Are State-Run IRAs the Best Option for Your Employees?
Retirement is a milestone most American workers look forward to. Yet, according to CNBC an estimated 78 million Americans, or half of American workers, don't have access to an employer-sponsored retirement plan to help prepare for this milestone.
Some states (like Illinois) have picked up on this deficit, and have pushed for legislation that would require all businesses to offer workers an individual retirement savings option by 2017. The state is also in the vanguard of those offering state-run Auto-IRAs as a way to help solve the retirement savings gap, with California, Oregon, and Maryland having already joined Illinois in establishing a program.
State-run Auto-IRAs are intended to lend a helping hand to employees who don't already have access to a retirement plan. But are they the best option for employers and their employees?
What Is a State-Run Auto-IRA?
According to the Pension Rights Center, half of the states in the nation are discussing the possibility of creating state-run Auto-IRAs for workers at small businesses. While the details of state-run Auto-IRAs will vary, they’ll share a similar concept. Small businesses* would be able to set up automatic withdrawals from paychecks to be deposited in an IRA managed by a vendor selected by the state. Contributions would automatically be set at around 3 percent of the individual employee’s pay.
What’s the Difference Between a State-Run Auto-IRA and a 401(k)?
According to US News & World Report, the financial community has concerns about state-run Auto- IRAs as compared to 401(k)s. "401(k) plans offer benefits an IRA can't beat, like more investor protections, a higher cap on contributions, and a potential employer match".
The biggest difference between the two types of retirement plans is the amount employees can contribute on an annual basis. With a 401(k), contributions are capped at $18,000, but with an IRA contributions can only reach $5,500. Include compound interest and the difference in savings could increase exponentially over time.
Another difference is that a state-run Auto-IRA would not offer a company match. With 401(k)s, employers can contribute to their employees’ retirement accounts, which can help make saving for retirement more desirable.
How Do Regulations Affect State-Run Auto-IRAs?
Unlike 401(k) plans, state-run Auto-IRAs do not have long-established regulations, which may cause confusion concerning issues such as whether they should be governed by the Employee Retirement Income Security Act (ERISA).
ERISA is a law that sets standards for retirement plans in order to help protect consumers and ensure that their money is being handled appropriately.
If state-run Auto-IRAs were required to be governed by ERISA, states would need to assume costs, regulatory burdens, and liability associated with non-compliance, which could end up adding an extra element of complexity to the state-run IRA plan. However, the U.S. Department of Labor (DOL) has issued advice that in general, Auto-IRAs are not subject to ERISA.
Along with the full requirements outlined by the DOL, states would primarily need to accomplish the following if state-run Auto-IRAs become governed by ERISA:
- Establish and administer the program under state law, and require certain private sector employers to participate
- Be responsible for investing employee savings, or selecting investment options from which employees can choose, and for the security of payroll deductions and employee savings
- Create and enforce employee notice requirements about participant rights under the program
What May State-Run Auto-IRA Plans Mean for Your Business and Its Employees?
According to NPR, people are 15 times more likely to save for retirement if they have a workplace savings vehicle. When a plan includes automatic enrollment, participation rises to approximately 90-95 percent.
State-run Auto-IRA may seem like a simple solution for helping your employees save for retirement, but it's important to compare it to other financial options to decide which best fits your needs as well as those of your employees. For example, traditional 401(k) plans, safe harbor 401(k)s, and profit-sharing plans may all be easy to set up with help from a third-party recordkeeper. They provide higher limits for annual retirement savings as well as the potential to offer an employer match, and they allow the employers or owners themselves to put away funds for retirement.
Consider these facts when deciding which type of plan to offer your employees, but remember that regardless of whether your company decides to offer a state-run Auto-IRA, a 401(k), or other plan, the most important decision may be to help your employees start saving for their futures today.
*See individual state legislation for qualifications.