New California Law Could Require Private Employers to Provide Access to State-Run Defined Contribution Plan
On September 28, 2012, Governor Jerry Brown signed into law a bill (S.B. 1234, the California Secure Choice Retirement Savings Trust Act) that would require private sector employers to enroll their employees in a payroll deposit retirement savings arrangement called the California Secure Choice Retirement Savings Investment Program “Program”). It is not clear whether the Program will ever get off the ground, but if it does it could significantly change the way retirement benefits are provided to California employees.
How the Program Works
A covered employer will be required to withhold and contribute to the Program fund 3% of each eligible employee’s annual compensation, unless the employee:
- opts out of the Program; or
- elects a different withholding percentage.
Employees who participate in a Taft-Hartley pension plan pursuant to a collective bargaining agreement, and employees covered under the Railway Labor Act or who are engaged in interstate commerce so as to not be subject to the legislative powers of the state, will not be eligible to participate.
Not all employers will be required to participate. The Program will cover all private employers that:
- do business in California (including both for profit and not for profit employers);
- have five or more employees; and
- do not offer an employer-sponsored retirement plan, or a payroll deduction IRA program in which employees are automatically enrolled.
Governmental employers, including the federal government, the state, and any county, municipality or state unit or instrumentality, are exempt. A covered employer that fails to permit its employees to participate in the Program could be subject to penalties of up to $500 per employee.
Significant Hurdles to Implementation
Before the Program can move forward, an appointed governing board must obtain rulings from the Internal Revenue Service (“Service”) and the U.S. Department of Labor (“DOL”) confirming that:
- contributions under the Program can be made on a pre-tax basis; and
- the Program is not covered by ERISA.
If the governing board is able to secure these rulings, it would then seek legislative approval to move forward with implementation of the Program. In addition, the Program may face other legal challenges. Other state and local laws that require employer participation in an employee benefit program have been challenged, with mixed success, on the basis that they “relate to” an employee benefit plan and, therefore, are preempted by Section 514 of ERISA.1
The Program’s governing board will consist of the following seven members:
- The California State Treasurer
- The California State Director of Finance, or his or her designee
- The California State Controller
- An individual with retirement savings expertise appointed by the Senate Rules Committee
- Two representatives (one of small business and one of the public) appointed by the Governor
- An employee representative appointed by the Speaker of the Assembly
The governing board will have fiduciary duties of loyalty and care that are similar to those set forth in Section 404(a) of ERISA and Section 17 of the California Constitution, and is required to adopt an investment policy that mitigates risk through diversification and provides a stable and low-risk rate of return. Interestingly, the board is authorized to maintained a “gain and loss reserve account” to which “excess earnings” may be allocated. Presumably, those excess earnings could be used to offset investment losses in subsequent years.
Investment decisions will be made by the governing board, and not by individual Program participants. Assets will be managed by professional investment managers and/or the CalPERS Board of Administration.
The California Employment Development Department will be responsible for disseminating information about the Program and providing forms, such as an opt-out form for employees who do not wish to participate in the Program.
Supporters and Critics
Supporters, including labor groups, say the Program gives workers more savings options, particularly workers in low paying jobs. They also say it will not cost the state money because it will be backed by underwriters and reinsured to protect returns.
Critics say that low income workers might be better off financially if they put after-tax earnings in a Roth IRA. They also say that the Program has too many unanswered questions and that if it fails to meet investment targets, taxpayers and employers could be held responsible for covering losses and administrative costs.
1For example, a “pay-or-play” provision in the San Francisco Health Care Security Ordinance that requires covered employers to make a minimum expenditure for health care on behalf of each of their covered employees who perform work in San Francisco faced a preemption challenge that eventually was rejected by the 9th Circuit in January 2008.