FAQ on State-Sponsored IRAs
What is a state-sponsored retirement plan?
A state-sponsored retirement plan is a financial vehicle for individuals who don't have access to an employer-sponsored retirement savings program, such as a pension, a 401(k) plan, or a 403(b) plan. Most state-sponsored programs adopt one of three structures:
- A traditional individual retirement account (IRA), which allows individuals to direct pretax income toward investments that grow tax-deferred;
- A Roth IRA, similar to a traditional IRA, but is funded by after-tax dollars. However, when the investor reaches retirement age, he or she withdraws funds tax-free (earnings may be subject to taxes).
- An open marketplace for private employers to choose a defined contribution plan, in which both the employee and employer can make contributions toward an investment retirement account for each employee’s benefit.
In general, state-sponsored retirement plans establish a mandatory system of payroll deposit for qualifying businesses that don't offer a workplace retirement plan. Some state plans require companies to automatically defer IRA contributions from wages (usually 3 percent) from all workers' paychecks. Other state plans permit employers to make voluntary contributions to their workers' IRA accounts;
Why were they implemented?
More than half of American workers — about 55 million — lack access to an employer-based retirement savings plan, particularly those who work for small companies, as well as younger workers, minorities, and low to moderate-income earners.
State-sponsored retirement plans are intended to help these individuals put aside money for their retirement years. Statistics show that Americans need encouragement: 69 percent have less than $1,000 in savings, and about one-third wonder whether they'll be able to cover basic living costs when they retire. Although many U.S. workers report feeling stressed about retirement, only six in 10 say they have saved for that goal, and only four in 10 have tried to determine how much money they'll need.
Which states have these plans?
Oregon is the furthest along with its program, OregonSaves, which has already begun this summer, with a gradual plan implementation through 2020. It is one of nine states that have established or are in the process of establishing retirement plans for private-sector employees who don't have a savings program at work.
California, Connecticut, and Illinois have passed legislation to create state-run retirement plans for private-sector workers, all of which are currently expected to be available over the next few years. Maryland, Massachusetts, Washington, Vermont, and New Jersey also have plans to implement state-run retirement plans in the upcoming years.
What are the benefits?
State-sponsored retirement plans allow people to save for their nonworking years, even if they lack access to an employer-sponsored retirement savings plan. Their contributions grow in professionally managed investment accounts.
State-sponsored retirement plans allow employees to make voluntary contributions to their accounts through payroll deductions. Employees can opt out of automatic enrollment in state-sponsored retirement plans.
What's the difference between a 401(k) plan and a state-sponsored retirement plan?
Traditional 401(k) retirement savings plans sponsored by the employer are established at a company's discretion. They offer investment vehicles chosen by the firm’s leaders.
Employer-sponsored plans have a number of advantages over state-sponsored retirement savings plans, particularly the company match and the max amount employees can contribute (see below). For more information, please see What’s the Difference? State-Sponsored Retirement Plan vs. Employer-Sponsored 401(k).
Which plan can help me address my employees’ retirement concerns?
Given the retirement crisis that looms over America today, the development of state-sponsored savings plans represents a move in the right direction. Any way to encourage people to save is laudable, when:
- One out of every three Americans has no savings at all;
- One in four 65-year-olds today will live past age 90; and
- An average healthy couple can expect to spend about $377,000 on health care during retirement.
But state-sponsored savings plans are not adequate to prepare people for retirement. They are not comprehensive enough, generous enough, or safe enough. Employers hold the key. By acknowledging their responsibility for the well-being of their employees, U.S. businesses can help turn the retirement emergency into retirement opportunity.
Employer-sponsored 401(k) plans:
- Help attract and retain talent, because employees put a high value on a workplace 401(k);
- Allow participants much higher annual contribution levels than state-sponsored retirement plans — $18,000 vs. $5,500; and
- May be coordinated with employer-sponsored health savings accounts (HSAs) to maximize the power of participants’ contributed funds.
Regardless of whether your state decides to mandate a retirement plan, employers who don’t offer a workplace retirement program may want to consider doing so, given many workers’ uncertainties about their financial preparedness for retirement.