What Are State-Mandated Retirement Plans?
State-mandated retirement plans are retirement accounts that states require employers to offer. Though the specifics can vary for each state, employers must either enroll their employees into the state’s retirement program or sponsor a qualified alternative, such as a 401(k).
Setting up an employer-sponsored plan can be challenging for some employers, especially those with fewer employees. Thus, state-mandated retirement plans were created to encourage employees to save for retirement and provide employers with a simpler alternative.
Employers are not the plan sponsors of state-mandated retirement plans. Instead, the state supervises the program while the employer collects contributions through salary deferrals.
Depending on the state, failure to enroll employees in a state-mandated retirement plan or to set up an employer-sponsored retirement plan may result in penalties or fines.
Employer Requirements for State-Mandated Retirement Plans
Requirements for mandated retirement plans differ depending on the particular state. Generally, the number of employees and the years of business operation affect the specific requirements for employers.
Employers who fail to enroll their workers in any retirement plan, whether state-mandated or private, face substantial penalties ranging from $10 to $500 per employee.
It is important to remember that companies need not follow the mandated retirement plan if they already have an employer-sponsored program in place. They must simply provide the state with documentary proof that a retirement plan is already in place to avoid penalties.
States With Mandatory Retirement Plans
Currently, there are 16 states that mandate private-sector employers to provide retirement plans.
These include California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, New Jersey, New Mexico, New York, Oregon, Vermont, Virginia, and Washington.
Key features of each state’s programs are summarized in the table below:
For further guidance, it is best to contact each state's authorities on the latest rules and legislations that govern their respective state-mandated retirement plans.
State-Mandated Retirement Plans vs Employer-Sponsored 401(k) Plans
As previously mentioned, employers may choose between enrolling employees in a state’s mandated retirement plan or setting up an employer-sponsored plan to comply with the state’s requirements. Below are key factors to consider when choosing between the two types of plans.
Investment Structure
Most state-mandated retirement plans propose programs involving Roth individual retirement accounts (IRAs). Employees can save after-tax dollars into an account up to an annual contribution limit and enjoy tax-free withdrawals starting age 59 ½.
For employer-sponsored 401(k) plans, contributions can either be pre- or after-tax, depending on available options. Contribution limits are defined by the Internal Revenue Service (IRS). Withdrawals may be taxed depending on contribution options.
Investment Options
State-mandated retirement plans offer employers no flexibility in choosing assets to invest in. A state-selected board determines the specific investments that will form part of the retirement plan's portfolio.
On the other hand, employer-sponsored plans have various investment options. Companies have the discretion to select investments based on risk tolerance. Employees can also choose which assets they want to include in their accounts. There is also the opportunity to offer sustainable 401(k) portfolio options.
Automatic Enrollment
Since they are mandated, state-sponsored retirement plans require employers to enroll their workers into the program automatically. Typical rates start at 3% of annual salary as automatic contributions.
For employer-sponsored plans, automatic enrollment depends on the company's discretion.
However, employees can opt out of both state- and employer-sponsored retirement plans.
Annual Salary Deferral Limit
State-mandated plans offering Roth IRAs have a lower salary deferral limit than employer-sponsored plans. The maximum amount employees can save in 2023 is $6,500, with a catch-up contribution of $1,000 for ages 50 and older.
Employer-sponsored plans, such as the 401(k), follow the limit set by the IRS for 2023, which is $22,500. There is also a catch-up contribution of up to $7,500 for those aged 50 and above. These limits are updated annually.
Employer Matching Contributions
State-sponsored retirement plans do not typically allow employers to match worker contributions. It means fewer amounts saved compared to employer-sponsored plans. It also removes extra tax benefits for employers.
Matching contributions depend on the discretion of the company for employer-sponsored plans. For example, they can match up to 100% of employee contributions within certain IRS limits. Matching contributions can also be deducted from a company's tax liabilities.
Federal Tax Credits
Mandated retirement plans do not qualify employers for federal tax credits. It is a big difference compared to employer-sponsored plans.
For instance, the IRS allows up to a maximum of $5,000 in tax credits per year for the first three years for companies that start an employer-sponsored 401(k) plan for their employees. This amount is to cover set up and administrative costs.
Employer Costs
Lastly, setting up state-mandated retirement plans costs nothing to employers since they are not plan sponsors. Companies are only in charge of deducting contributions from employee paychecks. The overall administration of the plans falls to the respective state.
It differs from employer-sponsored plans, which come with various costs from setup to administration and continuous management. Companies can also expect fees for record-keeping, financial advice, and expert consultation.
_Plan_(1).png?width=960&height=875&name=State-Mandated_Retirement_Plan_vs_Employer-Sponsored_401(K)_Plan_(1).png)
How to Choose the Right Retirement Plan
You must consider several factors in choosing the right retirement plan to offer your employees.
Think about how much your employees are willing and able to save each year into a retirement plan. State-sponsored plans have lower contribution limits which can be beneficial for lower-income workers.
Such may not be suitable for employees who want to save more for retirement. Sponsoring your own retirement plan can give you more flexibility in terms of higher maximum contribution options for all employees.
You should also consider the tax implications for you and your employees. Since most state-sponsored programs are designed similarly to a Roth IRA, they do not reduce taxable income for employees during the contribution phase of their plans.
Whereas, if you sponsor your own retirement plan, you can tailor it and provide various options depending on the employee's taxation goals. You may offer a traditional 401(k) and allow pre-tax dollars to be contributed so they can enjoy tax deductions now.
Additionally, state-sponsored plans may limit tax deductions and credits you can enjoy. Since they do not typically allow matching contributions, you cannot reduce tax liabilities compared to employer-sponsored retirement plans.
Lastly, consider the set-up and administrative costs of sponsoring your own retirement plan. Though you can get tax credits of up to $5,000 per year, it is only available for the first three years. You have to shoulder all costs later, and fees can be significant in the long run.
You may consult a financial advisor to help you decide whether to go with a state-sponsored retirement plan or start your own.
Whether you are looking to start a new employer-sponsored plan or switching over from an old one, you may also make use of Carbon Collective’s online 401(k) plan comparison tool, which will help you choose between different providers.
The Bottom Line
State-mandated retirement plans provide employees with a surefire way to build a retirement nest egg. They are easy to set up and require minimal administration on the employer's part.
However, sponsoring your own retirement plan can offer you and your employees more flexibility regarding contribution limits, tax deductions, and credits.
It is important to consider your business goals and objectives before deciding which type of retirement plan is best for you.
With the help of an experienced financial advisor or retirement specialist, you should be able to make an informed decision that meets the needs of both your business and workforce.
State-Mandated Retirement Plans FAQs
What are the benefits of state-mandated retirement plans?
State-mandated retirement plans offer a number of benefits to employers and employees alike. They provide a way for employers to ensure they meet their employees' retirement needs without additional setup and administrative costs. For employees, state-mandated retirement plans can be an alternative, especially if they do not have access to employer-sponsored plans.
Are employers required to offer retirement plans?
Some states require employers to provide their employees with a retirement plan. Depending on the state, employers may be required to offer or facilitate certain types of retirement savings plans, or they may be required to enroll employees in an existing state-sponsored retirement plan automatically.
Are there penalties for not abiding by the state-mandated retirement plan?
Yes. Employers may be charged anywhere from $10 to $500 per employee if they do not comply with state mandates regarding retirement plans.
What are the requirements of state-mandated retirement plans for employers?
Requirements for state-mandated retirement plans may vary per state, but they generally revolve around the number of employees and the length of business operation. It is important to note that state-sponsored retirement plans are only mandatory for companies that do not already sponsor plans for their employees.
What are the drawbacks of state-mandated retirement plans?
Some drawbacks of state-mandated retirement plans include lower contribution limits, no matching contributions from employers, and lesser flexibility in terms of investment structure and options.
