American workers rely on their employers’ plans for most of their retirement savings. But among businesses with fewer than 100 employees, only 41% of employees participate in retirement plans.* To 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 October 31, 2021, 14 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:
Ten state plans, such as those in California and my home state of 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 New Mexico 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.
State-by-state status is compiled from Georgetown University’s Center for Retirement Initiatives as of December 13, 2021.
For more detail about your state’s plan and its current legislative status, go to cri.georgetown.edu/states/.
To get a feel for the logistics of a state program, let’s look at the example of my state 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, funds are held in a money market fund and 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, 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. The deadline to register for employers with more than 50 employees has passed, while employers with five or more employees have until June 30, 2022, to do so.
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.
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. First, employers starting their first-ever retirement plan may qualify for a federal tax credit up to $5,000 a year to defray startup costs. The credit can be used for up to three years after the plan’s launch. Second, plan costs have been steadily declining for more than a decade.
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 many 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 licensed 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, National Compensation Survey, March 2021
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