Many small-business owners have had high anxiety over 401(k) plans since 2017 when Oregon became the first state to mandate offering retirement accounts to employees. Small-business owners are worried they may be in violation of state laws about mandated retirement accounts, and that’s why it’s good — but not easy — to keep abreast of changes and how they affect you.
Must You Offer Employees a 401(k)?
The short answer is no, at this point, there are no federal laws requiring employers of any size to offer a 401(k) plan to employees. However, there are some states that require businesses to either offer a retirement plan to their employees or use a state-sponsored program. While a 401(k) is the most popular plan type, other retirement plan types are also available.
Most of the state-sponsored programs are Roth IRAs (Individual Retirement Accounts), not 401(k)s, and although both are retirement savings vehicles, there’s a world of difference between them. Let’s take a look at each.
What Is an IRA and How Does It Work?
You might think you know the answer to that question, especially if you have one, but you might be wrong. An IRA is a personal retirement account (remember: the “I” is for “Individual”), previously used more often by those who had no access at work to a 401(k). An IRA is a private nest egg, and only the account owner makes contributions.
What Is a 401(k) and How Does It Work?
A 401(k), a popular retirement vehicle that over time has largely replaced pensions, is available only through employers. The IRS sets lots of rules about which employees companies can and cannot bar from participating in the 401(k) plan. Generally speaking, full-time employees are allowed to participate in a 401(k) plan if their company offers it. According to a CNBC survey, about 40% of people do not avail themselves of this benefit, but that is employees’ choice to make.
401(k) vs. IRA
Why is the 401(k) considered the gold standard of retirement accounts? Because employees can save so much more in them. The maximum employees can save in a 401(k) in 2024 is $23,000, while the IRA max is a paltry $7,000. Additionally, many employers offer matching funds, contributing a percentage on the dollar of whatever the employee contributes. No one gets matching funds with an IRA.
That being said, some employees have their own IRA even while participating in a company-offered 401(k). Not everyone has an extra $30K to sock away every year, but there are other ways of managing to fund two types of accounts. Employees’ first priority is often to contribute a percentage that maximizes the employer match. For instance, if the employee earns $100K and the employer offers a match up to 6%, the employee should prioritize saving at least $6,000 to get the full amount of matching funds. After that, any extra money could be put in either the 401(k) or the IRA.
Why bother opening an IRA? If the employer doesn’t offer a Roth option with their 401(k) plan, employees might want to open a Roth IRA so that they have some retirement savings they can eventually withdraw tax-free. Additionally, many 401(k) plans do not offer as diverse a selection of funds in which to invest as an IRA does, if investors are paying attention to that type of thing.
So to recap, 401(k): Good, IRA: Not Bad.
Where Are Retirement Accounts Mandated?
Today, many states are mandating that employers offer retirement accounts to employees. There is even a House bill that is seeking to make retirement accounts mandates federal. But, this would mandate the use of any type of retirement plan, not 401(k)s specifically. This is important because there are many retirement vehicles available to small businesses, so it still preserves the freedom of choice.
The truth is that about half of U.S. workers have no access to a 401(k) plan at work, and many of these workplaces are small businesses. This shortfall was the catalyst for the birth of government mandates — an attempt to get more U.S. workers to save more for retirement.
One issue standing in the way of small businesses offering 401(k)s has been that these plans were historically expensive and time-consuming to operate, making them impossibly unaffordable to small-business owners. Now, 401GO provides easy setup and affordable management of 401(k) plans, making them an excellent — and allowable — alternative to state-sponsored IRA plans. A 401GO 401(k) is better because state IRAs are nothing more than regular IRAs that employees get through work. They’re better than nothing because they are easy to get and encourage employees to save, but at the same time they cause problems, because in most states these IRAs are not only offered — employees are automatically enrolled in them. If they don’t read the fine print and don’t realize they have an IRA until they notice money missing in their paychecks, it’s hard to get this money back, causing a myriad of additional problems.
While most companies that offer 401(k)s do the same, automatically enrolling employees in the plan at a 3% contribution rate, the enrollment and opt-out processes are much better when using 401GO.
Where Are Retirement Accounts Mandated?
California, Colorado, Connecticut, Illinois, Maine, Maryland, Oregon, and Virginia have retirement plan mandates, while Delaware, Hawaii, Minnesota, Nevada, New Jersey, New York and Vermont have passed legislation to mandate retirement plan offerings. Washington, New Mexico, Missouri and Massachusetts offer voluntary plans with no mandates. Other states have votes coming up on the matter, and still others are considering legislation.
Even if you live in a state where the mandate has passed and is in effect, it can be difficult to know if the mandate applies to you. In some instances, the mandate applies to small businesses with 5 or more employees. Elsewhere the number may be lower. It’s important to keep an eye on the law and watch for any changes that might occur. If you have a financial advisor or a good accountant, this person might take care of this task for you.
Even though 401(k) plans are not mandatory, it’s still important for business owners to be aware of the laws in their state. Offering a good, affordable 401(k) from 401GO now could save you a lot of headaches in the long run.
