What is a State Run Retirement Plan?
State Run Retirement Plan are individual “cash balance” accounts where benefits at retirement are based solely on contributions and returns. A cash balance plan is an already-existing type of defined benefit pension plan that incorporates some features of a defined contribution plan. The State Run Retirement Plann major features are:
Consistent contributions: as in a 401(k)-type plan, workers and/or their employers would contribute at least 3 percent of pay into their individual State Plan
Guaranteed returns: each account would be guaranteed to earn a return of at least 3%, or about 1% above inflation. This guarantee ensures that funds are protected from the volatility of the stock market; workers do not have to worry about losing a significant portion of their savings right before retirement.
Pooled investments: All individual account assets would be invested together in one large pool, with an emphasis on low-risk, long-term gains. Pooling takes advantage of economies of scale and minimizes financial risks.
Portable accounts: Individual Accounts would be portable; the account would automatically move with a worker from job to job, unlike 401(k)s, which are tied to a particular job and difficult to roll over.
Lifelong retirement income: at retirement, workers would convert all or part of their State Plan balance into an annuity—a guaranteed stream of income for life—to ensure that they do not outlive their savings.
Investment management costs could be minimized by using the already-existing public pension infrastructure to invest the funds. State pension funds, which operate on a not-for-profit basis, have highly skilled, professional investment managers and administrators that are charged with overseeing and investing more than $3.1 trillion in retirement savings.8 In such an arrangement, assets in State Plan would be kept in a separate investment pool from public pension fund assets.
Why is a State Run Retirement Plan a Better Retirement Plan than a 401(k)?
The 401(k) system is inherently inefficient because it generates high administrative and investment management costs that are ultimately absorbed by the workers themselves.9 401(k)s also expose workers to a host of risks:10
Market risk: workers who have 401(k)s risk losing a chunk of their savings in a market downturn, a particularly damaging prospect for workers nearing retirement.
Longevity risk: retirees relying on their 401(k) to supplement Social Security may outlive their savings.
Investment risk: 401(k)s force workers to manage their own portfolios, which often leads to lower-than-optimal performance for many reasons: workers sell losing investments while holding winning investments, tend to hold un-diversified portfolios, are invested in too many high-risk stocks, and generally lack the expertise necessary to earn high returns.
Contribution risk: workers often contribute too little or too inconsistently to their accounts to accumulate a sufficient nest egg. High account fees can exacerbate this problem, taking a big bite out of already-inadequate savings.
Leakage risk: workers often whittle away their savings by cashing out assets when they change jobs, by borrowing from their 401(k)s, and by making hardship withdrawals from their accounts before retirement.
These risks and costs are an inherent part of the 401(k) system. Thus, reforms like stricter regulations on brokers, disclosure of 401(k) fees, or requiring plan sponsors to offer more lower-cost index funds, would be band-aids; they wouldn’t fix this fundamentally broken system. Fees would still remain high and workers would still be forced to shoulder most of the risks.
On the other hand, the State Plan would encourage workers to save consistently, and their hard-earned savings would be invested in financial vehicles that charge low fees and provide steady returns. At retirement, their nest egg would be converted into a low-cost annuity to ensure that they have a guaranteed stream of income for the rest of their lives.
What is the Guaranteed Minimum Rate of Return?
The guaranteed minimum rate of return is one of the defining characteristics of the State Plan. It ensures that at retirement, savers receive a benefit that includes the total amount of funds they deposited into their account over their work life plus at least some annual minimum rate of return on their assets.
This minimum guarantee insures workers against the possibility of losing a significant portion of their hard-earned savings during bad economic times while also allowing them to capture higher investment returns when the market is performing well. Even in a year of poor investment returns, participants would be guaranteed at least a 3% rate of return on their investments, or 1% after adjusting for inflation. However, in high-performing years participants would receive additional returns, projected to be as high as 7% (5% after adjusting for inflation). To enable the fund to meet its 3% guarantee in low-earning years, some of the investment earnings in excess of the guarantee would also be deposited into a “rainy day fund”.
This is not a radical idea: TIAA-CREF, one of the largest investment firms in the country, has offered a similar fund, their TIAA Traditional Annuity Fund, to non-profit workers and teachers for over 80 years. DEMOS – State Guaranteed Retirement Accounts