Overview
State laws requiring employers to either establish qualified retirement plans or make automatic deductions from employees’ wages and remit them to a state-run IRA program are the latest proposed solutions for the low savings rates of American workers. Five states (California, Connecticut, Illinois, Maryland, and Oregon) have already enacted statutes of this sort, and many other legislatures are considering them. State laws typically include these provisions:
- Employers that do not have plans meeting specified requirements and have more than a specified number of employees must take part in the program.
- The covered employers must deduct a set percentage of employees’ wages each pay period. Although employees have the right to opt out, the assumption (probably justified) is that most will not do so and will, in time, get into the habit of saving for retirement.
- The amounts deducted are remitted to individual retirement accounts (traditional IRAs in some states, Roth IRAs in others) administered by a state agency or its contractor. The state determines what investment choices are available and designates a default investment fund. The administering agency or contractor handles participants’ investment elections, some employee communications, and other operational details.
- Although the investment vehicles are IRAs, the state may limit contributing employees’ ability to withdraw funds or switch to a different provider. These restrictions aim to ensure that savings do not “leak out” to meet pre-retirement needs and may also facilitate investments in assets with limited liquidity.
- The state may reimburse employers in some fashion, e.g., through tax credits, for expenses that they incur in connection with the program.
The key features are mandatory participation by employers and automatic deductions from wages. Without those, state programs would add nothing to the savings opportunities available under existing law. The “problem” that advocates of such statutes have identified is that many employers do not volunteer to establish retirement savings plans, and, when they do, many employees do not volunteer to put money into them.
An obstacle exists, however, to compulsory schemes. The Employee Retirement Income Security Act of 1974 (ERISA) forbids states from enacting laws that “relate to” ERISA-covered plans, including laws requiring employers to establish them. Inconveniently, the Department of Labor (DOL) long ago took the position that a retirement savings program funded by automatic deductions from wages is subject to ERISA, even if employees are given the right to opt out of it. Hence, absent a change in the DOL’s view, states are unable to force employers to take part in the kind of program described above.
On August 30, the DOL delivered the change. It adopted final regulations setting forth how “state payroll deduction savings programs” can be structured to avoid ERISA coverage. Proposed regulations published at the same time will allow political subdivisions to enact their own mandates when their states do not.
The final regulation provides a “safe harbor” from ERISA for any state-mandated program that satisfies all of the following requirements:
- The participating employers must be required by law to take part. The mandate does not have to apply universally. It may, like each of those enacted so far, exclude employers that offer other retirement savings arrangements or have less than a specified number of employees, and there is nothing in the regulation otherwise limiting coverage or non-coverage.
- Employee contributions may not be mandatory, but they may be made by automatic deduction unless the worker opts out. Affected employees must be given “adequate advance notice” of the opt-out right.
- A state agency or instrumentality must administer the program and be responsible for investing funds, determining investment options available to employees, ensuring that employees are notified of and can enforce their rights, and establishing procedures for the timely remittance of contributions and security of program assets. The state may contract with private parties to perform these functions, so long as it retains ultimate responsibility.
- Employers may have “no discretionary authority, control, or responsibility under the program,” no standing to sue to enforce employees’ rights, and no involvement beyond deducting contributions from pay, transmitting them to the program administrator, giving employees notice of payroll deductions, maintaining records of deductions and their transmittal, providing information to the administrator “necessary to facilitate the operation of the program,” distributing information about the program, and allowing the state to publicize it to employees.
- The employer may not make contributions or give employees monetary incentives to participate.
- Any tax credits or other compensation provided to employers in connection with the program may “not exceed an amount that reasonably approximates the employer’s (or a typical employer’s) costs under the program.”
These conditions are modeled on the DOL’s safe harbor ERISA exemption for programs under which employers, acting unilaterally or under a collective bargaining agreement, deduct and remit contributions to IRAs for employees who voluntarily sign up with the IRA provider. DOL Regs., §2510.3-2(d). There, too, the employer may play no role other than “without endorsement to permit the [IRA provider] to publicize the program to employees or members, to collect contributions through payroll deductions or dues checkoffs and to remit them to the” provider. The significant difference is that the private sector exemption is available only if participation by employees is “completely voluntary.”
In the preamble to the proposed version of regulation, the DOL stated that its consistent view has been that employee’s contributions are “completely voluntary” only if they are “self-initiated.” Giving them the right to opt out is not sufficient. 80 Fed. Reg. 72006, 72008 (Nov. 18, 2015). The rationale for nixing opt outs was that “where the employer is acting on [its] own volition to provide the benefit program, the employer's actions – e.g., requiring an automatic enrollment arrangement – would constitute its ‘establishment’ of a plan within the meaning of ERISA's text, and trigger ERISA's protections for the employees whose money is deposited into an IRA.” Id. The underlying concept is that, when an individual decides on his own initiative how much money to save and where to invest it, there is no strong argument for imposing an extra layer of regulation simply because his employer serves as a conduit. When, however, an effort is needed to avoid putting money into a savings scheme, a rationale arises for ERISA protections.
The preamble does not discuss whether, if ERISA protections are valuable for opt out programs created by a private employer, they can be dispensed with merely because the employer is compelled to offer the program.
The preamble also does not discuss another aspect of “completely voluntary” participation, namely, the ability of employees to control their IRAs. It has always been taken for granted that an employer that wishes to set up a non-ERISA IRA deduction program cannot compel workers to keep their funds in any particular IRA or prevent them from making withdrawals at the time of their choosing. State-mandated programs will be allowed to do both.
The preamble observes that, because state-mandated programs use IRAs as their investment vehicle, employees will enjoy the protection of the Internal Revenue Code’s prohibited transaction rules. It conspicuously does not discuss whether, and to what extent, the DOL will attempt to apply fiduciary standards to these IRAs, or how it would do so. ERISA does not cover IRAs (other than those established under ERISA-covered plans), and the Internal Revenue Code has no fiduciary standards. Individuals with state-mandated IRA’s will have to seek redress under state law or federal securities law.
The goal of state-mandated IRAs is not controversial, however, the means chosen to accomplish the goal is. There are reasons why legislation to implement them, while widely discussed, has been enacted by only five states and has been defeated or sidetracked in at least a dozen.
First, the potential burden on employers is more severe than it may appear at first glance. Without jeopardizing the ERISA exemption, states will be able to regulate the manner in which contributions are deducted and remitted, require employers to distribute information about the program and give state personnel access to their facilities in order to publicize it, and establish reporting requirements “to facilitate the operation of the program.” The aggregate cost and disruption cannot be assumed to be non-trivial. The situation will be worse for companies unlucky enough to be subject to mandates in more than one jurisdiction (a tangible risk if the DOL authorizes mandates by cities, counties, and other lower levels of government). The regulation does allow states to reimburse costs entailed by their programs, but they are under no obligation to do so.
Second, many state and local pension systems face severe financial and administrative challenges. Adding new responsibilities may aggravate some systems’ current problems.
Third, the ability of states to “trap” employees’ funds in state-run IRAs removes an important check on subpar program operation and investment performance. Ordinarily, an IRA owner can exit from an unsatisfactory provider. The ability to move from a state program to the private sector will be subject to curtailment by the state.
Fourth, and perhaps most troubling, state programs may well accumulate large amounts of private capital whose management will be under the control of government officials. Fears have already been expressed that hard-pressed states will find ways to tap this pool of assets, perhaps by offering or mandating purchases of their municipal bonds as an IRA investment. Additional concerns are “pay for play” schemes involving contractors and other forms of misconduct.
The DOL’s new regulation removes one of the arguments most often raised by opponents of state IRA mandates – that their adoption contravenes ERISA. We will now begin to see, in the “laboratory of the states,” how this experiment turns out.