Welcome back! In Part 1 of this series, I laid out what CalSavers is, what it is trying to accomplish, and why. We also discussed what the rollout is going to look like for both employees as well as employers. Today, I would like to turn our attention to some of the more nuanced parts of CalSavers and how this law is most definitely not a fix for all Californians.
As a quick recap, CalSavers is California State’s answer to the impending retirement crisis. Based on your company’s eligibility, or lack thereof, your company will be required to comply with the CalSavers Program. If you have 5 or more employees, and your company does not offer an adequate retirement savings plan for those employees, the State of California will require you to register for CalSavers. One piece of this debate is quite ironic in that the State of California claims that this program is “completely voluntary”, and while it is voluntary for participants, it is anything but voluntary for employers in the state. Part 2 of this discussion will center on some of the sticky details of the CalSavers program and the failures built into the system.
Once your employees are enrolled in the program, either through their own actions, or through their inertia, 5% of their salary will be deducted from their pay and placed in their retirement account. This is where some of the nuance to financial planning comes into the equation. The funds that are withheld are to be placed in a ROTH IRA for the participant and will be administered by Ascensus College Savings Recordkeeping Services. In most cases, I would argue that this ROTH IRA treatment is completely fine, and can really assist people to save for retirement. These funds will be invested using funds created by State Street, and there will be a stock fund, a bond fund, a stable value fund, and a Target Date Series of funds. The default is that if the participant fails to make an election, that the first $1,000 of contributions will be placed in the stable value fund, and that each additional dollar will be placed in the Target Date Fund that corresponds to the year closest to your retirement at age 65.
However, anyone that knows how a ROTH IRA works will know that the contributions you make to the account can be withdrawn at any time without penalty. Only the growth in the account has a restriction on use before the age of 59 ½. I fear that this nuanced treatment of ROTH accounts will only keep people further from retirement security. Once a fair sum of money is saved in the account, then a new car, or a vacation, or just putting food on the table when times get a bit rough, will be the norm. The account will be looked at as a piggy bank, not unlike big tax refunds are looked at for some. This is a worst case scenario where those people with little or no fiscal discipline will torpedo their future for the shiny things of today. This is precisely why other retirement accounts levy a 10% penalty on early withdrawals; to deter people from distributing the money for current use. Now let’s investigate whether a family that has the fiscal discipline to leave those savings alone will have enough in retirement.
Let’s take a look at some numbers and see what kind of retirement security this brings to an average household in Bakersfield, California over a 30 year work history. I live in Kern County, a modest county by almost any measure, and more affordable than many California counties. The median household income in Kern from 2010 through 2014 was $48,574 based on information from the US Census Bureau. I will assume that this household receives a modest 2.5% raise every year, and that they do not change their savings percentage of 5%. Now, if we take 5% of that household income each year, the automated savings amount dictated by this program, and invest it with an average rate of return of 6%, after 30 years there would be a little bit over $268,000 in retirement savings, for the household. While for many people this seems like a sizable sum of money, it is not enough to support you through a possible 25-30 year retirement. This amount of savings would generate around $10,000 per year in income and with Social Security showing signs of fatigue, this average family living on $48,000 per year would take a severe haircut in retirement to the tune of about $10,000 to $15,000 a year.
While the State of California has great intentions with the implementation of this program, the downside is that it doesn’t do nearly enough to fix the future retirement crisis. Using the same above example household, in order to replace only half of the $48,000 income today through investment accounts (the other half being provided by Social Security), this average household would need to have over $600,000 in accumulated retirement savings in current dollars. This program will not provide the kind of retirement security that it promises. Is it a step in the right direction? Possibly, but the retirement crisis is very real, and saving $2,000 to $3,000 per year for a family is not going to fix the issue.
Now that we’ve debunked the premise that CalSavers is going to save us from ourselves, let’s look to another potential issue. Not everyone is allowed to contribute to a ROTH IRA. The State’s own website has a note that, “CalSavers accounts are Roth (post tax) IRAs, and those with higher incomes may not be eligible to contribute. If you earn more than the Roth IRA income limits set by the federal government, you may need to opt out of CalSavers.”
Well, isn’t that nice? While California acknowledges that they will be offering Traditional IRA options in the future, they aren’t offering those options currently, and that could create some problems for higher earning people that fail or forget to opt out of the program.
All of the above issues and nuanced treatment of retirement savings can be addressed, discussed, and potentially alleviated with sound and proper plan design. Your company retirement plan may not be able to solve the retirement crisis for society, but, if built the right way, you could solve the retirement crisis for your own employees as well as yourself. It takes a little bit of time and effort to create a qualified retirement plan that checks all of the boxes for your organization’s needs and meets the California State requirements, but it is an investment that is well worth it in the end.
For a no-nonsense, no-obligation look at your organization’s situation and recommendations for a strategic and optimal path forward, contact Moneywise Wealth Management at (661) 847-1000 or firstname.lastname@example.org
*Disclosure* The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.