Why are states beginning to mandate small business retirement plans?

Why are states beginning to mandate small business retirement plans?


It’s no secret that the current retirement landscape is unsustainable; too few people are adequately preparing for the golden years of their lives, too many people are relying on Social Security to fund their retirement, and too frequently, employers aren’t doing anything to help. If we continue down this path, the future (not to mention the economy) may look drastically different than what we envision when thinking about retirement and the future in general.

As a result, state governments are stepping in. In an attempt to help today’s workforce adequately prepare for a financially-secure future, state governments across the country have started outlining legislation that requires all types of employers to offer some type of retirement plan for their workers to save in. Since 2012, over half of the states have introduced legislation at the state level to implement or study options for state-sponsored retirement savings plans; California and Oregon are leading the charge, with the CalSavers and Oregon Saves, respectively, already launched—and eight other states, plus the city of Seattle, are following closely behind.

But is this really necessary?

Why retirement state mandates are necessary

What if we told you that only 17 percent of American workers are “very confident” in their ability to live comfortably throughout retirement? [1] Or that more than one in three employers say their employees will either be “not at all” or “only a little bit” prepared for retirement when they reach retirement age? [2]

While that’s impactful information (or at least, it should be), we know that simply preaching to workers that they need to save and prepare for retirement is not enough to tangibly move the needle. We could spout out alarming statistics about the current state of retirement readiness among today’s workforce all day long, but that wouldn’t be worth our time. Or yours.

Instead, let’s change the conversation to one that’s more helpful to all involved. Multiple state governments have already enacted the mandates, so let’s aim to understand why the mandates are necessary and how they may affect our country’s overall retirement readiness years down the line.

Let’s start with one frequent, overarching question regarding the state mandates: why is the government stepping in now?

It starts with the fact that people have the potential to live longer today than in any other time in history, and as such, workers need to financially prepare themselves for a longer lifespan. And by extension, a longer retirement.

Adding to the problem is that once-reliable defined benefit plans (think, pensions) became increasingly unsustainable for employers to offer, due in part to high costs and in part to the financial risk of maintaining a defined benefit plan for employees. Meaning, the burden of obtaining a financially-secure retirement is falling on employees—rather than the employer—for the first time. And as we’ve seen, insufficient savings, coupled with subpar economic growth, rising household debt, and low investment interest rates, are preventing today’s workers from achieving the retirement reality they always envisioned.

Workers clearly need a little bit of help from their employers to reach maximum retirement readiness, but reality is, the current retirement landscape doesn’t exactly have a level playing field. In fact, there are large discrepancies in regard to employees even having access to a retirement savings plan based on company size, industry, employee education level, and the like. The state-run retirement programs mandate that all employers offer some type of savings plan to employees, allowing workers who would otherwise not have access to a plan to begin putting away money for their future.

Furthermore, and perhaps most importantly, states aren’t just worried about the current climate in the retirement industry and among their citizenry—they’re thinking years into the future. Think about it; workers who aren’t saving enough for retirement right now and plan to live off of Social Security in the future are setting themselves up to need support in their old age. And when a mass of people hit retirement and they don’t have adequate savings to cover things like healthcare, housing costs, and other every day essentials, it’s the states that end up paying more money—both earlier and longer—than the federal government. And with 10,000 Baby Boomers reaching Full Retirement Age every single day, states are starting to feel the pain.

Read more: Are state auto-IRAs the answer to the retirement savings gap?

The fact of the matter is this: workers are more likely to take control of their retirement outcomes and proactively save for the future when they have access to an employer-sponsored plan. We’ve seen this result in study after study—and the statistics can be staggering. Like the fact that the average retirement deficit (the gap between retirement savings that American households have today versus what they should have to maintain their standard of living in retirement) is five times higher among workers who won’t have access to a defined contribution plan in the future than those that will. It gets even more alarming when looking at the actual numbers; those who won’t have access to a defined contribution plan like a 401(k) or IRA are facing a retirement income deficit of $78,046 compared to a much smaller deficit of $14,638 among workers who will have access to a plan [3].

So how can we ensure that we’re setting today’s workforce up for a successful future when so many workers don’t even have access to a savings program? How can we realistically expect workers to own their retirement readiness if we don’t give them a way to do so?

Cue the state mandates.

How will a state mandated retirement plan help savers reach retirement readiness?

As we mentioned earlier, the state mandates were designed to level the playing field to plan access, so to speak, by providing all employees with a retirement plan to save in—regardless of company size, employee education level, race, age, etc. And if the reason why this is necessary still isn’t obvious, we’ll lay it out for you.

To put it simply, workers aren’t actively engaged in saving for their future—we already know that. Why would they think about something so far off in the distant future, like retirement, when student loans, housing costs, and bills are piling up today?

Providing access to an employer-sponsored plan may be just the kick workers need to get in gear and begin properly preparing for their future. In fact, even modest income workers are 12 times more likely to save for the future through an employer-sponsored retirement plan than they are to take the time to open an IRA account on their own [4]. And on the flipside, when no type of savings plan is offered through their employer, less than half of workers are saving for retirement [5].

Now do you see the necessity?

How will small business owners be affected by the retirement state mandates?

So the mandates will help today’s workers prepare for a more secure retirement in the future, but how will the business owners, who are now being mandated to offer a retirement plan to employees, be affected? Cost may be an initial concern for some—but in reality, the mandates aren’t going to take funds out of small business owners’ pockets since the plan will be state-funded and state-run. And even so, in reality, the employer cost of sponsoring a retirement plan actually tends to be lower than that of other benefits that are usually offered to employees, like health insurance and paid leave [6].

Additionally, the state mandates will allow business owners to save for their own retirement—which may not have been an option before if no plan was offered through the business and the owner never opened up an IRA account for themselves.

Related: How offering a retirement plan can help you grow your business

Other business owners may be concerned about having their hard-earned money, as well as their employees’ money, in the hands of the government. For those business owners, we’d like to remind you that there are other options at your disposal—and we’ll get into them in more detail in a minute.

But for right now, let’s dive into the various state mandate program models out there right now.

Retirement state mandate plan options

While the goals of the state mandated retirement programs all center around helping workers reach retirement readiness and future financial independence, the specifics of the mandates themselves vary by state. The local state governments were tasked with maximizing effectiveness in order to safeguard our collective future as a society, while minimizing cost and financial risk to the employers the mandates are required of. To help accomplish this, state legislations have outlined four retirement program models:

  • Mandatory auto-IRA programs (enacted in Oregon, Illinois, California, Connecticut, Maryland, and Seattle. Active in NYC, New Jersey, and Massachusetts)

  • Voluntary retirement plan marketplace (Washington)

  • Voluntary state-based open multiple employer plans (MEPs) (non-profits in Vermont, Massachusetts)

  • Voluntary payroll deduction IRA programs (New York—and many other states considering)

It’s important for employers to note that while these four program models would satisfy the mandate within their specific state, there are additional options that would do so, as well. Our favorite of which—the 401(k).

Should I offer my employees a state IRA or a 401(k)?

A recent survey reported that nearly three in four employers believe most of their employees could continue working until age 65 and still not have enough saved to meet their retirement needs [7].

Kudos to the state governments for stepping in to provide some type of solution to this problem—but a state-run plan may not be the best option to help workers truly own their retirement readiness and reach financial independence. Taking a cue from this statistic, doesn’t it make more sense to offer a retirement plan that employees can save more than $6,000 per year in? Why not offer a retirement plan such as a 401(k), where employees can save up to $19,000 per year? Wouldn’t that get employees much closer to reaching the retirement of their dreams? And not just them—but the business owner, as well?

There’s a certain factor of convenience with choosing the state plan—we get it. But when it comes to taking care of your and your employees’ futures, why go with a canned version or a simplistic cookie cutter offering for your retirement plan when you could instead choose an option with a higher degree of added value and customization for you and your employees? With 401(k):

  • Employer fees can be tax deductible

  • Plan is cost-efficient for business owners

  • Participants can save more than any other retirement savings vehicle

  • Owner-only Solo(k) options are available

  • Matching contributions are allowed

  • Plan is compliant with state mandates

You might also be interested in: Why a state retirement plan may not be a good fit for a small business

Clearly, 401(k) plans offer certain advantages to both the employees and the employer. A 401(k) has the most customizable options for small businesses, including plan loan options and larger contribution limits for participants—ultimately getting you and your employees closer to retirement readiness. While a mandated IRA plan does offer you a platform to save money for the future, a 401(k) plan allows you to maximize your own retirement savings while still remaining compliant with the mandate and providing employees with a vehicle to save in. So before deciding to settle for a state Roth IRA, and certainly before signing up for one, do your research and make sure you understand the differences between all of the plan options that will satisfy the state mandate.

We know that the new retirement state mandates are creating uncertainty and murkiness around employers’ specific requirements within their state, but we want to remind you that you’re not in this alone. If you have any questions, we’re here to help. Give our retirement specialists a call today: 800.236.7400.


Sources:

[1] Financial help wanted: Employees clamor for long-term retirement planning, Employee Benefit News, 2018.

[2] As Financial Challenges Impact Workers, Employers Are Ready to Help, International Foundation of Employee Benefit Plans, 2018.

[3] 2019 Retirement Security Projection Model, Employee Benefits Research Institute, 2019.

[4] That Sinking Feeling?, National Association of Plan Advisors, 2019.

[5] 18th Annual Transamerica Retirement Survey, Transamerica Center for Retirement Studies, 2018.

[6] Employer Cost for Employee Compensation, Bureau of Labor Statistics, 2018.

[7] 17th Annual Transamerica Retirement Survey, Transamerica Center for Retirement Studies, 2017.