Research shows that one of the key hurdles for achieving retirement security is having access to a retirement plan at work.
And, until recently, as many as 57 million people in the United States didn’t have access to an employer-sponsored retirement plan. Many of those workers were employed by small businesses.
To address this gap, the states have begun to step in with their own solutions over the last decade or so. One of the most common programs is an automatic individual retirement account (auto-IRA) program. As many as a dozen states have passed legislation to create auto-IRAs for workers whose employers don’t offer a retirement plan.
In her article in the first quarter issue of Benefits Quarterly “When We All Have Access: The U.S. Retirement Ecosystem of the Future,” Lisa A. Massena, CFA, offers an overview of the development and progress of state-sponsored programs, focusing mainly on the auto-IRA model. Massena is the founder of Massena Associates, where she consults with governments to develop savings programs. She was also the founding executive director of OregonSaves, which is the state-sponsored auto-IRA program in Oregon.
Massena explains that these auto-IRAs, which have also been called secure choice savings programs, were first proposed at the federal level as a solution to undersaving for retirement. They began gaining traction in 2012 with the passage of early program-related legislation in California.
What Are Auto-IRAs?
The state sets up a system to accept an employee’s payroll contributions into an IRA. Employers of a certain size that don’t offer their own retirement plan are generally required to enroll their workers in the program, although workers may opt out. Auto-IRAs by their nature cover employees who, as a group, work in jobs that experience higher turnover and are lower paid than their counterparts whose employers offer a plan.
Massena identifies the following common characteristics of the state programs:
- Automatic enrollment—often at 5% of employee pay
- Automatic escalation—often to a 10% cap
- Streamlined investment menus
- Roth IRAs as standard account type
- A focus on simplicity and ease of use
As of 2022, the U.S. had 12 state auto-IRA programs authorized in California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, New Jersey, New York, Oregon and Virginia. The cities of New York, New York and Seattle, Washington also have authorized their own auto-IRA programs, although both are likely to defer to state-level programs, if and as they are offered (the state of New York has authorized a program, while the state of Washington has not).
In addition, four other states have enabled other types of programs that are typically voluntary, unlike the auto-IRAs, Massena writes. Massachusetts and Vermont have authorized multiple employer plans (MEPs)—a state version of the pooled employer plans (PEPs) that are now becoming popular in the private sector. Washington State and New Mexico have authorized retirement savings marketplaces, and New Mexico’s legislation includes a companion program, an employer-voluntary payroll deduction IRA.
What Do Employers Need to Know?
Employers that already offer retirement plans are typically exempted from state programs, however the state may require a business to file for an exemption. As previously mentioned, employer participation in auto-IRAs is generally required if the business does not offer a retirement plan.
Most state programs use Roth IRAs as their default account type. Many also offer traditional IRAs for savers whose incomes are higher than Roth IRAs allow. For 2023, the Roth income limit is $153,000 for single filers and $228,000 for married filing jointly. However, data shows that median earnings for workers enrolled in the Oregon and California programs was between $29,000 and $36,000 a year in the early years of both programs, far below the IRS income limit, Massena explains.
These programs also create administrative requirements for employers. For example, they need to facilitate the automatic enrollment of workers, and they must withhold and remit payroll deductions for participating employees. Employers may also be required to provide certain demographic information to the state programs. Some states also require employers to play an active role in educating eligible employees about the program features by disseminating information about the state-run program within a specific window when an employee is hired.
Employers also should be aware of the various deadlines of their state programs and potential for noncompliance fines or penalties. For example, the Illinois Secure Choice Retirement Savings Program had several registration deadlines, depending on employer size. The final registration deadline is November 1, 2023 for employers with five to 15 employees. The state said enforcement would begin this year for noncompliant employers with 25 or more employees.
Advantages for employers include the following:
- Ability to offer a low-cost retirement savings account
- Lower fiduciary burden
- Less reporting required. For example, employers don’t have to conduct nondiscrimination testing, Form 5500 reporting and ERISA disclosure.
- No employer contribution. Employers are not permitted to contribute to these accounts.
One disadvantage is that employers don’t have a choice of design as they would if they sponsored their own plan.
State-sponsored retirement programs have faced opposition, with critics arguing that they create a patchwork of rules and that employees are not protected because the programs are not covered by ERISA. Critics also point out that employees can’t save as much in these accounts as they could in an employer-sponsored 401(k) plan, partly because they do not allow employer contributions, and partly because of IRA contribution limits.
There has also been concern that state programs might encourage employers to drop their existing plans. Massena cites a Pew Charitable Trusts study that appears to show that in states with active auto-IRA deadlines, new plan formation has risen significantly.
State programs have faced challenges in court, although most have been resolved to date, Massena explains, noting that in a February 2022 decision, the U.S. Supreme Court decided not to review the Ninth Circuit Court of Appeals 2021 ruling in favor of the CalSavers Retirement Savings Program. The Ninth Circuit ruling stated: “We hold that the preemption challenge fails. CalSavers is not an ERISA plan because it is established and maintained by the State, not employers; it does not require employers to operate their own ERISA plans; and it does not have an impermissible reference to or connection with ERISA. Nor does CalSavers interfere with ERISA’s core purposes. Accordingly, ERISA does not preempt the California law.”
Massena provides the following statistics on participation in the three programs with the longest history (California, Illinois and Oregon):
- Retention rates are around 69%.
- About 655, 275 savers had accumulated more than $640 million in retirement assets as of February 2023.
- Average savings rates vary from 5.1% in California to 5.6% in Illinois and 6.2% in Oregon.
- As of mid-2022, Oregon program data shows that about 25% of all funds ever contributed have been withdrawn. California’s cumulative withdrawal rate is lower—at about 12.6%—possibly reflecting the newness of the program relative to Oregon’s or other reasons.
Turn to International Foundation resources, including Today’s Headlines and InfoQuick for the latest news and up-to-date information on state-based retirement savings programs.