Are your clients prepared for their financial future?
A significant portion of Americans don’t know how to save for retirement. They may feel like saving for retirement is hopeless because they don’t have enough money, or they are saving much less than they actually need. With longer life spans and decreasing government benefits, the country’s coming retirees face an uncertain future.
At Gusto, our mission is to create a world where work empowers a better life. A better life requires the peace of mind that comes with long-term financial security. To gain insight into the retirement crisis, we partnered with CPA Academy to bring you a webinar, “Private Sector 401(k) vs. State-Sponsored IRA: A Guide for Accountants.” It was led by Nicolle Willson, a Certified 401(k) Professional and Certified Financial Planner (CFP®) at Guideline 401(k)
Nicolle Willson, JD, CFP, C(k)P, heads Guideline’s Retirement Consultant Department. Formerly an attorney who graduated from the UCLA School of Law, Nicolle found her true passion for financial planning and helping individuals achieve their retirement and other financial goals. She now translates her 10+ years of financial planning and wealth management experience into helping small business owners create the perfect 401(k) plans for themselves and their employees.
In this article, we cover states with mandatory retirement plans, how they compare to private-sector retirement plans, and the history of state-sponsored IRAs.
The retirement crisis in America
Government-mandated retirement plans were created in response to startlingly low levels of readiness for retirement among Americans. With a sizable chunk of Americans having little to nothing saved, the future for retirees looks bleak. Historically, most people relied on pensions, social security, and personal savings in their older years.
However, pensions have been largely eliminated, workplace retirement plans aren’t widely available, and social security benefits are increasingly uncertain. So the burden of saving now falls primarily on individuals. Add to this a population with an increasing expected life span, saddled with student loan debt and reeling from recessions, and it’s easy to see why some experts see a crisis looming.
To illustrate this point, Nicolle pointed to sobering statistics from a 2020 Federal Reserve report that put many Americans at high risk for having insubstantial savings as they age:
- 26% of non-retired people have no retirement savings
- Social Security is the most common income source for retirees
- 64% of non-retirees with savings don’t feel they’re on track with their savings
- 60% of non-retirees had low levels of comfort regarding making retirement decisions
- 29% of people who had retired in 2020 did so due to COVID-19
- 47% of retirees adjusted the timing of their retirement due to health problems, caring for family, or being forced to retire
So why don’t Americans have retirement money in the bank? It boils down to the perceived or actual inability to do so. Maybe they live paycheck to paycheck, are focused on paying down debts, plan to rely solely on social security, or have limited financial literacy. Some may be opting to avoid retirement altogether, thinking saving the requisite nest egg to be hopeless.
Whatever the reasons, having insufficient savings or none at all puts people at risk as they grow older. Even those who have some savings may not be thinking about unforeseen circumstances, such as illness or a forced early retirement.
“Almost half of those already retired did so earlier than expected because of unforeseen circumstances. So knowing that a significant number of U.S. workers won’t be able to support their retirement with their current planning, we might wonder if they can live on Social Security alone.”
– Nicolle Willson
Unfortunately, Social Security should be viewed as supplementary income. It’s paltry compared to the cost of living for most people, and it becomes even more scant when a partner passes away. Nicolle explained that when the program was designed, it was done so without taking into account the full economic picture for retirees.
“It is worth noting that the Social Security Administration designed the program to replace 40% of pre-retirement income for average earners. So that means they didn’t actually take into account what retirees usually spend during retirement. As of October 2020, that number is about $50,000 a year for a household headed by an adult 65 or over. So if you have two Social Security earners with an average benefit of this $18,259 per year, they’ll cover about 73% of their expenses. If you have only one earner, then only about 36% of those expenses are going to be covered by Social Security.”
– Nicolle Willson
Depending on where retirees live, the gap between social security benefits and the cost of living is significant, ranging from a few thousand to tens of thousands. An event such as the death of a spouse, a health crisis, or a move could easily tip the scales for retirees, taking them into poverty. All of these factors, plus the fact that private-sector retirement plans can be cost-prohibitive for many people, pushed states to step in.
The state’s response to the retirement crisis
State governments recognized the crisis and understood that if the majority of the population is unable to retire, they would need to rely on government aid. To avoid providing additional aid, states introduced legislation mandating that employers phase in retirement plans, starting from the largest organizations down to small businesses with less than five people. Since 2012, at least 45 states have either implemented or considered legislation to target the millions of people who lack access to a retirement plan through their job.
“Here, you have a quarter of the country’s workers with no savings [and] more than half with insignificant savings. Who is covering the rest of that bill? States are thinking their governments are probably going to be responsible for covering part of it. So if these states can incentivize workers to start saving for retirement, then they feel it’ll work out better for everyone involved in the long run.”
– Nicolle Willson
State mandates would impact a significant portion of businesses because a large percentage of employers don’t offer retirement plans at all, even though employer-sponsored retirement plans are how most Americans save for retirement. AARP found that people are 15 times more likely to save for retirement if they have a workplace plan.
“A number of states also looked at how many workers had access to a workplace retirement plan. Turns out that 33% of private-sector workers, or 41 million people in the US, are not able to save for retirement through their workplace or even have their employer save for their own benefit because they lack access to a retirement plan.”
– Nicolle Willson
After realizing they needed to take action, legislators examined which options would work best. Between traditional and Roth accounts, states opted for Roth. This type of account makes it easier for everyone involved for a number of reasons:
“States thought that if they’re going to be requiring employers to provide this retirement plan, they need to make it as easy on the employer as possible. So they looked for something that was very simple to set up with very minimal maintenance or administration. IRAs definitely fit the bill here. Opening an IRA account is very easy, and once the account is open and investments are chosen, there’s really no additional information for the employer.”
– Nicolle Willson
With IRAs, employers are responsible for managing contributions by deducting them from pay and depositing them into employee accounts—they have no responsibilities beyond that. Additionally, employer liability is limited because IRAs aren’t covered by the Employee Retirement Income Security Act. This means employers won’t be considered responsible in matters of investment selection or administration. Finally, setting up an IRA plan is entirely free for employers. The fee is passed on to the employee, who will see a 1% Assets Under Management fee on their account balance.
How state-sponsored programs make it easy for everyone to save
State-sponsored IRA programs feature auto-enrollment, which means employees will need to consciously opt out of a plan to avoid it. At first glance, that could make company leadership panic because it makes sense to think that employees will react badly to being forced to do anything. However, Nicolle explained that evidence shows differently—she pointed to a study done by Pew Charitable Trusts:
“[The study] shows some initial reactions to state IRA plans by workers who didn’t have access to a retirement plan. Approximately 75% of workers said they would stay in the program. Only 10% would opt out of the program altogether. Here you see the vast majority of workers who currently don’t have access to retirement plans, not only wanting access, but actually wanting somebody to force them to save.”
– Nicolle Willson
Nicolle explained that while most people do not like being forced to do things, many recognize that they won’t save for retirement unless it’s automatic. Whether the person has trouble managing money or doesn’t believe that they have enough, many people have difficulty setting money aside.
“Having an automatic way to save is beneficial. And I will say that with 401(k) plans in general, you do see this phenomenon. If people set a contribution rate out of their pay, they usually forget what they used to have in their higher paycheck, and that money just actually starts accumulating in their retirement account with no harm done to their normal budget.”
– Nicolle Willson
Roth IRA funds also make it relatively easy to access funds in an emergency. The cost for taking out funds early is minor, which makes it a much more fluid account to possess.
“States also want to make sure it’s easy to get money out of the plan if employees need it. … With any IRA, you have the freedom to take money out whenever you want, but if you do it before age 59 and a half, you’re going to be subject to tax and a 10% tax penalty. With Roth IRAs, the penalty is still going to apply, but since your contributions are already made after-tax, the penalty is only going to be assessed on taxable earnings, making it much less in comparison.”
– Nicolle Willson
Giving people access to state-sponsored workplace IRAs creates a savings opportunity many people never had, and the automated process makes it effortless. A Vanguard study supports auto-enrollment’s efficacy, as it revealed that the average savings rate, including employer contributions, is 56% higher in IRAs with auto-enroll.
States with mandatory retirement plans
Different states have opted for different styles of retirement plans, and they are at various stages of implementation. States with active plans include California, Illinois, Oregon, Washington State, Massachusetts, and Vermont. States that have pending Auto-IRA plans include Colorado, Connecticut, Maine, Maryland, New Jersey, New Mexico, New York, and Virginia. 23 additional states have introduced legislation.
In addition to auto-IRA plans, some states have adopted alternatives such as the Active Marketplace IRA program, which is voluntary and allows employers to shop the marketplace for state-verified plans and Multiple Employer Plans (MEPS).
States with Active Auto-IRA Plans:
- California—CalSavers
- Illinois—Illinois Secure Choice
- Oregon—OregonSaves
States with Active Marketplace IRA programs:
- Washington State—Small Business Retirement Marketplace
States with Multiple Employer Plans:
- Massachusetts—Massachusetts Defined Contribution (CORE) Plan
- Vermont—Green Mountain Secure Retirement Plan
Nicolle discussed the progress of active auto-IRA plans as of December 2021. There were 358 million dollars in savings spread throughout 410,000 accounts. That amounts to a 68% participation rate. She explained that while that may look insignificant compared to 401(k) plans, the programs have only begun recently. She pointed out research from The Employee Benefit Research Institute done on the Oregon Saves Program:
“To recognize the impact that state-run IRAs can make, let’s take a look at what a national auto-IRA plan could potentially look like. [When the] Employee Benefit Research Institute look[ed] at results from the OregonSaves program, they found that if it were applied nationwide, the $3.83 trillion aggregate retirement savings deficit would fall by 12% or $456 billion. So while it would not solve the entire retirement crisis, it would make a significant dent.”
– Nicolle Willson
With those potential benefits, it is only a matter of time before most states implement sponsored IRA programs.
Learn more about state-sponsored IRA programs
State lawmakers are responding to the looming retirement crisis with legislation for state-sponsored Roth IRA accounts, and a handful of states have already implemented these initiatives. When this transition occurs, companies of all sizes will need to make this retirement-saving option available to their staff.
In many cases, employees will be automatically enrolled but will have the option to decline enrollment. However, studies show that most people view auto-enrollment favorably and that people save significantly more money with auto-enrollment.
Gusto is here to raise awareness about all aspects of accounting. If you haven’t already, check out the entire webinar here. Also, be sure to read our other article from this webinar, An Overview of State-Auto IRAs and Their Benefits.
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