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Illinois Retirement Initiative Could Blaze a Path for Other States

Will the Land of Lincoln soon be known for something other than Al Capone and imprisoned former governors?

Scott Cooley, 01/26/2015

For the next few weeks, Scott Cooley will be filling in for John Rekenthaler, who is on sabbatical.

When you travel abroad and tell people that you are from Illinois, the response usually includes something about Al Capone, corrupt governors, or Michael Jordan. People might even mention our bitterly cold, interminable winters or (delicious) pizzas the size and weight of manhole covers. Now, we might see another reaction: an appreciation of Illinois as a state that is attempting to help more workers save for retirement.

Earlier this year, then-Governor Pat Quinn signed the Illinois Secure Choice Savings Program Act. Starting in 2017, among employers that do not offer a qualified retirement plan, companies with more than 25 workers will need to auto enroll their employees in a Roth IRA account. Employees will have the option to vary their 3% default contribution percentage or cancel their auto enrollment in the program, which does not include an employer contribution, but experience has shown that auto enrollment significantly increases participation in retirement accounts.

There is an acute need for additional workplace savings programs in this country. An estimated 50% of adult private-sector workers in the United States lack access to an employer-sponsored retirement program, with lower-income workers particularly unlikely to have a plan available. Proponents of the Illinois initiative say that 2.5 million workers will have access to the Secure Choice retirement accounts. That includes employees at companies with fewer than 25 workers; those companies will have the option but not the requirement to participate in Secure Choice. The state is in the process of figuring out exactly how many workers will obtain mandatory coverage through Secure Choice.

Similar to investors in other Roth IRAs, Secure Choice enrollees will have access to their money at any point. Although employees will make contributions on an aftertax basis, increases in their investment value will not be subject to tax, nor will most withdrawals made after age 59 and a half. Withdrawals of the principal invested may be made on a tax-free basis prior to retirement.

The structure of the Secure Choice program should help minimize--but not eliminate--the employer regulatory burden. While sponsoring a 401(k) can produce a heavy compliance burden for employers under the Employee Retirement Income Security Act (ERISA), Secure Choice attempts to cut through much of the regulatory red tape. In short, the program's proponents say that employers will not face ERISA obligations because they will not engage in any of the activities that trigger the provisions of ERISA. Rather than relying on the employer to determine which investments are available to workers, which would produce ERISA obligations, a state-sponsored committee will take the lead in selecting an external investment manager. Under Secure Choice, employers will be unable to make contributions to the employee accounts, which are another triggering event for ERISA.

Some details of the workers' investment options must still be worked out, but they will include a default target-date option, along with more aggressive and conservative choices. Morningstar research has shown that investors' returns are higher if they use a target-date or managed-account option, versus making fund selections on their own.

A lot is riding on the rollout of the Illinois Secure Choice Savings Program. A smooth implementation for employees may spur other states to enact similar legislation, according to Courtney Eccles, the policy director for the Woodstock Institute, a Chicago-based think tank and advocacy group that actively supported passage of the Secure Choice legislation. Eccles says that Oregon and California are among the approximately one dozen states that are actively considering adopting a similar program.

Scott Cooley is a senior analyst with Morningstar.com. He would love to hear from you, particularly if you have nice things to say, but he cannot provide specific portfolio advice.
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