Raquel Pichardo-Allison talks to David C. John, co-author of President Barack Obama's proposal to offer automatic savings plan enrolment, about America's changing attitude towards retirement security
Raquel Pichardo-Allison: How closely have you worked with the president on this retirement proposal?
David C. John: We introduced this in 2006. It was introduced into Congress again in 2007 with bi-partisan sponsorship. I was advising the McCain Campaign. The McCain campaign endorsed the proposal. My colleague Mark Iwry advised the Obama campaign and they also endorsed it.
It was the same identical proposal. We felt pretty good going into the November elections. Since then, the Obama administration included the automatic individual retirement arrangement (IRA) in the budget and they have explicitly endorsed the proposal.
Raquel Pichardo-Allison: What kind of support is there for this on Capitol Hill?
David C. John: We've had tremendous support and it's obviously bi-partisan support. The bill was introduced into both the house and the senate the last time with bi-partisan sponsors. Sadly, the republic sponsors both in the house and the senate lost the election. We don't think it was because of this, but they did lose. We are now in the process of recruiting new sponsors.
Raquel Pichardo-Allison: What are some of the hurdles in getting this implemented?
David C. John: Number one has been the question of small accounts. What we're talking about is hypothetically adding 40 million people to the savings world. A lot of those are going to be saving very small amounts.
The Obama administration has proposed changing a tax incentive called The Saver's Credit so that it would go directly to the account... It would basically provide a 50% match of the first $1,000. The savers credit is designed to fix the (small account) controversy.
The other issue is whether or not the industry will be able to provide every worker who wants an account at an appropriate administrative cost. We have proposed that there would be an internet clearing house that would enable an employer to... be connected with any IRA provider that's interested in serving that company. Then hopefully hitting one more button will enable direct connection to that individual who can then sign up. It's a very low-cost, simple, system.
The third issue is that when (small businesses) are told they must offer this product to their employees, their answer is, "Are you out of your mind? I'm busy running a business." We structured this so that it's only a mandatory offering for companies with 10 employees or more, the ones most likely to outsource their payroll processing. We reduced the administrative burden as much as we could.
Raquel Pichardo-Allison: How much will this cost a small business?
David C. John: If you already have a payroll processor... this might add $6 to $7 per pay period, per company... for having direct deposit. We have already offered a tax credit of up to $250 per year for two years to help meet those costs.
Raquel Pichardo-Allison: Some are questioning if 401(k) plans will survive. Is this meant to replace a 401(k)?David C. John: Our system will not replace a 401(k). It is specifically designed to be both a strengthening and an addition to the 401(k) system.
What we're targeting is the half of the American workforce, roughly 40 million workers, who work for a company where the employer does not provide any form of retirement savings or pension plan.
Raquel Pichardo-Allison: Once an individual is enrolled, what will the default funds be?
David C. John: For the smallest investor, initially, the money would go into the equivalent of a passbook savings account or a stable value fund. Once their retirements hit a certain level, it would automatically be rolled over into the equivalent of a life-cycle fund.
But we recognise that the world didn't stop when we wrote our legislation. So we have it set up that there is enough flexibility so that when something new and better comes along, it'll be fairly simple to just pull out the life-span fund and put in an improvement.
Raquel Pichardo-Allison: Lifestyle fund platforms have come under scrutiny for underperforming. What are some of the alternatives you've been considering?
David C. John: Well, we looked at a wide variety of investment strategies and we came to the conclusion that the proportion of the population who are going to be lower-wage workers, women, minorities and small businesses. We have found that because this is automatic enrolment, it needs to be as simple as possible. And we need to keep the cost low, so we're talking about a system that may have one or two, or at the most, three investment options.
We anticipate that the default would be the lifestyle fund. If someone is really risk averse, there might be a stable value fund, then maybe one or more other funds to be determined. Raquel Pichardo-Allison: How long would it take for your plan to be implemented?
David C. John: If it is approved this year, it could be up and running in 12 to 18 months.
Raquel Pichardo-Allison: If we looked at the original 2006 proposal and compare it to the existing proposal, what are some of the major changes?
David C. John: We've adjusted it over the years to reflect changes in the industry. Now that we are at the point that the Obama administration is pushing the bill, we are continuing to discuss with them the fine points of implementation.
For one thing the original version had as a backup something like the Thrift Savings Plan. We now have that as a third level that only goes into effect if the private industry can't meet goals otherwise. Otherwise, it'd be that online system we discussed earlier.
Second, we put in the savings account mechanism for the very low balance savers.
Third, at one point we said that the employers had the choice of telling employees, "You find your IRA and we'll arrange to have your payroll deposited directly." We found that that wouldn't work because frankly, if most people were going to go out and find their own IRA, they would have done so long ago and we wouldn't need to be doing this.
So what we've got is a system where the employer chooses a private sector company...and in addition, the employer can say, (the employee) can put their money into their own personal IRA.
Raquel Pichardo-Allison: Information has floated around that this could cost some $55bn to implement.
David C. John: You've got the right budgetary cost. But what that is, is a combination of the cost of the forgone tax in the auto-IRA, plus the cost to the change in the savers credit.
The $55bn is over 10 years, so it's basically $5.5bn per year. We anticipate that when the details of the budget come out in April, that those costs will be broken down and we are working with OMB and the tax committee to reduce the estimate.
Raquel Pichardo-Allison: Looking ahead, five to ten years from now, where do you see the US retirement system?
David C. John: We actually have a number of major challenges, and if the good things happen - which in politics is always 50/50 - we will see a strengthened retirement savings system that is much more universal, that includes an escalation, so that we make sure people are saving a sufficient amount of money.
The area that I am most concerned about is that in the US, we have a social security system which has promised more benefit than it is going to have revenue to pay for. So far, that is the issue where congress is whistling and looking off in the distance and has tried desperately not to discuss. It's not an issue that any of the solutions are good news - you raise taxes, cut benefits or put in a personal savings element. But the longer they wait, the worse the problem becomes.
Raquel Pichardo-Allison: You worked with President George Bush in 2005 to overhaul the social security system.
David C. John: I was one of the outside people, he also had lots of good inside people.
Raquel Pichardo-Allison: That didn't go through.
David C. John: I'd say a stunning lack of success.
Raquel Pichardo-Allison: Has the attitude changed from then to now?
David C. John: The attitude hasn't changed. We were proposing to take a portion of the existing social security taxes and put them into an investment account that would help to pay for the workers' social security benefits in future years.
The problem is that the Bush administration had very poor execution. You can't replace something with a partial promise. So... they came up with a management system with a deferred taxation... and a change in the benefit formula which they started talking about several weeks later. But the fact is neither one of them resolved 100% of the problem. They kept saying, "Congress will work that out."
Meanwhile the other side, who were brilliant in the way they handled this, could very happily fill in the blanks with the things that made the Bush proposal look the worst. The whole thing collapsed like a house of cards.
The one thing the Bush administration managed to accomplish was raise the question of whether social security was secure. What they didn't have was a good answer. Those of us who worked on that can take a good part of that blame.
Most respondents in this week's Pensions Buzz do not think businesses should be able suspend AE contributions if in financial distress.
Former BHS owner Dominic Chappell has lost the appeal against his section 72 conviction and sentence for failing to hand over information to The Pensions Regulator (TPR).
This week's top stories include Marsh and McLennan Companies agreeing to buy JLT, and the home secretary calling for AE to be scrapped in a no-deal Brexit scenario.
Lesley Titcomb says the watchdog wants closer interactions with pension funds to spot problems sooner and act before having to use its more stringent powers