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IRA Financial Blog

Will Your State Force Your Business to have a 401(k)? – Episode 375

Adam Talks

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses several pieces of legislation that some states have already enacted that are forcing businesses to offer retirement plans.

Is your State Going to Force You and your Business to have a 401(k)?

Well, it could. Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. On today’s Adam Talks, going to be discussing several important pieces of legislation that a number of states have already enacted that are essentially forcing businesses, some big and some states all, yeah, all businesses that do not offer a 401(k) to essentially offer the state IRA program. So, this is something that hasn’t got a lot of attention. So far, the states that have enacted, not fully implemented, but enacted, are Maryland, Colorado, Connecticut, New York, New Jersey, Virginia, Maine, Vermont, New Mexico, and the city of Seattle. And the states that have fully implemented an active state IRA programs are California, Illinois, Mass., only for nonprofits, Oregon, and Washington, okay?

So, I’m going to chat about the history of this, started under President Obama, give you, obviously, some of the characteristics of these plans and then talk about each state-specific rules and legislation, and then ultimately kind of give you my thoughts. So actually, let me just kind of start real quick with my thoughts. So, I’m 100% in favor of encouraging people to save for retirement. I think it’s vital. There are just too many people that don’t have access to retirement plans. The numbers are staggering; it’s almost 37% of people that work don’t have access to 401(k)s at work. Why? Because a lot of small businesses don’t have 401(k) plans for a number of reasons, cost and the like, administration burdens, but guess where most of the new hires are? Small businesses. There’s a recent Wall Street Journal article that talks about four to five new employees are coming from businesses under 250 employees. So, there is a huge pool of people that are coming into these small businesses, and the concern is that a lot of these folks aren’t going to get access to 401(k) plans. And if they don’t get access to 401(k) plans, they’re potentially missing out on the potential for saving and retirement saving is important.

Yeah, we have Social Security. We expect that to be around the next 20, 30, 40 years, but that’s not enough, right? We’ve recently dealing with lots of inflation. We’re going to need a lot more to live on than just Social Security, and there’s no guarantee that it will be there when we need it. So, we need to start saving for ourselves. The United States, we have a great retirement system, but it’s a private retirement system. It’s up to us to save. If we don’t save, the government’s not saving for us. Yes, they will provide some Social Security, but that’s money we put into the system, right? We’re just getting it back, and they’re actually taxing it. Prior to 1982, they didn’t even tax Social Security payments; now they do. So, if you get $30,000, the IRS is going to take percentage of that back in tax, and again, there’s no guarantee that it’s going to be there when we need it down the road.

So, it’s up to us to save. Starting in 1974, ERISA created IRAs, 401(k) plans. And since there, we’ve essentially mobilized to try to get more and more people to be part of the system. There’s $13 trillion in IRAs, $32 trillion in retirement accounts, 60 million IRAs; not enough folks are saving, unfortunately. Some of it’s just education, some of it’s just student debt, cost of living increases, just kind of just surviving, right? And it’s hard to put away money every year for the future. Not the short-term future, but future, maybe 30, 40, 50 years down the road. So, I get it. That’s really the intent behind these auto IRA programs, to say, hey, if you have a business and you’re not offering a 401(k), then probably want you doing something for your employees. The problem is this: is it the government’s role to force small businesses to offer retirement plans? Should the government be doing that? Is that constitutional? Can they force a small business owner to offer a certain retirement plan to their employees? Probably, Congress has the power to make laws. Probably, they can do that. Is it the right thing to do? I’m not sure, and we’ll talk about some states and what they’ve done, and I think some states have done it better than others, in terms of making it not overly burdensome on really small businesses like under five employees. Maybe it’d be enough just to educate them and send them information and maybe just re-enroll them, but not actually, you know, kind of force the plan on the employees. Now, the employees don’t have to save, but you’re putting a big burden on small business to kind of comply, because if you don’t comply, the states will impose penalties on you.

So, obviously anyone can set up a 401(k). I’m a big believer, IRA Financial has a 401(k). I own two third-party administration companies that have 1,200-1,300 plans; small businesses, and they’re great plans and they’re not overly expensive. Right? But I get it. The administration maybe cost you $1,500 a year. The problem is, if you do a safe harbor plan, you’re essentially having to do a least 3% match on someone’s salary. So if you have five employees and let’s say everyone makes $50K, just keep it simple. If you do a safe harbor IRA, which is the most common for small businesses. Why? Safe harbor 401(k) plans allow the highly comps, the owners, to guarantee max out without having to do any complicated ERISA tests like top heavy or deferral percentage or contribution percentage. So this way, the highly comps, the owners, know for sure they’ll be able to max out, which is important to them. But, in order to get that right, they’re going to have to, under the safe harbor rules, put at least 3% in, either across the board or only to folks that at least put in 3% of their own money. But let’s say we have a 3% plan, non-elective; so five employees, $50K, that’s $1,500 a pop. $7,500 plus the $1,500 administration, about $9,000. It’s cash flow. Now, is it life or death money to companies? To some, yeah. To some small businesses, yeah, it’s life or death money, right? That $9K is rent money right? Pays salaries. It’s important money. So, it’s a big burden. The 401(k) is great. It helps retain employees, pushes people to save. It has lots of benefits, but there’s a cost.

So now, some of these states want to come in and say, okay, we get you’re not offering plans, but that’s not good enough. We’re going to force you to offer some type of IRA program. Now, the nice thing about IRA programs is the IRA custodian, i.e. IRA Financial Trust, would do the administration; the company wouldn’t. So there’d be very small cost to the company, but compliance is a cost. You need someone to figure this stuff out, and if you don’t offer these plans, then you can get fined significantly.

So, here’s some statistics that I mentioned. Employers with 500 or more employees, 90% of them have 401(k), and only 50% of firms with under 100 workers have 401(k)s, okay? So, there’s obviously a big segment, and the sweet spot is like companies from one to ten employees. That’s the sweet spot where there’s lots of growth, lots of hiring, and those companies just don’t have plans because of the cost.

So, let’s talk about, real quick, just overall characteristics of these IRA programs. They’re not as sexy as you think. They’re basically Roth plans, so it’s not tax deductible. They’re essentially Roth, and essentially, the biggest negative is that the individual can’t really decide what they invest in. There’s investment firms and investments chosen by the state. You’re stuck in like very conservative state investments. Super conservative. Some states even cap the amount that could be accumulated. Some of these plans will force employers to auto-enroll employees; at least three to five percent of their salary. Workers could opt out, but it’s up to them. Obviously, the idea is get them to enroll, opt them in, they can opt out, and then there is going to be potentially be some administration for the employer, right? The states are going to need to keep track of who’s what, who’s doing what; you’re going to need to show that you’re offering this program. There’s definitely going to be paperwork that the company is going to do. And if you’re a company of two, three, four employees, that’s money you got to spend to have someone do it. So, I get the benefits; I see where states are going, I commend them. But, I’m not sure this is the right way to do it. I think it is burdensome. I’m not sure it’s the right way.

So let me go state by state, right? I mentioned there’s a number of states that have enacted legislation, and California, Illinois, Mass., Oregon, and Washington have actually fully implemented their system. So, let’s start and go through the list; shouldn’t take too long, and I’ll kind of talk about some of the characteristics of each of the states.

So, California is obviously the most burdensome and the most aggressive, and they’re doing as part of the Cal Savers program. And essentially, all employers, not just employers over certain size, all employers with at least one employee, okay. Sole proprietors are excluded. Great. So, if you have an LLC with one employee, you got to opt into this program. You must register for the program by the end of 2025, so you have time. And if you offer a private plan, you don’t have to be a part of this IRA program, but if you don’t, you have to at least apply by December 31, 2025. All businesses except sole proprietors, and you’re going to have to enroll into this kind of auto IRA program. So, that’s every business in the state that has more than one employee that does not have their own 401(k). So, yeah, there’s two more years or so or more, right? There’s all ’23, all ’24 and all ’25, so it’s about three years to get ready for this, but it’s going to be a big push.

Let’s go to Colorado. Colorado is capping it with companies over five employees, which is fair. I get it. And there’s a phase-in deadline in 2023, so it depends on your business. So, if you live in Colorado, run a business in Colorado, start paying attention to this program, especially if you have five or more employees.

Connecticut. This is only for businesses with five to 25 employees, must register by October 31, 2023. So, you don’t have that much time right? The next nine or ten months. It’s part of the California Secure Saving Program, and they’re going to limit it to basically businesses from five to 25 employees. They could expand it below that. But as of now, companies in that range have to register for this program. Again, they’re going to take most of the same characteristics, going to be autoenroll, workers can opt out, but the negative is your employees will be forced to invest in these state investments, right? So, you can’t do your own thing. You’re not going to be able to, like, buy Tesla individually or buy Bitcoin or by other, real estate, or do other types of crowdfunding. They’re going to force you into their investments. So, states aren’t stupid, right? They’re making money on this stuff too. Their intent’s good, but every time states get involved in your own, in your private retirement, I don’t like it. Government has its function, but I don’t like when they start getting in and telling you what to invest in. I have an issue with that.

Delaware. They’re going to propose a launch as of January 1, 2025. It’s going to be called Delaware Earns, and it’s going to be for businesses, five or more employees that have been in operation for at least six months. It’s going to be an auto IRA program. Any employee of 18 years of age who receive wages in Delaware will be eligible, and the contribution amount per pay period will be 3% to 6%. There’s an auto escalation of 1-2% with a maximum of 15%. Any business that fails to comply, going to pay a penalty of $250 per employee per year, up to a maximum of $5,000 per year, okay? So, they’re going to penalize you if you don’t do it. I get it right? It’s a good thing. We want more and more people saving, fair, fair, fair, fair, but you’re putting quite a, not a large, but a moderate burden on businesses, small businesses, so I’m not sure how I feel about that.

Hawaii is super aggressive like California. It’s called the Hawaii Retirement Savings Program. Any business in Hawaii open at least two years with at least one employee must participate who doesn’t have a 401(k). The state, has not yet set a launch date, but that’s in the works. And presently the contribution amount default will be 5% per pay period. Of course, there are also going to be penalties for failure to comply. In addition, there will be a penalty of $25 each month the covered employees’ not enrolled in the program and $50 for each month they continue to not be enrolled.

Illinois. It’s called the Illinois Secure Choice Retirement Program. It’s going to be for businesses between five and 15 employees. They must register by November 2023, and employers that do not comply may face penalties of up to $250 per employee for the first year.

Maine. Tentatively scheduled for April 1, 2023, so this is around the corner, a couple of months. Employers with five or more employees, been in operation for at least two years and have no retirement plan. They may be required to participate in the program unless they register for exemptions. The registration plans be implemented in three phases, starting with a proposed deadline of April 23 for businesses of 25 or more employees, followed by October ’23, 15 to 24 employees, and April ’24, five to 14 employees. Program will be auto-enroll, plus there’ll be a 5% default contribution and an auto escalation of 1%.

Maryland. This requires businesses of all sizes to offer employees automatic enrollment and payroll deduction IRAs. This launched in September ’22. So, if you are in Maryland, hopefully you’re doing this, because if not, you could be facing penalties.

Massachusetts. Voluntary and allows nonprofit orgs with 20 or fewer employees to participate in the multiple, it’s basically their own 401(k) MEC, multiple employer plan. This is for nonprofits, okay? They haven’t rolled out any program for for-profit businesses.

Jersey. It’s called the New Jersey Secure Choice Savings Program. Provides employers with 25 or more, been in business at least two years that don’t have a 401(k) to offer this. So, I’m I’m better than, so if there is a cap of at least, let’s say 25 plus, I can live with it. But, to force companies of all sizes, like California, or five or more, I think it’s too small. It’s overly burdensome on small businesses, and I’m just not in favor of it. But if you have it maybe for companies of 25 or more, 20 or more, 30 or more, I can live with that. I think the state should also offer a credit, maybe $1,000 or $500, just to cover some of the costs that are going to be attributable to having someone spend some time during the year complying with this program because there are penalties and there’s going to be some compliance work. You’re going to have to fill out paperwork, whether manually or online, to show compliance with this program.

New Mexico. July 2024, they’re planning to launch this program. The program will be auto-enrollment, give employees a choice. It’s voluntary. There’s going to be no penalties. So, that’s pretty fair, right? It’s basically like, hey, we’re offering this to you, but we’ll see how many people do it if it’s voluntary. I understand why they want to force compliance because they want to get more small businesses to offer this. I get it. It’s cool, it’s fair. But maybe limit it to 25 or more employees, open, let’s say two, three, four, five years.

New York. They have what’s called a Secure Choice Savers Program. Ten or more employees, open at least two years. Okay. Tens maybe a little too small, but it’s better than California. It’s better than five.

And then Oregon is super aggressive like California. Businesses with three, four employees are expected to register by March 1 of this year. And businesses with one or two employees have up until July 31, 2023. The penalties could be up to $5,000 a year. So, if you have three or four employees, you have to register by March 1, 2023. One to two employees July 31, everyone else should have been enrolled. So Oregon, like California, they basically want to force all businesses to auto-enroll and then penalize them up to $5K. That’s harsh.

I wonder if anyone is going to argue unconstitutionality and try to argue this in front of the Supreme Court. We’ll see. This seems like broad overreach by the government forcing small businesses to set up retirement plans. Not sure if it’s constitutional or not, but we’ll see. Again, just for the 10th time, I understand what they’re trying to do. I applaud the intent. I just think the process is flawed, and I think it’s super burdensome, depending on the state, on certain businesses, and I’m just not sure it’s the right way of going about it.

Vermont. I actually think Vermont is doing a good job. You would think they’d be a lot like California and Oregon, but they’re not. It’s only for employers, well, they’re trying to implement this. Right now, it’s designed for employers with 50 or fewer employees. Self-employed businesses can also participate. This program is scheduled to launch December ’22. So, it’s launched already. Employees will automatically enroll but have the ability to opt out and we’ll see what happens. But, it’s basically, they’re offering this MEC program, kind of like Massachusetts, for anyone with 50 or less employees. They can just join this multiple employer plan run by the state. Hopefully, they’ll be low cost. The problem is the investments will be limited and again, there’s going to be some burden administratively on the company.

And then Virginia is scheduled to launch March 2023. Requires employers with 25 or more employees to participate. The goal is to offer 800,000 private sector employees a chance to start saving.

Washington State. About 131,000 businesses don’t offer workplace retirement plans; translates to up to 2 million employees. And they’re trying to set something up. State has established its Retirement Small Business Marketplace to help businesses offer a plan. Participating financial service providers offer low-cost plans to employers with 100 or fewer employees, including sole props. So, it’s unclear if it’s required. It’s more something that they’re incentivizing small businesses to do.

But, all this is happening and more and more states are putting legislation on the books. We’ll see when it actually goes live. But, this all started with President Obama and the Auto IRA program, which he tried to launch around 2012, ’13, ’14. A couple of states enacted it, like Oregon, California, and it just kind of fizzled out. But there are a number of states that have taken the core of the Auto IRA program and then kind of turned it into their own state IRA program. Listen, there’s too many people not saving for retirement. We’re not teaching retirement education in high school and college. It’s a problem. I agree. It’s a problem. I’m not sure what the right way of doing it is. Yes, businesses are the place where you can grab the most people and get this Auto IRA and deduct it from their paycheck. So, I agree it’s the right spot to target businesses. The issue is you can’t burden them, I understand if you don’t penalize them, no one’s going to do it. We got to find a healthier way. Again, maybe a credit to offset some of the cost. Maybe the employer just needs to, as part of the payroll process, just introduce this and provide a link to get started, but that’s kind of where the requirement ends. I think a lot of people are going to get turned off because of the investments. People get excited about investments. They want to do things, and if you force them into super conservative investments run by the state, I think you’re going to turn people off. Maybe the returns will be steady and stable, hopefully. But it’s their money, right? They want to be able to invest it the way they want, and I’m concerned that a lot of these programs, from what I’ve seen, especially California, Oregon, the investment options are quite limited.

So, we’ll see how it goes; I’m surprised isn’t getting more attention, especially the fact where government is trying to impose their will on businesses and force them into offering state retirement plans. So, no one’s challenged it, as far as I know, unconstitutionality. It didn’t go anywhere with Obama, but a lot of states have picked up the steam and now are looking to go further with it and kind of run it themselves.

So, it’s starting. I mentioned the states that have implemented it and some of the other states that are looking to. There’s more states that have addressed this and are close to putting legislation on the books that will just create an Auto State IRA program. So, we shall see what happens. Hopefully, it does create more attention and more people want to save for their retirement, but are we cool with governments forcing small businesses to offer retirement plans to their employees and then penalizing them if they don’t? Maybe if they offer a credit, I can live with it, but these penalties, like $5,000, per employee, overall penalties is harsh.

So, we’ll see where it goes, but I just wanted to share it with you. That was something that, on one hand, I kind of in favor of, I like it. On the other hand, I just think it’s an overreach by the government. Yeah, they’re trying to do good, I get it, but it’s total overreach. So, we’ll see where it goes. But right now, the certain states have it. It’s around. No one’s challenged it. And if you’re in California, Oregon, Maryland, certain other states, you’re going to have to comply; the penalties are harsh. So, to be continued. I think you’ll see more and more states look at this, because there is a big void, right? I mentioned that number where if you’re a small business, 57%, 56, companies with, 56% under 100 workers. So, there’s a big chunk that don’t have access to. If only 50% of companies with 100 or fewer workers have 401(k)s, then you’re talking about, obviously 44% that don’t. That’s a lot of people. It’s millions and millions of Americans that aren’t getting access. Yes, I should have said this at first, you can always set up an IRA, right? The  government doesn’t have to force you to do it, or force a business to do an Auto IRA or 401(k). You can always go to IRA Financial, Schwab, Fidelity, TD, just open an IRA, put your own $6,500 or $7,500 in. It’s your right. So, that’s the weird thing with this, like there is a program that already exists called the IRA that you can do. So, do we need this push by the government? Does the government need to be literally in our business? Not sure. Right?

Maybe all you need to do is provide education or maybe open a free account for them at an institution. Maybe that should be enough. Why do we need these IRA programs? Just say, hey, we’re going to give you an IRA, here’s a link to an IRA, and that’s our only obligation, is we have to at least enroll you into an IRA. It’s up to you to put money in. Think that would be fine. No penalties. Just as part of the on-boarding process, part of payroll. If you have payroll, you have to open an IRA somewhere. I can live with that. But for the government, the state governments, to be literally in your business, their hands are literally in your pocket and telling you what to do, I personally think that’s an overstretch, and I started a business, I was a small business at one point. I would not think kindly of government forcing me to offer these programs, especially when I have two, three employees and I have to allocate time and expenses to this. I think that’s kind of unfair.

So, there you go, that’s my two cents, whatever that’s worth. Otherwise, I hope you guys enjoyed the video, the podcast, important topic. Just wanted to share it because there’s not been a lot of attention on it. So, I hope you guys have an amazing day. Thanks for watching or listening. It’s a weekly podcast. Obviously, you should know; been doing this like five years, almost. Drops every Wednesday. So, hope you guys enjoyed it. Have an amazing rest of your day and cheers. Take care.

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