With relatively little national attention, California Gov. Jerry Brown last month signed into law the first state defined benefit pension scheme for private workers. The California Secure Choice Retirement Savings Program automatically enrolls employees not already offered retirement plans at work into cash-balance accounts that pay a guaranteed rate of return.
The Legislature cited a study finding that 62 percent of California private-sector employees are not in employer-sponsored retirement plans. Thanks to Brown, they'll now get a pension benefit closer in style to what public-sector jobs offer. Depending on whose vision you share, this is either providing retirement security to the masses or doubling down on a model that's driving states like California toward insolvency.
Like the typical entitlement, this one was designed with modest benefits that can be increased down the road as the program matures. Employees are automatically enrolled in the retirement accounts (unless they opt out) and contribute 3 percent of salary. Employers don't have to contribute. The money is professionally managed in a trust overseen by a board composed of the state treasurer, finance director and appointees by the governor and Legislature.
The guaranteed return is close to the yield on a long-term Treasury bond and the benefits are paid as an annuity. With automatic enrollment, a broad participant base and basic annuity this plan resembles something between Social Security and CalPERS. That is where the danger lies.
Defenders insist that, unlike public pensions such as CalPERS, it leaves no liability on the backs of California taxpayers. But that's only true in the most technical sense. The program will contract with a private underwriter to provide the annuities.
The state is on the hook for the cost of maintaining this defined benefit through insurance premiums or whatever method it uses to fund the annuities. If the minimum rate of return is increased from the low single digits to the high single digits (comparable to what public pension plans project), the state will have to pay more to guarantee it.
Insulation from the markets is one of the selling points of the cash-balance plan, but if the current bull market continues there will be political pressure for expanding benefits. This is what happened at the height of the tech bubble in 1999 when then-Gov.
Gray Davis signed a bill giving retroactive pension increases to CalPERS members, based in part on an assumption that the Dow Jones industrial average would hit 25,000 by 2009. The markets usually don't behave according to best-laid plans, but the government still has to pay for its promises.
Supporters also tout the program's investment trust. The New America Foundation compares it favorably to the Thrift Savings Program, the popular retirement plan for federal civilian workers. But the key difference is that the federal government only offers index funds to participants. When it was designed in 1986, the Reagan administration fought hard to keep retirement savings from being politicized and insisted that they be passively managed.
In contrast, the California plan follows the public pension model of an actively-managed investment pool. The money could even end up being run through CalPERS.
Finally, this new private-sector pension poses tremendous risks for small businesses. Every California enterprise of five or more workers must set up the retirement accounts or face a fine of up to $500 per employee. Employers are not required to contribute to the accounts right now, but that provision could be changed if there is enough pressure by labor groups that they chip in.
In short, this program has the potential to retrofit the defined benefit pension model -- discarded by most companies a long time ago -- over the California businesses who can least afford it.
The shortfall in retirement savings by middle and lower-income people is a deep concern, and it is emblematic of a larger problem of thrift being an underappreciated virtue.
But mandating employer-provided accounts and promising a state-sanctioned investment return further confuses retirement as an expectation, rather than an objective. Younger people will have to take a proactive role toward it that emphasizes more work, savings and investment.
Rich Danker is economics director at American Principles Project, a Washington policy organization. He has written for Investor's Business Daily, CNBC.com., Forbes.com and a number of other publications.