State-Mandated Auto IRAs Face Funding Hurdles

By charging higher participant fees in the short run, state-mandated automatic retirement savings programs can hasten the day when the program can pay for itself, a new report said.

Plans could become financially self-sufficient within a decade by setting fees at around 100 basis points, having meaningful contribution and relatively low per-account costs, according to the issue brief published this month by the Center for Retirement Research at Boston College.

By that point they would not only be able to break-even but also to pay back initial losses, the brief said.

“States that have passed auto-IRA laws face a challenge: these programs must pay for themselves,” the brief said.

“In today’s budget environment, states don’t want to have a money-loser,” Geoffrey Sanzenbacher, research economist at the center and co-author of the brief, told Bloomberg BNA on Dec. 19.

States’ Challenge

Laws requiring employers without retirement plans to enroll their workers automatically in state-sponsored IRAs are on the book in five states—California, Connecticut, Illinois, Maryland and Oregon—though no such programs exist as of yet.

States face several challenges in getting the programs to pay for themselves include start-up and ongoing maintenance costs, the brief said.

Using Oregon’s Retirement Savings Plan as an example, the program’s estimated startup costs are approximately $11 million, including $1 million in fixed costs and $10 million for plan administrators to “establish connections with thousands of employers to get data for automatic enrollment and to process payroll deductions,” it said.

The fixed cost of maintaining an account may be about $35 per account per year, with another roughly $1.3 million per year in costs for program governance, communicating with employers and employees, and staffing, it said.

Investment management fees for large asset pools should be about 15 basis points (0.15 percent of assets), covered by the overall program fee as opposed to being charged directly to the participant.

Money coming into the program depends on the average participant contribution rate and the average participant’s income, the brief said. Workers in Oregon were assumed to contribute 5 percent of pay initially, with auto-escalation over time to 10 percent.

Assets in automatic IRAs will start off low “then grow to a more substantial level as the program is rolled out to more workers and investment returns accumulate,” the brief said. “The level of assets in the program is important because higher assets require lower fees per dollar to generate a given level of income.”

Estimated ongoing costs as a percentage of assets in Oregon’s Retirement Savings Program are 3.37 percent in the second program year but then fall eventually to 0.39 percent in year 15, the brief said.

Plan Administration

The laws establishing auto-IRA programs envision private sector companies providing administrative services with oversight provided by the state.

States will need to show the program can be self-financing to attract private sector companies willing to provide these services, Sanzenbacher said.

“Keeping participant fees at 100 basis points or higher initially and per-account maintenance to $40 or less” should suffice to get them to sign-on, he said.

“In the long run, the states that have established auto-IRA programs expect the fees on assets to be much lower than 100 basis points,” he said. “This is just the cost of starting up.”

Third party administrators want to be convinced that the program will turn a profit in a reasonable time horizon, typically within 10 years, he said.

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