Congress Killed Auto-IRAs Run By States and Cities
In March, Republicans in Congress rolled back a "last minute" Obama administration rule which allowed city governments to create “low cost” employer-sponsored retirement accounts for small businesses. On May 3rd, the Senate passed legislation rolling back a similar rule allowing State governments to do the same.
The two rules allowed local governments to avoid ERISA regulations and create and administer “Auto-IRA” programs, which automatically force employees to take a percentage of their income and ‘invest’ it into a retirement account. Employees could then opt-out of the program if they didn't want it.
The Obama administration gave us a number of beneficial and needed financial programs including ABLE accounts for the disabled and making all retirement investment advisors fiduciaries (the future of the fiduciary rule is also in question). Unfortunately, the Auto-IRA isn’t high on my list of Obama administration initiatives I liked.
The Need Auto-IRA Intended to Address
Automatic enrollment in work-sponsored retirement programs have been proven to be the most successful method of 'encouraging' the public to invest. Sadly, the general public is amazingly creative in coming up with reasons not to invest for their retirement.
The Auto-IRA intended to expand work-sponsored programs by forcing small employers to join a local government-run program if they didn't offer their own 401(k) or similar program. The Auto-IRA was a needed step in the right direction, but was not the ideal solution.
Although a number of fundamental problems and concerns with the Auto-IRA program makes me OK with its death, there is still a need to address the tens of millions who don’t have an auto-enrollment retirement program at work. Republicans have begun drafting legislation which they say will solve this problem in an improved manner, but the truth will be in the details.
Concerns with Auto-IRA
Ultimately, congress needs to address the lack of participation in IRA and other self-directed programs, but I believe making personal financial education a requirement at the high-school and university levels would be the better choice.
Whether the solution is a new retirement investing account or more education, the Auto-IRA program wasn’t an ideal solution. The program lacked ERISA protection, had potentially poor management, and generally offered limited investment options. The Auto-IRA was a step in the right direction, but I won’t be mourning the death.
Exempting from ERISA Protection
The key legislation which protects consumers’ retirement funds is the Employee Retirement Income Security Act, or ERISA for short. ERISA provides a host of consumer-protection features including providing choice in investment options, protection of funds from creditors, and the fiduciary requirement.
In fact, the fiduciary-related protections found in ERISA was the legal basis for Obama's Department of Labor to require retirement plan investment advisors to adhere to the fiduciary rule. A standard which should always have been the case, and which the Trump administration sadly might be scaling back.
Strangely, though, the Auto-IRA program exempted state and city governments from ERISA, leaving consumers without these protections. Considering those most likely to ‘benefit’ from an Auto-IRA program are lower-wage earners and unsophisticated investors, it seems strange the program would exempt local governments and private investment managers from ERISA protections.
Some states have written the fiduciary standard into their Auto-IRA law, but states and cities are not necessarily required to do so. Additionally, there are more ERISA protections than just the fiduciary standard. Considering the huge number of state and local government agencies which could create their own Auto-IRA program, exemption from ERISA isn’t likely to be in the consumer’s best interest.
Proponents say ERISA regulations are too costly for small employers to handle, but the Auto-IRA is administered by state and city governments, meaning they should have no problem abiding by the regulations.
Poor Management Track Record
Many would argue ERISA protections are not necessary since states and cities are subject to the voters and therefore will act in their best interests. Unfortunately, this theoretical principle does not always play out in the real world. California gave massive water rights to the privately held Wonderful company, which uses as much water each year as the entire city of San Francisco does in a decade. The state continues to defend the arrangement despite a massive drought.
Further, state and city governments don’t have the best track record managing their own employee’s retirement plans through their pension funds. According to Stanford’s PensionTracker.com, every state has unfunded pension obligations due to a combination of inaccuracies in retirement period estimates, demographic shifts, and lower-than-expected returns on investments. Don’t get me wrong, the problems of public pensions are not all the fault of local government. But they do demonstrate workers are in need of consumer protection within state and city run investment programs.
Worse, since the programs would be administered by the states and cities, consumers could have no ability to change investment managers or investments.
Investing in Treasury Bond Fund
One of the biggest problems with state and city government investment programs are the investment options, which are often established to be far more conservative than professional financial advisers recommend.
Auto-IRA participants often only have one choice for their investing, as is the case with the California Secure Choice fund. The option: an ultra-conservative Treasury Bond Fund, which invests solely in low-yield and safe U.S. Treasury Bonds. Comparably, the OregonSaves program shines as an outlier, offering a whopping three investment options for savers.
Don’t get me wrong, Treasuries are wonderful investments, but they will definitely not provide the returns American’s will need to secure their retirement. Yields on Treasury bonds rarely keep up with inflation, meaning, when held to maturity, the bonds will leave American’s with less purchasing power than they invested due to inflation eating away at the value of the dollar.
Treasury bond funds, however, have provided much higher returns over the past 30 years because of the steady three decade decline in interest rates. When interest rates drop, older higher-interest bonds become more valuable and sell for more in the market. And interest rates have been dropping consistently and steadily since the ridiculously high interest rates of the 1980s (mortgages were in the mid-teens). This trend made long-term bond funds more profitable than they otherwise would be.
Interest rates are currently at historic lows, however, as the constant barrage of mortgage ads will tell you. Over the next 30 years, the interest rate direction is highly likely to reverse, seeing rates climb. Just as dropping rates increased bond values, the rising rates would cause Treasury bond funds to drop in value. This double edged sword of low yield and dropping values could leave Auto-IRA investors with little to show for their hard-saved money.
Some critics have speculated part of the motivation for the Auto-IRA accounts is to create a stable and robust marketplace for Treasuries.
Ultimately the Auto-IRA program wasn’t the ideal solution to a very real problem, but it did attempt to address very real problem of American's not being financially ready for retirement. Fortunately, the death of the program means little to your personal ability to invest for retirement. You still have the option of opening your own IRA or Roth IRA account and taking control of your own retirement.
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Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at firstname.lastname@example.org