Illinois Retirement Initiative Could Blaze a Path for Other States

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.

The implementation of the Secure Choice program will likely involve a great deal of complexity, according to Sue Watt, vice president of product development for Morningstar's Retirement Solutions business. The United Kingdom introduced a program mandating auto enrollment and has struggled with a number of logistical issues, despite providing for a multiyear rollout period. Watt said that U.K. employers faced several challenges, including ensuring that they have the proper software to manage retirement account contributions, managing the eligibility of employees and ensuring that they are opted in upon meeting relevant criteria, delivering required notices to employees, and managing records for people who opt out.

Eccles says that supporters of Secure Choice are aware that the program will need to clear many logistical hurdles. To that end, state officials and program supporters have begun thinking about implementation and what needs to be accomplished for the program to be ready for enrollment in 2017.

The Illinois Secure Choice initiative is not a panacea for the problem of workers' having inadequate retirement resources. The 3% default contribution level is too low to deliver a sufficient retirement income for most workers, particularly given that employers will be unable to contribute to the accounts. Moreover, many employees would benefit more from a 401(k) than from a Roth IRA, as the former offers an up-front tax break that could be worth more to a participant than the tax-free withdrawals in retirement from a Roth IRA.

Eccles says that in a perfect world, everyone would have an access to an employer-sponsored retirement plan, but the Illinois Secure Choice Savings Program is a "really important first step." Watt says that "in theory, the mandated availability of a retirement savings plan is a good thing, but the devil is in the operational details."

I think they are both right: A successful rollout of this program will be challenging, but it could be a first step toward making employer-administered retirement accounts universally available. Here is hoping that Illinois can achieve a smooth implementation of Secure Choice that will give other states the confidence to follow its lead.

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