State-mandated IRAs: How they encourage employers to start 401(k) plans

For many Americans, saving for retirement starts with having an employer-provided plan, especially one that you’re automatically enrolled in with payroll deductions.

The problem: Nearly half of US private-sector workers — roughly 57 million people — don’t have access to an employer-sponsored pension, such as a 401(k). At least in some states, though, help may be on the way.

“Unfortunately, when workers do not have access to an employer-sponsored plan, they often don’t act on their own,” Angela M. Antonelli, executive director of the Center for Retirement Initiatives at Georgetown University, told Yahoo Finance. “Only 5% of workers take the steps to open up a retirement savings account if it is not provided by their employer. If a worker has access to an employer-sponsored plan, participation jumps to 72%.”

A growing number of states have passed laws in recent years to help solve this retirement savings quandary. And the new legislation appears to be spurring an uptick in employers choosing to offer a 401(k) plan instead of participating in their state’s program, according to a new working paper from the National Bureau of Economic Research (NBER).

As of June, 19 states have enacted retirement programs for private-sector workers. Fifteen of these states are auto-IRA programs. They require most private employers that don’t sponsor a savings plan of their own to enroll workers in a state-facilitated individual retirement account (IRA) at a preset savings rate — usually 3% to 5% of earnings — and automatically deducted from paychecks. The plans typically ramp up their employee’s contribution 1% each year until it reaches 10%, unless an employee opts out.

NBER researchers used US Census surveys on state residents’ behavior and the retirement plan reports, which employers file with the federal government, to scrutinize the indirect impact of auto-IRAs in the three states that have the longest-running programs: California, Oregon, and Illinois.

Their findings: The programs have increased by 3.2 % the likelihood that workers in these states are employed by a firm that offers its own retirement plan — and by 7% the probability that employees are participating in those employer plans, according to the paper.

Increases in employer-sponsored retirement plans linked to state policies

“Our research findings provide fairly strong evidence that these state policies in California, Oregon, and Illinois are leading to significant increases in the prevalence of employer-sponsored retirement plans (ESRPs), the likelihood that workers work for an employer that offers such a plan, and the likelihood that workers participate in plans that they have access to,” Adam Bloomfield, a senior economic policy adviser for the Federal Deposit Insurance Corporation and one of the paper’s researchers, told Yahoo Finance.

In reality, any measurable increase in coverage so early in policy rollout can be seen as a substantial increase by many people. And perhaps, more importantly, "it was not evident that these policies would ever result in a net increase in worker coverage by employer-sponsored plans," Bloomfield added.

Previous research backs this finding that state programs are nudging employers to offer their own plans.

The first three auto-IRA programs were launched in Oregon (in 2017), Illinois (in 2018), and California (in 2019). In each case, the following year saw a 35% higher growth rate among new 401(k) plans at private businesses compared to other states, according to a 2022 report from Pew Charitable Trusts.

A digital tablet with a stock market chart on its screen rests on top of a 401(k) statement that sits on a desktop.  A fountain pen, a calculator, and cup of coffee also frame the scene.
New legislation appears to be spurring an uptick in employers in those states choosing to offer a 401(k) plan instead of participating in their state’s retirement savings program. (Getty Creative) (DNY59 via Getty Images)

Here’s the backdrop: The new state laws require employers to either offer employer-sponsored retirement plans to workers or facilitate automatic payroll deductions that are deposited into individual retirement accounts (IRAs) established for workers by the state.

Nine of these programs are now rolling: California, Colorado, Connecticut, Illinois, Maryland, Massachusetts, Oregon, Virginia, and Washington are open to all eligible employers and workers.

Many of the more recently enacted programs — New York, New Jersey, Maine, Delaware, Hawaii — and the 2023 new auto-IRA programs — Nevada, Minnesota, Vermont (and Missouri voluntary MEP) — are likely to open within the next two years, 2024 and 2025, according to Antonelli.

How auto-IRA plans work

The nitty-gritty: Employee contributions are typically directed into Roth IRAs. Contributions to Roth accounts are not tax-deductible, unlike 401(k) plans or similar employer-sponsored retirement plans. Traditional IRAs, whose contributions may be tax deductible, are an option, however, in some states, depending on the plan details.

These programs are supervised by state-appointed boards and managed by private financial firms. Roth contributions come from after-tax wages, so withdrawals in retirement are tax-free. Employers are not required to make matching contributions.

You get a roster of options for investing your contributions, generally target -date funds, which tailor the investment mix to your projected retirement date, or stock, bond, and income funds.

As with most employer-provided plans, enrolled workers are charged administrative fees, which among current programs range up to $30 a year or around 0.25% to 1% of account assets.

Employers who ignore the mandate to enroll workers in their state’s plan are likely to face penalty fees. In California, for example, each eligible employer that, without good cause, fails to allow its eligible employees to participate in CalSavers within a three-month window, will pay a penalty of $250 per eligible employee — and an additional penalty of $500 per eligible employee if they drag their feet for more than 180 days.

So far the response from workers overall has been encouraging. As of June 30, there are 156,804 employers and almost 700,000 savers using a state program, and this is just five of the 19 state programs (CA, IL, OR, CT, and MD), according to Antonelli.

Young Asian woman handling personal finance with laptop. She is making financial plan and planning budget as she go through her financial bills, tax and expenses at home. Wealth management, banking and finance concept
Encouraging: As of June 30, almost 700,000 retirement savers are using a state program. (Getty Creative) (d3sign via Getty Images)

“The programs have shown that when workers are given the opportunity to save, many do,” she said. “But the options for employers have to be simple and low cost for them, and this is what state programs give them.”

If the early progress is any indicator, Antonelli expects that a few million workers will be covered by their state programs in the next three-to-five years. “At the same time, we can expect the private sector to also be contributing to expanding coverage and participation, although it is too early to tell by how much,” she said.

And they have a new incentive: Beginning this year, eligible businesses with 50 or fewer employees can qualify for a credit equal to 100% of the administrative costs for establishing a workplace retirement plan. Meantime, in a tight labor market with many small employers struggling to attract and retain workers, offering retirement benefits is a sweet enticement.

“The goal,” Antonelli added, “is to close the access gap.”

Kerry Hannon is a Senior Reporter and Columnist at Yahoo Finance. She is a workplace futurist, a career and retirement strategist, and the author of 14 books, including "In Control at 50+: How to Succeed in The New World of Work" and "Never Too Old To Get Rich." Follow her on Twitter @kerryhannon.

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