offer individual and small businesses a website to compare low-cost plans, and 12% are MEPs.
California, Illinois, Connecticut and Oregon have implemented auto-IRA programs with employer mandates, meaning some employers may be required to participate in the state-facilitated program if they do not offer a qualified plan to their employees.
Most of the pending state and city programs fall under the employer mandate auto-IRA model. The minority are volunteer programs. For example, New Mexico is currently the only state developing a voluntary auto-IRA model for employers. The MEP and marketplace models are also voluntary programs.
• Employees may opt-out if they don’t want to participate.
Regardless of the model, all employees may opt-out of state-run plans if they don’t want to participate. The auto-IRA programs in California, Illinois and Oregon were structured using behavioral finance to encourage retirement savings; employees must complete and submit a form to opt out of the plan. If an employee fails to take action, they will automatically be enrolled in the state-run IRA program. California, Illinois and Oregon are all achieving close to or more than 70% participation rate because of the automatic enrollment requirement.
On the federal level, some changes to encourage retirement savings have bipartisan support.
The House Ways and Means Committee has proposed automatic enrollment requirements for companies with 11 or more employees that have been in business for at least three years. It would require employees to be automatically enrolled at a rate of at least 3% with 1% annual automatic escalation until the worker is contributing 10% of their income. While employers with existing qualified retirement plans would be grandfathered in, they should consider automatic enrollment as a plan amendment. Employers who add automatic enrollment can claim a tax credit of $500 and significantly increase participation in their plan.
Automatic enrollment is key to creating a retirement ready nation, especially helping those living in low-income, underserved communities. Retirement plans with automatic feature settings help individuals make the right saving decisions because little to no effort or financial literacy is needed on their end. While all employees have the option to opt-out, more effort is required if they choose not to participate.
In a world where it seems like many people and parties are constantly in disagreement, 72% of Americans view the state-based retirement programs as a good idea, according to the National Institute on Retirement Security.
Regardless of generation and/or political views, many can agree that there is and has been a retirement savings crisis in America, especially in minority areas. State-facilitated programs will help bridge the gap in retirement savings for Americans, especially in disadvantaged, minority, and low-income communities where fewer people have access to an employer 401(k) plan.
While currently only 14 states and two cities are at various stages of implementation, all other states except for four have had recent state efforts. Not only that, but the Setting Every Community Up for Retirement Enhancement (SECURE) Act enacted January 1, 2020, was a result of understanding and accepting there is a retirement savings crisis that needs to be fixed.
Amie Agamata, CFP, is based in San Diego, Calif., with clients across the U.S. Her team’s business mission is “Working together to achieve financial success through understanding, education, and action©.” Amie is the incoming NexGen President-Elect for the Financial Planning Association (FPA) nationally, a member of the FPA Retirement Income Planning Advisory Council, and an incoming committee member of The American College Alumni Council.