There’s no federal requirement that employers offer retirement plans for workers. So, a number of states are rolling out requirements of their own. In most cases, these state-administered plans require that workers be auto-enrolled in a Roth Individual Retirement Account (IRA) funded through automatic payroll deductions.
That’s a relief for businesses that have worried that sponsoring a plan would be too cumbersome or expensive. It’s also good news for employees without adequate retirement savings.
“There's a lot of good news in here,” said Lisa Massena, CFA®, and founder of Massena Associates.
The extent of the problem
Only about half of American workers are covered by an employer-sponsored retirement plan at any given time, according to the Center for Retirement Research at Boston College. The reasons vary, but for three-quarters of the uncovered, the reason is simple: Their employer does not offer a plan.
That’s a massive problem in trying to help employees achieve long-term financial wellness.
“We know from basic economics that one of the most powerful forces is going to be the power of compounding,” said Anqi Chen, a research economist and the assistant director of savings research at the Center. “So, it matters that you start [saving] early and do it consistently. That's how you build assets for long-term goals.” (Related: Why saving for retirement early is important)
The federal government, recognizing that too few workers are saving for retirement, has responded in recent years with programs, such as the SEP IRA and the SIMPLE IRA, that are aimed at encouraging savings.
And therein is the problem. Those programs encourage saving for retirement. They don’t mandate it and they don’t make it particularly easy.
“There's been a lot of movement on the federal level trying to increase coverage, but it hasn't really been successful because a lot of those have been designed as voluntary programs,” Chen said.
The nature of the solution
Mandatory auto-IRAs require employers without a retirement plan to auto-enroll their employees in a Roth IRA. The default option for a worker is that money is deducted from their paycheck in the same way it’s deducted to pay for taxes. A worker can say no to the plan, but opting out requires that they actively decide to opt out. That’s the opposite of federal programs that require that a worker opt in. (Related: 8 FAQs on traditional vs. Roth IRAs)
“Savings have to occur at the point of paycheck,” Massena said. “So, states are reinforcing a really good best practice, which is the use of automatic enrollment. You know, it is such a useful tool in eliminating a practical hurdle, which is that if we have to go find the paperwork and figure out how to sign up, we won’t do it if we’re busy, which I think most of us are.”
As of July 2022, 11 states have passed legislation authorizing auto-IRA programs. Six of those states — Massachusetts, Connecticut, Illinois, California, Oregon, and Washington — have live programs. The other five ― Colorado, Maine, New Jersey, New York, and Maryland ― have not fully implemented the programs yet.
The results are impressive. There are more than 497,000 funded accounts with $457 million in retirement savings that can be traced to state mandates, according to Massena. Her estimate is that when all 11 states have live programs, they will provide retirement accounts to 31 percent of the current uncovered workforce, or 19 million workers.
Next up: Maryland
Back in 2016, the governor of Maryland signed the Maryland Small Business Retirement Savings Program into law. The program, dubbed Maryland$aves, requires employers to take automatic deductions from employees' paychecks and put them into Roth IRA accounts. The law is expected to go into effect in September 2022.
Start-ups that have been operating for less than two years do not have to comply. Nor do small companies that are still writing paychecks by hand.
But the most significant exemption is for businesses that already offer a voluntary payroll-based retirement savings plan, such as a 401(k).
Mike A. Cammarata is a partner and Certified Financial Planner™ professional with Tide Creek Financial Group based in Elkridge, Maryland. His company offers a variety of investment services, including the creation of 401(k) retirement plans for businesses. He sees an opportunity for small businesses and the advisors who work with them now that Maryland$aves is law.
“A lot of people I have spoken with have said: ‘Well, you know, I've always wanted to offer a retirement plan, but it was pretty low on my priority list,’” Cammarata said. “‘But if we’re going to have to do the Maryland state program, why don’t I just go ahead and open up a retirement plan now. We would have more control over where those funds live, which vendor we want to use, and what investment options we can take.’”
Cammarata noted that auto-deduction Roth IRAs don’t allow employers to match contributions. That’s a reason for small employers to consider offering other retirement plans rather than just accepting the state-mandated program. (Related: Understanding voluntary benefits)
“It’s a very good recruiting and retention tool to offer an employer plan and not the state plan, because if you offer a match [to employees’ contributions], then you're more likely to get and keep employees,” Cammarata said. “I would encourage every business owner to really look at the different options. Look at offering an employer-sponsored plan. See what the costs would be. Find out if you get tax deductions for offering that plan.”
Massena agrees. “These programs are really a solid half step between an employer doing nothing and an employer doing a traditional plan of one type or another,” she said. “So, when employers want to do more for their workers, and when employees see that it’s no big deal to send that deduction off every payroll, it’s motivation to find the best possible plan for the people at your company.”
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