Are you aware of state-mandated auto-IRAs and how they affect you?
Individual Retirement Accounts (IRAs) are savings accounts that can help you and your clients save for retirement while also gaining tax advantages. Auto-enrollment IRAs are rapidly being adopted across the country in response to the retirement crisis, and even though they are all IRAs, not all plans are created equal.
At Gusto, we’re here to help you guide clients in the right financial direction. To gain insight into state-sponsored auto-IRAs, we partnered with CPA Academy to bring you a webinar, “Private Sector 401(k) vs. State-Sponsored IRA: A Guide for Accountants.” This webinar was presented by Nicolle Willson, a Certified 401(k) Professional and Certified Financial Planner (CFP®) at Guideline 401(k)
Nicolle Willson, JD, CFP, C(k)P, is the head of Guideline’s Retirement Consultant Department. She leverages her ten years of financial planning and wealth management experience to help small business owners create the perfect 401(k) plans for themselves and their employees. Prior to working in the finance industry, Nicolle was an attorney with a degree from UCLA School of Law. Now, Nicolle has found her true passion for financial planning and helping individuals achieve their financial goals.
In this article, we’ll look at what makes state-sponsored programs unique, auto-IRA programs by state, and penalties for non-compliance.
Features of an auto-IRA program
State-sponsored retirement savings funds were created in response to a looming retirement crisis. A quarter of non-retired people surveyed by the Federal Reserve in 2020 have no retirement savings at all, while the majority of others have insubstantial funds saved. These mandated retirement plans impact a significant number of businesses because many employers don’t offer retirement plans. While details vary from state to state, auto-enroll IRA plans carry significant commonalities.
For example, auto-enroll IRA programs don’t allow for pre-tax contributions and are subject to max-Roth contributions for high earners. Most programs also feature an easy setup process in addition to a limited administrative burden on employers. Additionally, the plans are free for employers, and employers won’t be eligible to contribute to accounts because they are Roth IRAs.
Since there is no cost to the employer, businesses won’t be earning any tax savings. However, workers can gain significant tax deductions. Enrolled employees are eligible for up to $6,000 plus an additional thousand dollar catch-up provided they are 50 years old or over. It’s important to bear in mind that income limitations do apply, as they do in any Roth IRA.
Single filers in 2021 are phased out of making contributions beginning at $125,000 Adjusted Gross Income (AGI), and no further contributions can be made when earners hit an AGI of $140,000 or over. If you have high-income earning clients, keep an eye on their automatic contributions as they may be done accidentally.
“You do need to be very careful if you are a high-income earner and subject to a state auto-enrollment IRA, because if you accidentally contribute, you could end up with a headache on your hands just trying to recharacterize those contributions.”– Nicolle Willson
Remember, employees will only be able to make Roth contributions through state-sponsored programs. As a result, there is no benefit for pre-tax contributions. And since state-sponsored Roth IRAs don’t allow employer contributions, there is also no extra savings boost for employees who have matching or profit-sharing contributions. Since IRA plan contributions consist solely of those by employees, employees also immediately own all funds in accounts.
When compared to administering a 401(k) plan, employers have significantly less responsibility. However, they do still carry significant duties.
“Under a state IRA program, employers will need to distribute plan information, including [distributing] timely notices to employees, taking care of enrollment and onboarding, processing payroll deductions, and … remitting employee contributions.”– Nicolle Willson
Mismanaging these IRAs would undoubtedly alienate employees from employers, Nicolle cautioned. As many people are automatically enrolled and need to choose to opt out, some employees may already be wary of the plan. Furthermore, neglecting to disenroll someone could have a detrimental impact on them.
“Employers are expected to stay compliant with all of the specific state programs, guidelines, and requirements. [It’s] also worth noting that these high-income earners could potentially be auto-enrolled in the plan but wouldn’t qualify for a Roth contribution, and this could trigger an ineligible contribution and a tax penalty.”– Nicolle Willson
Even though employers are not responsible for possible tax penalties incurred by these accounts, leaders who mismanage their staff’s finances could sever the relationship between themselves and their staff.
An overview of existing state programs
Auto-IRA legislation is gaining significant traction, and it won’t be long before the majority of the country adopts it. Depending on whether you are looking into this for your own benefit or that of your clients, it is essential to know the basics of the programs and how they work. If you serve clients from various states, be sure to stay informed about any nuances, changes, enrollment deadlines, and penalties for failing to enroll.
Thankfully, state-sponsored programs are fairly simple, and they share similarities across the board. To explore how auto-IRA works, take a look at the three states who have currently fully implemented them.
Program Features and Benefits
Oregon Saves Retirement Savings Program
- Affects all employers with no existing plan (no matter the size)
- 5% starting default contribution rate with auto-escalation to 10%
- The first $1,000 will begin as a Capital Preservation Fund
- Employees choose between Target Date Retirement Funds or Growth Funds
- Costs employees 0.25% of assets annually and $1.50 monthly
CalSavers Retirement Saving Program
- Affects employers with at least five employees
- 5% starting default contribution rate with auto-escalation up to 8%
- Investments begin as money market accounts for the first 30 days
- Employees choose between Target Date Retirement Funds, Environmental, Social, and Governance Funds, Core Bond Fund, and Global Equity Funds
- Costs to employees 0.825% to 0.95% of assets annually
Illinois Secure Choice Retirement Saving Program
- Employers with at least 25 employees and no existing plan
- 5% optional starting contribution rate and 1% increase annually
- Investments begin as money market accounts for the first 90 days
- Employees choose between Target Date Retirement Funds, Capital Preservation Funds, Conservative Funds, or Growth Funds
- Costs employees 0.75% of assets annually
Deadlines by state
Most states have varying degrees of state-sponsored retirement programs, and while California and Illinois divided the deadlines based on company size, Oregon had a strict requirement for every business to register, regardless of size. As such, the Oregon deadline for all businesses has already passed. Employers who failed to comply face a penalty of $250 per employee for the first year and $500 per employee for subsequent years.
California’s deadlines for companies with over 100 employees and over 50 employees have passed, while the deadline for companies with 5 or more employees will pass June 30, 2022. Employers are penalized $250 per eligible employee if the employer does not enroll them within 90 days of a notice of failure to comply. At 180 days, they face an additional penalty of $500 per employee.
In Illinois, the deadline for 25 or more employees has passed. The deadline for 15-25 employees is coming up on September 1, 2022. The deadline for 5-15 employees isn’t until September 1, 2023. The program began assessing non-compliance penalties in late 2021. Companies who have missed deadlines face a penalty of $250 per employee for the first year of non-compliance and $500 per employee for an additional year.
“The safest thing to do if you are a business that falls under these mandates is to just start setting something up soon.”– Nicolle Willson
If you or any of your clients live in states implementing auto-IRA legislation, act quickly to avoid the hassle of penalties.
Learn more about state-sponsored IRA programs
California, Illinois, and Oregon feature state-sponsored retirement savings programs that make saving for the future easy. The three programs bear similarities that are widespread among all state-sponsored Roth IRA programs.
All state-sponsored IRAs feature auto-enrollment and very little administration on behalf of employers compared to 401(k) plans, but it’s important to note that while the administrative burden is minimal, employers need to communicate clearly and often with employees regarding the plans. Failure to do so can lead to penalties that can result in turnover and strain employee relationships. Additionally, penalties can be costly if businesses fail to enroll.
For all plans, employees start off with a base percentage rate which can increase over time. The nature of the investment portfolio also changes after enrollment and can range from Target Date Retirement Funds to Growth Funds to Conservative Funds and more.
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 in this series, A Brief History of State-Sponsored IRA Programs.
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