Should States Regulate IRAs?

Employees in companies that do not offer a 401k arrangement face a disadvantage in saving for retirement.  Tax exemption makes 401k retirement funds grow much quicker and the tax exemption is a strong incentive for employees to contribute regularly.  The employee benefits from participation and society benefits in future years because the 401k funded employee is less likely to be a burden on welfare agencies.    

Employee benefits such as 401k programs, employee pensions and employee health plans are subject to the 1974 Employee Retirement Income Security Act (ERISA), which sets minimum standards for the plans and for the conduct of fiduciary managers of those plans.  The ERISA paperwork and administrative burden is substantial and cumbersome.  The 40-year legacy of ERISA compliant existing benefit plans make changes to ERISA regulations difficult.

In 2016, the Department of Labor imposed a rule that would keep ERISA from preempting state law on setting up employee retirement saving plans.  California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, Oregon and Washington have enacted legislation allowing for 401k-like plans.  Rep. Tim Walberg (R-Mich.) and Rep. Francis Rooney (R-Fla.) introduced a joint resolution that would stop the Department of Labor regulation of individual retirement accounts (IRAs), explaining — “Employers will face a confusing patchwork of rules, and many small businesses may forgo offering retirement plans altogether… Congress must act to protect workers and small businesses from these misguided regulations.”  They sound negative, but there are some aspects of state IRAs that may need additional thought.

The California version of a state IRA is called Secure Choice.  California employers with 5 or more employees must offer it to their employees unless they already offer a retirement plan.   “Secure Choice savings plan payroll contributions go into an IRA managed by a private-sector financial firm and overseen by the Secure Choice Board.” 

Secure Choice is described as portable within California, but it may lack a mechanism to accept contributions if the employee moves to another state.  It is permissible to have multiple IRAs at the federal level and multiple federal and state IRAs should be permitted to coexist, but perhaps without the right to transfer funds between state and federal level IRAs.  Sorting out the tax implications of a multistate and federal bucket of IRAs could be a new career for attorneys.

California will deduct a small participation fee from contributions.  If contributions are federally tax exempt and if participation fees are not too high, then these state IRAs should give a better yield than stashing money in a bank savings account.

Initially Secure Choice funds will be placed in US Treasuries.  The Secure Choice Board will develop other options in time.  Employees should hope that promise means options such as money market, federal government bonds, corporate bonds, and corporate equities.  None is especially risky but only corporate equity is likely to generate a noticeable yield.  

Market yield volatility on the IRA investment choices is less of an issue than the peril of malfeasance by administrators such as those in Illinois (far behind in moving contributions into the pension fund), or in Rhode Island (looting of the pension fund), or in Detroit (malfeasance of fiduciaries). 

Sometimes oceans of money in pension funds pose an irresistible temptation to politicians who need funds for their favorite public works project.  Why not replace some real cash with an IOU?  The Social Security Trust Fund is stuffed with such IOUs.  Those IOUs “are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures”.  The bonds held by the Social Security Trust Fund are meaningless.  Participants in state IRA programs must be protected from government officials diverting their retirement investments from real assets into notional but meaningless government IOUs.  The Pension Benefit Guarantee Board must not be raided to provide restitution for missing funds (due to incompetence or malfeasance).  The states need to be fully accountable for funds missing in their state’s IRA.

Interstate handling of IRAs needs to be sorted out and there should be strong similarities between state IRA regulations in each state.  Rules for transfer between multiple in-state IRAs and interstate transfers between IRAs need to be set.   Audits to detect financial malfeasance by fiduciaries and a ban on diverting retirement funds into an IOU collection (“trust fund”) are roles for the federal government to take on.   Perhaps Representatives Walberg and Rooney are right.  A little extra thought is needed to protect employees from state government.

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