BILL ANALYSIS Senate Appropriations Committee Fiscal Summary Senator Christine Kehoe, Chair 125 (De Leon) Hearing Date: 8/27/2009 Amended: 6/18/2009 Consultant: Maureen Ortiz Policy Vote: PE&R 4-2 _________________________________________________________________ ____ BILL SUMMARY: AB 125 creates the California Employee Savings Program to be administered by CalPERS designed to offer individual retirement accounts (IRAs) to employees of private-sector or non-profit employers that do not otherwise provide access to retirement savings plans. _________________________________________________________________ ____ Fiscal Impact (in thousands) Major Provisions 2009-10 2010-11 2011-12 Fund CalPERS $845 $845 $1,200 General EDD $23,952 $14,725 $14,718 General potentially offset by fees _________________________________________________________________ ____ STAFF COMMENTS: SUSPENSE FILE. Although the intent of AB 125 is for the program to be self-funded and have the costs fully covered by fees deducted from participants' IRA contributions, the feasibility of that funding will depend on the level of participation, as well as the amount of assets in the program. Therefore, it would most likely be necessary for the State to appropriate or loan funds to CalPERS and EDD to cover their costs for the study phase, the start-up phase and an initial period of operations until the program can sustain itself. AB 125 allows donations from nonprofit or private entities, as well as federal funding, for these purposes. Since the existing CalPERS Defined Benefit Plan is a pension plan qualified under Section 401(a) of the Internal Revenue Code, its assets may only be used for the exclusive benefit of the employees or the beneficiaries of the employers sponsoring the plan. Therefore, to ensure that existing assets will not become liable for the funding of this new program, AB 125 specifically prohibits CalPERS from using any funds in the defined benefit plans, health and welfare plans, deferred compensation plans, or any other plan administered for state and local governments to study, initiate, develop, implement or administer an IRA program established pursuant to this bill. AB 125 provides that funding must first be made available before the commencement of the feasibility study. CalPERS estimates startup costs of $1.69 million over a period of 24 months which includes approximately $75,000 to conduct a market survey to determine likely participation rates, potential contribution levels and the rate of account closures and rollovers; approximately $500,000 to secure the services of outside tax and securities counsel to obtain necessary federal regulatory approvals; and approximately $1.2 million for 10.4 PYs to carry out such tasks as program design, identifying customer service, participant education, systems automation, accounting, auditing and financial Page 2 AB 125 (De Leon) reporting costs, developing and administering requests for market survey and legal services, and potential costs for third-party administrator, trustee, investment and marketing service providers. In addition to the above cost estimate, CalPERS would incur another $250,000 to $500,000 in legal expenses if the board were to seek approvals for authorized ERISA-regulated SIMPLE and SEP IRAs. CalPERS will be allowed to completely develop and administer the program in-house, contract out with a third party, or to use a combination of the two approaches. AB 125 provides that all expenses of the program will be funded by contributions to or investment returns of, the program, but also allows for funding appropriated by the Legislature. The bill creates the California Employee Savings Program Administrative Fund for these purposes, continuously appropriates the money in that fund, and also authorizes CalPERS to establish multiple accounts within the fund in order to allocate moneys for various program needs. It will be important for the IRAs to maintain administrative costs at a level that participants are willing to bear through fees charged either as a percentage of assets in their accounts, or through a fixed annual fee. It should be noted though, that when participants are allowed to make contributions in very small amounts, the plan administrative costs may consume a large percentage of their assets, thereby, actually discouraging participation. Another important consideration is whether the IRA assets could be effectively separated from CalPERS' governmental assets in order to prevent the possibility of interference with its current exemption from ERISA. Employment Development Department (EDD) AB 125 authorizes CalPERS to use the current tax processing and accounting system of the EDD, or to use either a financial services company or a third-party administrator that has the capability to receive and process employee information and contributions for payroll deduction IRA arrangements. However, if EDD is selected by the CalPERS board, it must participate in the implementation and administration of the program. EDD has estimated the following costs based on the premise that it will act as a pass-through entity from employers to CalPERS. The estimate does not reflect any costs for collection and enforcement activities, nor the reconciling of information through EDD's processing and accounting areas. For FY 2009/10, EDD anticipates one-time costs of approximately $17.9 million in addition to $6 million for 60 PYs. During FY 2010/11, one-time costs will be about $363,000, but ongoing will increase to $14.4 million to support approximately 125 PYs. These costs include the procurement of a new database system to store employer and employee data, accounting error suspense, on-line corrections, transfers, activation and in-activation, data retention and removal. Also needed are new software, servers, and imaging updates in order to facilitate new workload requirements. Page 3 AB 125 (De Leon) The anticipated workload for EDD is based on the assumption that fifty percent of employers will file by paper, and fifty percent will use electronic methods. AB 125 specifically authorizes EDD to charge a fee for any administrative costs it incurs. However, it will be likely that General Fund expenditures will be necessary to fund the development and implementation of the withholding program, as well as part of the ongoing costs, if EDD is unable to generate a sufficient administrative fee. Funds received for the CalESP program must be kept separate and may not be commingled with existing funds for UI, DI, Employment Training Tax, Personal Income Taxes, and Contingency Funds. Therefore, it may be necessary to create a special fund or account for receipt of fees or other sources of revenue. Study AB 125 requires CalPERS to conduct an economic feasibility study to determine whether the necessary conditions for implementation can be met. This market survey will include such items as participation rates, participants' comfort with various investment vehicles and degree of risk, contribution levels, and to what extent participants will close accounts and/or rollover funds. The study will not commence until sufficient funds are made available through a nonprofit or private entity, federal funding, or an annual Budget Act appropriation. Upon completion of the study, the Board will present its finding to the Legislature for review. Approval Phase After completion of the study and concluding that the IRA program is in fact feasible, CalPERS will then need to request funding through either a Budget Act appropriation, donations, or federal funding for obtaining all necessary approvals, and then, for designing the program. Approvals, rulings, determinations from federal entities include the IRS, Department of Labor, and the Securities Exchange Commission. CalPERS will report to the Legislature after these two tasks are completed. Implementation Upon completing the study, obtaining all federal approvals, and designing the IRA program, CalPERS will then be required to request funding for implementation. This funding will also come from an appropriation in the annual Budget Act, donations from nonprofit or private entities, or from federal sources. AB 125 provides that implementation may not begin until adequate funding sufficient to fund program development, implementation and administrative costs are obtained, and requires that the program must be self-sustaining after implementation. The CalPERS board must file a report with the Legislature at this time that includes the following: 1) information regarding the expectations of the program, 2) an outline of the program, and 3) details relating to the administration and projected cost of the program. AB 125 specifies that implementation may not begin until this report is completed, and until the funds for the Page 4 AB 125 (De Leon) projected cost of the program are appropriated by the Legislature in an Annual Budget Act. After implementation has begun, the board will be required to submit annual reports to the Legislature relating to the status of the program including outreach, investments, and solvency efforts. In addition, the board must submit a report to the Legislature 90 days prior to discontinuing or suspending the program for any reason. Defined Benefit Plan In addition to the IRA program, AB 125 requires CalPERS to conduct a feasibility study of creating a defined benefit plan option, develop, and obtain the necessary federal approvals for implementation if funds are made available for this purpose through the annual budget act, private donations, or from federal sources. It is unclear how a define benefit plan could be established that would meet the portability requirements of the program. Specifically, AB 125 does the following: 1) Requires CalPERS to offer one or more IRAs including traditional IRAs, payroll deduction IRAs, SIMPLE IRAs, or other IRAs as specified. The CalPERS Board may select from among several possible structures and features 2) Authorizes CalPERS to do the following: a) employ staff, b) retain and contract with private financial institutions, other financial and service providers, consultants, third-party administrators and other professionals as necessary, c) collaborate with financial and business entities to reach an effective and efficient design, implementation, and administration of the program, and to maximize outreach to eligible employers and employees, d) pay all associated expenses from contributions to and investment returns of the program or IRA plans, e) facilitate compliance by the IRA plans with all requirements under the Internal Revenue Code, f) cause the IRA plans to be designed, established and operated in accordance with best practices and to maximize participation through the use of automatic features, g) seek to minimize costs by facilitating the pooling of small employers and individuals, h) arrange for collective, common, and pooled investment of assets of the IRA arrangements to the extent that such action does not jeopardize any current ERISA exemptions as specified, i) disseminate educational information concerning saving and planning for retirement, j) disseminate information to employers regarding potential tax credits, k) submit progress and status reports to participating employers and employees, l) determine employer and employee eligibility to participate in the CalESP, and Page 5 AB 125 (De Leon) m) establish a process to enable employees to arrange payroll deductions through their employers and to require employers to forward contributions to the program. CalPERS will be required to obtain all necessary approvals, rulings, opinions, determinations, or confirmation from the Internal Revenue Service, the Department of Labor, and the Securities and Exchange Commission in order to ensure that all plans established under this program adhere to requirements of federal law. AB 125 authorizes CalPERS to use the current tax processing and accounting system of the Employment Development Department (EDD), financial services companies, and third-party administrators. It requires EDD to assist CalPERS to study and implement the processing of payroll deduction authorizations. AB 125 further authorizes EDD to charge a fee for administrative costs for implementation and administration. However, the bill does not designate the payer of that fee, whether it will be the employer or employee. Members of the CalPERS Board, state officers and employees, and investment managers under contract with CalPERS will be indemnified from the General Fund and held harmless by the state, as specified. Traditional IRAs - Include tax-deferred retirement savings accounts whereby taxes are not paid on contributions and investment earnings until withdrawal, and ROTH IRAs, where contributions are made on an after-tax basis and are not subject to taxes upon withdrawal. These IRAs are available whether or not an individual is covered by another retirement plan, however, the income tax deductibility of their contributions may be affected if they or their spouse is covered by an employer retirement plan. The contribution limit is $5000 for 2009. This is the maximum amount that can be contributed in 2009 regardless of whether the contributions are to one or more traditional IRAs or whether all or parts of the contributions are nondeductible. A traditional IRA is not sponsored by an employer so the assets are not considered pension plan assets subject to the Employee Retirement Income Security Act of 1974 ("ERISA"), nor are the contributions made through payroll deductions. Payroll Deduction IRAs - These are for employers who do not want to adopt a retirement plan, but still want to allow their employees to save through payroll deductions. The decisions about how much to contribute up to the $5000 limit, and when to contribute are made by the employee. Although the limits and the contributions to a payroll deduction IRA are tax-deductible to the same extent as traditional IRAs, it provides a more convenient and consistent means for the employee to make these contributions. Depending upon how the payroll deduction IRA is set up and level of endorsement by the employer, the IRA assets may be subject to ERISA. Savings Incentive Match Plans for Employees of Small Employers, or SIMPLE IRAs - These are a savings option for employers with 100 or fewer employees that allow employees to contribute a percentage of their salary each pay check and to have their Page 6 AB 125 (De Leon) employer contribute too. Under a SIMPLE IRA, employees can contribute up to $10,500 annually. Employers can either match up to 3 percent of an employee's wage or make a fixed contribution. SIMPLE IRAs are considered pension plan assets and are subject to ERISA. Simplified Employee Pensions, or SEP IRAs - Allows employers to set up an IRA for their employees. Employers are required to contribute a uniform percentage of pay for each employee, but they are not required to make contributions each year. An employer may contribute up to 25 percent of an employee's compensation up to the annual cap, which is $45,000 in 2008 and subject to annual cost-of-living adjustments for later years. SEP IRAs are considered pension plan assets and are subject to ERISA. Defined Benefit Plans - Employers and employees make contributions to the plan, calculated as a percentage of payroll, which are invested together to provide a fixed benefit upon the employee's retirement. The purpose of the California Employee Savings Program (CalESP) is to provide retirement savings opportunities to employees who do not have access to employer-sponsored plans in a convenient, low-cost and portable manner. Employees who participate in this program will not be construed to be members of the California Public Employees' Retirement System. Several other states have considered retirement savings proposals similar to AB 125 including Connecticut, Maryland, Michigan, Vermont, and Washington, however, none of those proposals have been signed into law. Maryland and Washington have recently conducted scoping studies. The study in Maryland concluded that funding of between $300,000 and $500,000 would be necessary for at least five to seven years before their program could be self-sustaining. The state of Washington reported startup costs of between $2.2 million and $3.4 million. This bill is similar to AB 2940 (De Leon) which was held on this committee's Suspense File last year.