Gareth Hopkins: California does auto-enrolment – the easy way

Gareth Hopkins GJH Pensions, California is on the cusp of its own auto-enrolment revolution says GJH Pensions director Gareth Hopkins. And it looks considerably simpler than the UK’s

The pensions readiness crisis in the UK may look worrying, but spare a thought for the US population, where the statistics are frightening.

Roughly 55 million American employees don’t have access to a workplace pension, around 55 per cent of households age 55 to 64 have savings of less than £19,000, and of that 55 per cent, 41 per cent have no savings at all.

In California alone, 7.5 million workers are not offered a company pension – but that is about to change, as the first wave of auto-enrolment is set to hit the US.

In February 2016, Senator Kevin de Leon introduced bill SB 1234, which was approved by the Senate on June 2 2016 by a vote of 25 – 13. The legislation is currently being fine tuned by the California Secure Choice Retirement Savings Investment Board and it is possible that 6.8 million Californians could start to be automatically enrolled into a workplace pension plan from the beginning of next year – small .

Employees who work for an employer that does not provide a workplace pension will be automatically enrolled into the California Secure Choice Retirement Savings Program, with an initial employee contribution rate of 3 per cent. Employers will not be required to contribute and employees can opt-out any time. For the first three years monies will be invested in low risk assets such as US Treasuries, and a policy for hardship withdrawals is being considered by the board.

One could write a thesis on the comparisons between the UK and US model for auto-enrolment; and a sequel essay debating about which approach is best. For better or worse, it is clear the US methodology is far more simple – something UK employers, especially SME’s, have been screaming out for.

No pension provider selection, no certification, no eligible employees – could this make for a smoother employer journey? Employees seem to get a better deal too. Kudos to the Californians for avoiding pot proliferation from the outset.

The US can learn a great deal from those countries that have gone down the auto-enrolment route earlier – the idea of ‘inertia’ is a good starting point. Industry perception has been that auto-enrolment works because of inertia. But the idea of employees having to do nothing is a dangerous philosophy. It is important that individuals understand their retirement benefits for a plethora of reasons – not least, to fully appreciate their employee benefits and, more importantly, to ensure they are saving enough. The proposed employee contribution of 3 per cent is clearly not going to be enough for a comfortable retirement – especially as the employer is not required to contribute.

Imagine that a worker enrolled for 20 years or more is now ready to draw their savings – only to realise the amount saved is just enough to survive on cat food. As far as the employee is concerned, they were told to do nothing – will they hold their employer accountable? Possibly. Companies can mitigate such risk by developing a full communications strategy, in an attempt to leverage their pensions offering.

Furthermore, opportunity for savings growth will be stifled by the Californian scheme’s proposed investment strategy. The first three years will see money invested in low growth yield options, and will then gradually move into a more diversified portfolio, which will include growth assets. UK contributions are typically immediately invested into a diversified portfolio – mainly consisting of growth assets. Compound interest is paramount to the growth of a pension fund, and it seems odd that members will not be exposed to growth assets from the outset – Einstein didn’t describe compound interest as ‘the eighth wonder of the world’ for nothing.

It is our view that the current default investment strategy as set by the Board will shift considerably in the coming years, and US employers will need support with any changes to legislation. Equally, as ‘simple’ as the Californian scheme may appear from the outset, legislation is expected to snowball over time. Statute is likely to be tweaked with regards to the minimum contributions, and we expect employers will have to contribute before long.

It is only a matter of time before other US states adopt auto-enrolment. The policy will go some way to helping workers save for retirement, and reduce the vast number of people not saving for later life – and other states will want to follow suit.