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This article is part of our Retirement Plan Trends series, which explores issues affecting the retirement space.
American workers rely on their employers’ plans for most of their retirement savings. But among businesses with fewer than 100 employees, only 42% of employees participate in retirement plans.* To help reduce this retirement coverage gap, nearly every state has either begun considering or actually implemented some version of a state-sponsored retirement program.
As of June 30, 2023, 19 states and two cities have enacted programs. Some are already active; some will take effect at a future date. Every state program is unique, but many share common features:
Fifteen state plans, such as those in California and Illinois, are considered mandatory plans. That is, employers with a certain number of employees must make available a state-run auto-IRA plan if they offer no other plan. These plans typically also require a minimum salary deduction, unless the employee opts out, as well as various financial penalties for non-compliance.
Other states, like Massachusetts and Washington, use a voluntary model, where employers can shop for a payroll-deduction-only plan – typically with some tax incentives – by using a state-approved menu of IRA and 401(k) providers.
47 states have programs now or are considering them
To get a feel for the logistics of a state program, let’s look at the example of Illinois’ Secure Choice Program, which was the first state plan to be signed into law. This program requires employers to automatically enroll their employees into the program or select a qualified plan in the private market if the business:
Employees in Secure Choice begin saving at a default rate of 5% of pay – unless they opt out. For the first 90 days after the initial contribution, the default is to hold the money in a money market fund unless participants elect otherwise. If no election is made, the funds are then defaulted into a target date fund. Non-compliance results in a penalty of $250 per employee the first year the employee is unenrolled and $500 per employee for the second year and beyond.
One of the more concerning aspects of state-sponsored plans is investment oversight. In Illinois, for example, investments are chosen by a board of seven: the state Treasurer, the State Comptroller, the director from the management and budget office of the governor and four additional representatives appointed by the governor. These seven individuals are in essence responsible for the retirement savings of thousands of Illinois businesses.
Typically, sponsors customize their retirement plans depending on their participants’ needs. In a state-sponsored plan, that nuance is lost.
Another example of a mandatory plan is California’s CalSavers program, which, like Illinois Secure Choice, requires employers without a retirement plan to join a state-run plan where investments are run by a state board. This includes all employers with at least one employee.
Unless they select their own rate, employees begin saving at a default rate of 5% of pay, with auto-escalation of 1% per year to be capped at 8% of salary. An employee may opt out of auto-escalation and set their own rate. As with the Illinois plan, CalSavers imposes penalties of up to $750 per eligible employee for non-compliance.
Given the restrictions and complexity of many state plans, some business owners may want to take a more active role by considering traditional retirement plan alternatives. Many traditional retirement plans were designed specifically to create a comfortable retirement for employees at a low cost with a minimum amount of employer involvement.
A couple of factors may encourage small employers to take a close look at sponsoring their own retirement plan:
Depending on the state program, the following arrangements might be preferable:
Because many small employers may have never considered implementing retirement plans prior to the introduction of new state programs, the opportunity to educate and assist these business owners is vast. While some may not be eager to take on this new responsibility, retirement plan professionals have the tools and resources to help make the experience better.
Some questions to ask about the arrangements in your state include:
The devil is in the details, which is why the best alternative to state-sponsored plans may be an investment professional. With the advent of state-sponsored plans, you, the financial professional, can help an employer comply with state mandates or create a customized retirement program consistent with the needs of the business and its employees. By guiding employers through the alternatives, you may be able to help them create the best plan for their business.
* Source: U.S. Bureau of Labor Statistics, “Employee Benefits in the United States – March 2023,” September 2023.
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