As a small business, it’s important to know your options when it comes to retirement plans.
Over the years, you may have heard Social Security won’t last forever — some say it will be depleted as early as 2035. Pensions are no longer as common as they were before. That leaves just personal savings as the main pillar for retirement.
Research has shown that employees are more likely to save for their futures if their employer offers retirement programs. Unfortunately, not enough are doing so. The U.S. Bureau of Labor Statistics found that 35% of private sector employees, around 43 million Americans, work for companies with fewer than 100 employees but only 48% of those offer retirement plans. States are now stepping in to help bridge the gap in the retirement crisis with state mandated programs.
Currently, 30 states are working on rolling out their own programs. Thirteen states have passed legislation, which includes:
- New Jersey
- New Mexico
- New York
Each state has its own list of requirements and deadlines for companies to meet and oftentimes it can be confusing since there is a lot of information to absorb.
There are certainly immediate benefits to enrolling in a state sponsored program. Many of them are free or very low cost at first, but they do not offer the same flexibility that private 401(k) solutions do. Rather than waiting til deadlines pass for the state mandated plans, start your research today so you can choose a plan that works best for your company and employees.
By understanding the finer details of state mandated plans, you’ll be able to make more informed decisions for yourselves and your employees. This is particularly important if you’re a small business owner in one of those 13 states. To help, we’ve listed out 5 things you should know about these programs that might not seem as obvious.
1. There is a misconception that state sponsored plans are 401(k)s
The majority of state sponsored plans are actually IRAs. A big difference between an IRA and a 401(k) is the maximum contribution for an IRA is $6,000, which compared to a 401(k) is $19,500 or $26,500 if you’re over the age of 50. The visual below shows the difference between California’s State Plan — CalSavers vs. a private 401(k) solution. Because the contribution limit is so drastically different, over a span of 20 years, there could be a difference of hundreds of thousands of dollars. For example, an individual who contributes $10,000 annually over 20 years has a potential of having $500,000 more saved for retirement with a 401(k) over an IRA (assuming the same 5% rate of return).
Hypothetical savings based on $6,000 annual contribution for CalSavers account versus a $19,500 annual contribution for Human Interest 401(k) over a 20-year period. This model is for illustrative purposes only and is not intended to serve as investment advice.The model assumes: The investor is under age 50, i.e., not eligible for catch-up contributions; investments receive 5% annual returns; the pace at which the contribution limit for IRAs and 401(k)s will increase over the next 10 years at a rate similar to which is it has increased over the last 10 years. That is, an IRA contribution limit will increase at roughly $100 per year and a 401(k) at roughly $300 per year. Historical contribution limits for 401(k)s and IRAs. CalSavers offers a Roth IRA, which means the contribution limit is also subject to income restrictions. Data accurate as of May 1, 2020.
2. Employers are not able to offer matching through state sponsored plans
Unlike 401(k)s, employers are restricted from offering matching or other contributions to their employees in the state mandated plans. Not only do employer matches help increase employee participation rates but it can also help the business owner compete for top talent and save on taxes. Employer match contributions come with a dollar-for-dollar tax deduction making offering a match more intriguing for employers.
3. State plans offer less flexible plan design and could cost more for employees
The pricing model for state plans might seem affordable at first glance, if not free, but can actually be more expensive for participants in the long run compared to employer sponsored 401(k) plans. For example, the state-sponsored CalSavers program lists employee fees at 0.825% to 0.95%, depending on the 401(k) provider average fund fees could potentially be much lower.
In addition, since state-sponsored plans are IRAs, employers will be limited to plan design. With an employer sponsored 401(k), employers will have the option for hours eligibility, profit sharing, employer match, and loans as previously mentioned.
4. The majority of state sponsored plans do not offer integrations with payroll providers
Because 401(k) contributions are deducted from payroll, integrations between your retirement plan provider and your payroll provider can allow for a more seamless plan administrator experience. Without a payroll integration, ongoing employer responsibilities include:
- Updating contribution amounts for each change to contribution rates or when employees opt-out
- Filing contributions every pay period and processing contributions
- Maintaining the employee census — adding new hires as they become eligible and terminating old employees
State sponsored programs without payroll integration can create significantly more work for the plan admins each pay period.
5. The SECURE Act passed in 2019 offers tax benefits for 401(k)s not IRAs
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed in 2019 to increase access to retirement plans. Small businesses with 100 or fewer employees are eligible to redeem tax benefits of up to $5,000 for offering a 401(k) with an additional $500 per year for adding auto-enrollment. Unfortunately, the SECURE Act excludes IRAs so the state-sponsored plans don’t apply for these savings.
As a small business owner, providing a retirement savings plan for your employees is a great tool to attract and retain workers. If your business is in one of the states with mandatory retirement plans, carefully consider what is best for the needs of your employees, and reach out to an expert if you need help to make the best decision.