What Are State-Mandated Retirement Plans?
State-mandated retirement plans are retirement savings programs that states require businesses in their respective jurisdictions to offer their workers. These plans aim to address the lack of employee access to secure retirement savings through employers across the US.
By having private businesses participate in a state-run plan or offer their own retirement savings plan, states can help ensure that their citizens and other workers within their region have adequate savings for retirement.
For many employers, especially those classified as small and midsize businesses (SMBs), characterized by fewer employees, setting up an employer-sponsored plan can be quite challenging.
Thus, state-mandated retirement plans were created to provide employers with a simpler alternative and encourage employees to save for retirement and secure their financial futures.
How State-Mandated Retirement Plans Work
The details of each program vary by state, but generally speaking, SMB owners must either enroll their employees in the state’s retirement plan or provide an alternative, such as 401(k)s or various types of individual retirement accounts (IRAs).
Other common features include employer-facilitated salary deductions with employee opt-out, modifiable contributions up to specified maximum amounts, no setup costs, minimal plan administration, and limited to no employer matching or profit-sharing contributions.
Noncompliance with the state mandate also typically results in the imposition of penalties or fines. SMB owners must check with state authorities for the specifics of how the state-mandated plan works in their respective regions.
States That Have Mandatory Retirement Plans
There are currently 16 states across the US that have mandatory retirement plans, including California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, New Jersey, New Mexico, New York, Oregon, Vermont, Virginia, and Washington.
Several of these states have already rolled out their respective programs, while others have scheduled implementation at a later date.
Each state has its respective guidelines regarding the coverage of its program and the penalties for non-compliance. For more information on each state’s program, you may click the links above to each plan’s website.
What SMB Owners Need to Know About State-Mandated Retirement Plans
As an SMB owner, one of the key considerations you must make is whether to provide your own retirement savings plan through the private market or enroll your employees in the state-mandated program.
While state-run retirement savings plans are relatively cheaper and simpler to administer, they are typically less flexible in terms of investment offerings for employees. Contribution limits also tend to be lower compared to private market alternatives.
Additionally, if you want to make extra contributions to your employees' accounts through matching or profit-sharing, you may be limited or prohibited outright under most state-run retirement savings plans.
Whatever you decide, it is worth noting that access to a secure and competent retirement savings plan is a well-sought-out aspect of employee benefits packages. It can help your SMB in recruiting and retaining talented workers.
Benefits of State-Mandated Retirement Plans
State-mandated retirement plans address the need for more accessible retirement savings options for employees. They ensure that most, if not all, of a state’s employees, have a choice to build a secure and stable financial future in their retirement years.
SMB owners benefit by being able to offer either a retirement savings plan on their own or through the state-run program. They get to attract and retain top talent, boost employee morale, and potentially increase overall productivity.
State-mandated plans come at no cost to businesses and require minimal administration and document submission for employers. These also typically do not require annual tax filing.
Drawbacks of State-Mandated Retirement Plans
Most state-mandated retirement plans only allow Roth contributions, meaning employees can only save after-tax dollars in their accounts. If an employee is not eligible to make Roth contributions, they will need to pay the penalty to correct it.
By definition, these plans are run and managed by their respective states, who act as plan sponsors. While it reduces employer fiduciary responsibility, states are not usually able to guide employees or participants when they encounter issues with their plans.
Total employee contributions are also limited and much lower than typical employer-sponsored retirement savings plans. Lastly, SMB owners who want to make matching or profit-sharing contributions are usually prohibited from doing so under most state-mandated plans.
In many cases, it may make sense to explore a sustainable 401(k) plan instead of going with one of the other options or being rushed into a state mandated plan.
Qualified Retirement Plan Options
Depending on their company's financial situation and business goals, SMB owners can elect to sponsor their own retirement savings plan instead of enrolling employees in the state-run programs. SMB owners can choose to offer the following:
Traditional 401(k)
This employer-sponsored plan allows employees to make pre-tax deferrals or contributions to their retirement savings. The Internal Revenue Service (IRS) sets the maximum amount an employee can defer yearly.
For 2023, employee pre-tax contributions limits are set at $22,500, with additional $7,500 catch-up for workers 50 and older.
SMB owners also have the flexibility to offer a matching or profit-sharing contribution, capped at a combined employer-employee deferral of $66,000 ($73,500 with catch-up).
Safe Harbor 401(k)
Similar to a traditional 401(k) in terms of contribution limits, the Safe Harbor 401(k) allows SMB owners to make matching contributions up to the IRS limits without worrying about passing nondiscrimination tests.
Usually, the IRS requires businesses to pass such compliance tests to ensure that a company's 401(k) plan is not overly advantageous for highly-compensated employees (HCEs). A Safe Harbor 401(k) is typically exempted from nondiscrimination testing.
Under a Safe Harbor 401(k), employers are not allowed to make matching or profit-sharing contributions. In fact, they are required to do so to maintain the plan’s safe harbor status.
Solo 401(k)
SMB owners can also sponsor a solo 401(k). This retirement savings plan is designed for entrepreneurs who are self-employed or own a business with no employees other than a spouse.
Solo 401(k) plans allow for deferrals of up to $22,500 in 2023, with a $7,500 catch-up for SMB owners aged 50 and above.
SMB owners can also make employer contributions of up to 25% of their net self-employment income. The combined pre-tax contribution limit is set at $66,000 ($73,500 with catch-up).
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is an employer-sponsored plan that permits employees to make salary deferral contributions and allows matching contributions from their employers.
It is similar to a traditional 401(k) plan, but with simpler rules and lower administrative costs. Employees can contribute up to 100% of their earnings, capped in 2023 at $15,500 per year, with a $3,500 catch-up for workers 50 or older.
SMB owners must match employee contributions dollar-for-dollar up to 3% of the employee’s salary or provide an alternate nonelective contribution of 2% of each eligible employee’s compensation.
Contributions are made pre-tax, and earnings grow tax-deferred until withdrawn at retirement.
SEP IRA
A Simplified Employee Pension (SEP) IRA is a plan that SMB owners can establish to contribute pre-tax earnings to their employees’ retirement savings. It allows employers to contribute up to 25% of employee wages, capped at $66,000 in 2023.
However, contributions are not mandatory, and employers have the flexibility to vary them from year to year. Unlike 401(k) plans, SEPs do not allow salary deferrals from employees.
In most cases, contributions made by SMB owners are tax deductible, and earnings can grow tax-deferred until withdrawn at retirement.
Traditional IRA
SMB owners can also opt for a traditional IRA. It has lower contribution limits than 401(k)s but offers more flexibility regarding investment options.
In 2023, workers can contribute up to $6,500 in pre-tax money, with a $1,000 catch-up for those aged 50 and above. The contributions are tax-deductible, and earnings grow tax-deferred until withdrawn at retirement.
SMB owners cannot make matching or profit-sharing contributions to their employees' traditional IRAs.
Roth IRA
Employees can open a Roth IRA and make contributions using after-tax dollars. Unlike other types of IRAs, workers have already paid taxes on the money they contribute, which means qualified withdrawals during retirement will generally be tax-free.
In 2023, employees can set aside up to $6,500 in post-tax earnings with an additional $1,000 catch-up for those aged 50 and above. Earnings grow tax-free until withdrawn at retirement.
Like other IRAs, SMB owners are not allowed to make matching or profit-sharing contributions to their employees' Roth IRAs.
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Final Thoughts
State-mandated retirement plans provide SMB owners with a simpler option for offering retirement plans to their employees at no cost. Typical state-run plans feature Roth contributions and lower limits than other retirement savings plans.
Matching contributions are also limited or prohibited outright. Specific details of state-mandated retirement plans vary by state. SMB owners must check with the respective state authorities for more information.
Currently, there are 16 states across the country that require SMBs to sponsor their own retirement plans or enroll employees in a state-run program. SMB owners must consider their company's financial situation and goals when deciding.
Should eligible businesses decide to sponsor their own retirement savings plan through the private market, they can choose between traditional, Safe Harbor, or Solo 401(k, or SIMPLE, SEP, traditional, or Roth IRA.
SMB owners must consider working with a qualified financial advisor for further guidance. Nonetheless, offering a competitive retirement savings plan can help businesses attract and retain top talent and boost employee morale for increased overall productivity.
SMB Owner's Guide to State-Mandated Retirement Plans FAQs
What is a state-mandated retirement plan?
A state-mandated retirement plan gives SMB owners a simpler option for offering a retirement savings plan for their employees at no cost and minimal administration. State-mandate retirement plans typically feature Roth contributions, lower contribution limits, employee opt-out, and limited to no employer match.
Which states have state-mandated retirement plan laws?
There are currently 16 states across the US that have state-mandated retirement plan laws. These include California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, New Jersey, New Mexico, New York, Oregon, Vermont, Virginia, and Washington.
How do you comply with state laws for state-mandated retirement plans?
Eligible employers can comply by either sponsoring their own retirement savings plan or enrolling their employees under their respective state's retirement plan.
What are the benefits of offering state-mandated retirement plans?
You get to offer a retirement plan to your employees at no startup costs and minimal administration. SMB owners also benefit because it improves employee recruitment and retention, boosts company morale, and potentially increases overall business performance.
How do you choose the right plan for your SMB?
You must consider your SMB's financial situation and goals. You must also check your respective state's retirement plan mandate for specific details on plan types, contribution limits, and noncompliance penalties. Ultimately, the decision is up to you to offer your own plan or enroll in the state-run program.
