Responding to the retirement income crisis, half the states are in various stages of developing plans for employees without workplace plans beyond Social Security. Will these plans be a "game-changer" as claimed by Angela Antonelli, executive director of the Center for Retirement Initiatives at Georgetown University's McCourt School of Public Policy? Or will they deliver more the illusion than reality of future retirement security?
I serve on the board of one of these--Connecticut. I am also a critic of the type of approach that the plans share--relying on individual invested savings to provide enough income during retirement.
The common idea of the plans is that employers would deduct 3% of employee pay to be placed in retirement investment accounts. Employers would not contribute. Essentially these would be state government-sponsored Individual Retirement Accounts.
There are a lot of questions to be settled. Who will administer the accounts? Will individuals direct the investments or will professional investors? Will the states act as mere pass throughs, facilitating the collection of employee savings that will then be managed and profited from by the private financial services industry? Or will states attempt to set up true public nonprofit retirement savings options that compete favorably with what the for-profit private sector has to offer?
The biggest question is, will the plans work? Will they resolve the retirement crisis by providing enough future income to ensure retirement security?
Unfortunately, the answer is a resounding no. There is no reason to believe that, even in combination with Social Security, they will provide enough for adequate retirement security. A 3% savings rate, even with the most favorable investment outcomes, will not come anywhere close to producing a large enough retirement nest egg. My best estimate is that at least a quarter of income would have to be socked away consistently over the working years under this approach to maintain a preretirement standard of living.
In addition, the financial services industry will drain off from the retirement savings accounts significant administrative fees, commissions and profits.
Keep those realities in mind when these plans are rolled out with great fanfare. Politicians and other promoters will repeat the game changer rhetoric as they pat themselves on the back for supposedly resolving the retirement crisis. The great danger is that individual participants will believe that they are now safe for retirement, not finding out the cruel truth until years later when they retire and realize that the accounts produce far less than expected.
If the 3% payroll deductions were invested instead in increasing Social Security benefits, far more retirement security would be achieved. Social Security's social insurance approach more efficiently produces retirement security than the retirement savings model that the states will use. That difference of approaches is the subject of a longer discussion at a different time.
Does that mean the state plans are useless? Not necessarily. If designed as true public options, they could be much better deals for participants than what the private market offers. Savings plans are a significant, though minor, part of the so-called three-legged stool of retirement security: Social Security, a workplace pension, and savings.
At a minimum, true public option plans would require: professional investing rather than leaving it to participants; nonprofit administration; and provision of nonprofit annuities upon retirement.
The challenge for the states will be to design and implement public option retirement savings plans over the loud objections of powerful financial services industry lobbyists.