In its latest policy paper, Morningstar suggests workers at large U.S. companies are served relatively well by the U.S. retirement system. For one, the vast majority of large-company employees have access to a defined contribution (DC) plan.
However, half of employees at small companies don’t have access to a retirement plan at all. Among those who do, plan costs are significantly higher than plans sponsored by larger companies, the paper says. In addition, few small-company plans have automatic enrollment or automatic deferral escalation features.
The paper notes that two policy proposals have attempted to rectify the issues plaguing the retirement system in the U.S.: State-run auto-IRAs and a proposed tweak to multiple employer plans (MEPs) to remove the “commonality” requirement, as introduced in the Retirement Enhancement and Savings Act.
However, the paper says both proposals also raise the risk of increasing fragmentation in the DC retirement plan system. Since state-run auto-IRAs are effectively Roth IRAs, they cannot be rolled over into Roth 401(k)s, which could end up having the effect of scattering a worker’s retirement assets. Should the worker eventually find a job with an employer-sponsored retirement plan, he will be unable to roll over his assets and benefit from potentially lower fees, according to the paper.
“State-run IRAs address one of the root causes of fragmentation within the retirement system in the U.S. in that it begins the process of delinking retirement savings from the employer” the paper says. “But, it introduces another form of fragmentation to the extent that it can scatter retirement savings across several, smaller accounts. Automatically enrolling workers who gladly participate in workplace-sponsored plans are saddled with more retirement accounts than before, as are workers who would move across state lines,” the paper says.
In addition, Morningstar argues that open MEPs do not delink retirement savings from the employer. They do not solve the problems caused by workers having several small accounts scattered across several employers and IRA providers. In addition, open MEPs do not go as far as state-run auto-IRAs in expanding coverage.
Learning from the UK
Morningstar says the U.S. can learn from the UK. As of 2012, employers in the UK have been required to automatically enroll workers who earn more than GBP10,000 in a workplace-sponsored retirement plan, starting with large employers and gradually phasing in smaller employers. Workers in the UK can choose to opt out of automatic enrollment, but relatively few do.
In addition, the paper notes, to facilitate the effort to automatically enroll most workers in the UK, the government set up a nationally funded pension plan called the National Employment Savings Trust (NEST). It is also free for employers to set up and use, making NEST comparatively more attractive for employers to offer relative to other pension plans.
Though employees must now be automatically enrolled in a pension plan, participation in NEST is not the only option. Employers can also choose to contract the services of a privately run pension provider—also known as a contract-based plan—and still comply with the directive to automatically enroll employees in a pension plan. Contract-based plans function similarly to open MEPs, allowing employers to avoid bearing the brunt of recordkeeping and fiduciary duties.
Morningstar points out that the UK solves for fragmentation in ways that the U.S. does not. The UK’s Department for Work and Pensions recognizes that workers’ best interests are not always served by scattering retirement assets across several employers, so it is working on technological solutions to allow workplace-sponsored pensions to follow workers as they switch jobs, and helps workers find small, forgotten pensions they left behind at previous employers. This also eases the burden on small employers, who might find that administering small, dormant workplace-sponsored pensions is uneconomical.
Morningstar’s policy experts propose two complementary solutions for improving the number and quality of small-company plans.
First, Morningstar recommends opening MEPs, in which small employers band together and leverage a larger amount of assets under management to provide a better plan for their workers. However, restrictions should be removed from MEPs as they currently exist, so that the current MEP becomes a truly open MEP. Such plans would allow small employers to offload many of their fiduciary responsibilities and to spread costs and administrative burdens. These plans could be open to self-employed workers, giving them an opportunity to save for retirement.
Second, Morningstar says permitting open MEPs would encourage more small companies to offer a DC plan, but that legislation alone would not ensure complete coverage. It recommends automatic enrollment into an IRA account, so that all new employees would be enrolled into such an account with the standard automatic-enrollment opt-out feature. An automatic IRA enrollment program would be a single, national program, covering all eligible Americans.The full policy paper is here.