State Auto-IRAs May Drive Some Small Businesses to Sponsor Their Own Plans

Statewide programs don't appear to cause employers to drop 401(k)s

Stephen Miller, CEBS By Stephen Miller, CEBS July 16, 2021
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State Auto-IRAs May Drive Some Small Businesses to Sponsor Their Own Plans

In states that have enacted retirement savings programs for private-sector workers, businesses that have their own plans are not switching to state-sponsored plans. Small businesses that don't yet have their own employer-sponsored plan are often opting to provide one instead of participating in their state's program, new research shows.

The findings were reported by the Pew Charitable Trusts, a nonprofit public-policy organization that analyzed Form 5500 benefits data employers file with the U.S. Department of Labor.

Typically, state-sponsored, automatic-enrollment individual retirement accounts (auto-IRAs) require employers without a retirement plan to enroll workers in a state-sponsored plan, "though employees can choose to opt out," wrote John Scott, project director for retirement savings at Pew Charitable Trusts.

Common features of state-run auto-IRAs include the following:

  • Savings default into a Roth IRA, with default contributions between 3 percent and 5 percent of an employee's pay.
  • Employer contributions aren't allowed because that practice would trigger compliance requirements under the Employee Retirement Income Security Act (ERISA).
  • Investment menus are easy to understand with limited options.
  • Fees are reasonable.
  • Boards are established to oversee the programs.

Eight states in recent years have established auto-IRA programs, Scott noted: Illinois in 2015, followed by Oregon, California, Connecticut, Maryland, New Jersey, Colorado and Virginia. Maine became the ninth state to do so last month, when Gov. Janet Mills signed an auto-IRA bill into law.

In May, New York City enacted a mandatory payroll-deduction auto-IRA program, to be implemented over the next two years, for employers that don't offer a retirement plan and employ five or more people. Seattle has also enacted legislation to establish an auto-IRA program.

Oregon, Illinois and California have begun enrolling workers and putting contributions into the accounts, and early evidence "indicates that auto-IRAs appear to complement the private-sector market for retirement plans such as 401(k)s," Scott wrote. "Some employers may be moving toward plan sponsorship in response to the state auto-IRA programs. Meanwhile, those that cannot afford their own plans can take advantage of a no-cost, basic savings program for their workers."

Scott's views are supported by a 2016 survey Pew conducted, with responses from 1,640 U.S. business owners and managers at companies with five to 250 workers. When asked their views of hypothetical auto-IRA programs:

  • At companies that offered a retirement savings plan, only 13 percent of respondents said they would drop their plan and enroll workers in a state-sponsored program if one were launched in their state.
  • At companies with no plan, 51 percent said they would start their own plan rather than enroll workers in the state-sponsored program.

"The availability of a statewide auto-IRA might encourage those employers that have the means but have not decided to sponsor their own plans," Scott said.

[Want to learn more about compensation and benefits? Join us at the SHRM Annual Conference & Expo 2021, taking place Sept. 9-12 in Las Vegas and virtually.]

401(k)s or Auto-Enroll IRAs?

As more small businesses face state mandates to sign employees up for coverage through a state-sponsored auto-IRA plan or provide a plan of their own, financial tech firms and 401(k) providers "see an opportunity to showcase their services as an alternative to state-run programs before what is essentially a brand-new market" of smaller employers, InvestmentNews.com reported last month. Small-business owners that haven't been offering plans to their employees "are often unaware of the key differences between payroll-deducted IRAs and 401(k)s," the article noted.

In contrast to most state-sponsored plans, which are Roth IRAs with investments chosen by the program, when employers offer their own plans "they can select their own investments" that may be more appropriate for their workforce, wrote Allison Brecher, general counsel at Vestwell, a digital record-keeping platform firm.

A traditional 401(k) plan allows contributions of pretax earnings of up to $19,500 this year, or $26,000 for participants age 50 or older, whereas a Roth IRA only permits post-tax contributions of up to $6,000 in earnings, or $7,000 for those 50 or older. In addition, Brecher noted, offering their own plan allows employers to provide company matching contributions and to establish their own eligibility and vesting rules, within the limits set by federal law.

Auto-IRA programs "generally won't have an employer match on work contributions, as 401(k) plans often do," CNBC reported last month.

"It's great that states are putting a real emphasis on the retirement crisis and stepping in to help," Brecher said. "But at the end of the day, this is about setting your employees—and yourself—up for retirement security. So look at the current proposals in your jurisdiction, think about what you're trying to accomplish, … and determine what will offer the greatest value for you and your team."

[Related SHRM Article: State-Run Auto-IRAs Are Spreading While Critics Note Shortcomings]

PEPs Offer Another Alternative

Newly authorized as of this year, pooled employer plans (PEPs) allow unrelated companies to join together in a shared 401(k) plan and may provide small businesses with an alternative to both a traditional employer-sponsored plan or a state-sponsored auto-IRA.

A PEP provides an opportunity for small or midsize employers to reduce their fiduciary responsibilities under ERISA, according to a June podcast by benefits consultancy Ropes & Gray.

"PEPs may be appealing for employers from a litigation risk management standpoint, as they allow for the outsourcing of fiduciary responsibilities to third parties, namely, the pooled plan provider," said David Kirchner, a principal at the Boston-based firm.

In addition, "PEPs provide economies of scale that may result in lower administrative costs [and] increased efficiencies," he noted.


[Small businesses can find offering a retirement plan to be daunting. SHRM is offering a program through Raymond James that may help. Visit www.shrm.org/401k to learn more.]


Related SHRM Articles:

More 401(k) Plans Want to Keep Retirees' Investments, SHRM Online, July 2021

401(k) 'Windows' Reconsidered as Portals for ESG Investments, SHRM Online, July 2021

401(k) Plan Match Formulas, Automatic Features, Add Value for Participants, SHRM Online, July 2021

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