What should we make of Illinois' new retirement savings plan?

Earlier this month, the Illinois Secure Choice Savings Program Act was signed into law, to be effective June 1 and fully implemented by 2017. While there have been a number of attempts in other states to mandate retirement saving, this is the first such piece of legislation to get across the finish line. In the words of the lead sponsor of the legislation, State Senator Daniel Biss (D.), the legislation is “an automatic enrollment IRA so that workers without employer sponsored retirement plans still have an easy way to save for retirement using a payroll deduction and benefiting from low fees.”

The Fiduciary Matters blog is aimed at the institutional investment community, but it’s worth taking a look at this piece of legislation from four different perspectives. These are just some brief initial thoughts, and there’s obviously a lot more to be said about this development in the coming months.

The individual. On the one hand, one could argue that individuals already have the choice of setting up an IRA, so the new mandate doesn’t really provide anything new at all. That argument overlooks the power of decision architecture (a.k.a. nudging), and the fact that a large number of individuals who would not set up an IRA by themselves would nevertheless not bother to opt out of one which is automatically set up on their behalf. So an auto-enroll approach seems like the most promising way to address coverage. And coverage is a real cause for concern: a 2008 Government Accountability Office study reported that only 25 percent of workers in the lowest-income quartile were offered a DC plan, and only 8 percent were actually enrolled in a DC plan with their current employer.¹

And while the Act’s default saving rate of 3% of salary is pretty anemic, it’s better than nothing.

The system. Coverage is important, but with every change in the way that the nation saves for retirement, we need to consider whether we are moving toward a more efficient system, or a less efficient one. One reason that it has been difficult to extend retirement savings to small employers and low-paid workers is that the costs and administrative burden of doing so can be prohibitive.

The details matter. Josh Cohen, Russell’s Managing Director, Defined Contribution, points out that “If employees of small companies across the whole nation are to save more for retirement, each state will need to find a way to implement well designed plans with quality investments. Some will get it right, and some won’t. Private market initiatives to create efficient solutions for this market should be considered and would provide further pressure on the states to offer competitive solutions.”

Employers. Advocates of the legislation have argued that it is good for the employers affected because it allows them to compete with larger employers who offer prospective employees a retirement plan. We suspect that employers will in practice be more concerned with the extra responsibilities the new law imposes on them: even though they are not required to run plans, they will need to administer the payroll deduction and handle elections to opt out or vary the savings rate. Multi-state employers may find things trickier.

For those employers who already provide a retirement plan, there’s no direct impact from the new legislation. Some employers may consider whether they would prefer to close their own program and use the state program instead.

Josh’s take on this is that “There is a big aversion to the concept of mandates these day, so it will be interesting to see the reaction. Will small employers welcome the new program? And could mid- and large-sized employers see it as an opportunity to step away from running their own plan, and move over to the State program instead. Something similar is starting to happen in health care.  It’s happened in other countries like Australia.  Could it happen to retirement plans here?”

The politics. Although all of the perspectives listed above are important, decisions about pension policy are made by politicians, whose incentives – unfortunately – don’t always completely align simply with the greatest public good. Whether the Illinois model spreads to other states (or even gets picked up at the Federal level) is going to depend not only on its reception in the Land of Lincoln, but also on the reaction of employers and of other groups not listed above but whose perspective will also matter: the media, unions, the financial services industry, other lobby groups, and so on. That in turn will depend on how well the program is implemented. How transparent will it be? How credible?

These are early days, and lots of people will be watching with interest to see how this initiative plays out.

¹Government Accountability Office. “Private Pensions: Low Defined Contribution Plan Savings May Pose Challenges to Retirement Security, Especially for Many Low-Income Workers,” 2008. Quoted in Ezra, Collie and Smith “The Retirement Plan Solution”. John Wiley & Sons, 2009.