A Federal Plan to Close the Coverage Gap: Myths vs. Reality

Since the Employee Retirement Income Security Act (ERISA) was passed in 1974, we have seen significant change in the retirement plan landscape: where traditional employer-sponsored defined benefit (DB) pension plans were once the dominant plan design, those plans continue to decline in both number and coverage, in large part due to corporate finance and market drivers. Today, defined contribution (DC) plans, including 401(k), 403(b), and 457 plans, once envisioned as supplemental savings plans, are now the primary or sole retirement plan for many workers. The responsibility for managing one’s retirement has shifted from the employer to the employee.

Although dramatic improvements have occurred to increase both coverage and asset sufficiency for employers that provide those plans, one striking statistic has not changed: nearly 48% of private workers in the US work for an employer that does not offer a retirement plan.¹ That number has remained largely static since the passage of ERISA. The difference between large and small employers also extends beyond the provision of a plan to differences in participation, savings rates, and cost.

Consider These Facts:

Access:

While 88% of workers at large companies have access to a retirement plan, only 49% of workers at small businesses do.²

Participation Rate:

The average participation rate across all plan sizes is 77%. For the smallest plan segment (employers with 1-49 plans), participation rates dip to 69%.³

Savings Rate and Shortfall Projections:

Across all plans, the average savings rate is 7.4%, while in the smallest plans it is 6.6%.⁴

Cost:

In the largest plans, the median “all-in” fee is 0.25%, whereas the median “all-in” fee for the smallest plans is 1.24%.⁵

The barely moving coverage needle has led public policymakers to consider initiatives beyond tax incentives to significantly increase coverage rates. In 2021, U.S. Rep. Richard Neal, then chairman of the House Ways and Means Committee, included provisions in the Ways and Means Committee passed version of the social infrastructure legislation, Build Back Better, that would have required all employers (with limited exceptions) to auto-enroll and auto-escalate workers into a 401(k) or SIMPLE plan or into an IRA. The bill also provided tax credits to small employers to cover administrative plan costs and any employer contributions made to the plan. Unfortunately, those provisions were ultimately dropped from the House-passed version of the legislation.⁶ This type of comprehensive federal solution, if enacted in the future, could serve as the retirement savings standard, broadening access to all workers.

Despite the limited increase in the coverage rate in the past 50 years in a voluntary retirement plan system, there continues to be strong opposition to a federal requirement for employers to provide a retirement plan for their workers. Certain “myths” regarding a mandatory system persist and have become entrenched in the views of many policymakers. Below are some of the most persistent myths, together with the reality of what a federal solution could do.

Myth: The voluntary system is working

Reality: Since the enactment of ERISA in 1974, many bills have been enacted with incentives and innovative plan designs targeted to small and mid-sized businesses in an attempt to increase adoption of private retirement plans. Even with the incentives that have been added over time, together with other innovations, such as open MEPs and PEPS, the coverage needle has not moved in any significant way. The reality is that many small employers have other priorities and either believe that retirement plans are too difficult or too expensive to adopt. Although the costs and complexities involved in establishing a plan have been greatly reduced, that message has not been either communicated effectively or understood.

Myth: The auto-401(k)/IRA legislation will drive small employers out of business

Reality: Although the legislation contains a requirement, with the exceptions for employers with less than 10 employees and for new businesses, together with the incentives included in SECURE and SECURE 2.0, including significant tax credits and the ability to join a MEP, the requirement is balanced by significant incentives. With the new tax incentives and the ability for plans to access the scale of a MEP or PEP, the cost burden for smaller employers establishing a retirement plan can be significantly reduced. Even if the employer decides to make a match, the tax credit available is very powerful. To illustrate the power of the additional credit based on contributions, assume that a 30-employee company has 20 employees with $100,000 or less of wages, and assume that the employer makes at least a $1,000 contribution for each of those employees. The contribution-based credit for that company over five years would total $70,000.

In addition, as discussed in the next section, in those states with a fully implemented Secure Choice program, private retirement plan formation has generally increased, indicating that the impact of a requirement, rather than driving employers out of business, is motivating them to investigate and even adopt private retirement plans rather than the state programs.

Myth: Having a federal solution won’t close the coverage gap

Reality: The latest findings from both US state-sponsored plans, as well as the UK where a mandate to sponsor a plan was implemented in 2012, demonstrate that putting a requirement in place does in fact help to close the coverage gap.

For the US, six states have launched their Secure Choice programs: Oregon, Illinois, California, Colorado, Maryland, and Connecticut with another eight currently in the process of implementing. The latest research from the Pew Charitable Trusts suggests that, in those states sponsoring automated savings programs, employers with plans continue to offer them and businesses without plans are adopting new ones at rates in line with, or even above, the national average.

In 2021, California still had a higher rate of retirement plan creation than the national average, and the state’s share of new plans remained among the highest in the country. Illinois, meanwhile,  consistently had a lower share of new to existing plans than the national average since 2013, but the share of new plan creation in the state increased in 2021 by more than 1 percentage point.⁷
In the UK, mandatory plan adoption for all employers with at least 1 employee, which included automatic enrolment, began with a phased introduction starting in October 2012. Since then, data from the Office for National Statistics’ Annual Survey of Hours and Earnings shows:

• Participation has increased among private sector eligible employees in every industry and occupation between 2012 and 2021, including those with historically low rates of employees saving into a workplace pension.
• Between January 2020 and August 2022, the number of active members of 11 large private pension providers have increased. The total contributions (amount saved) to these 11 providers have also increased over this time, and were 32% higher in August 2022 than in January 2020.⁸