Custom vs. State Retirement Plans: Which is Better?

Avoid State-Mandated Retirement Plans

An increasing number of states are implementing state-run retirement programs that require employers to either offer their own qualified retirement plan or be automatically enrolled in the state program. While the intent is to increase employee access to retirement savings, these state-mandated programs come with certain obligations and limitations that employers should be aware of.

How State Retirement Programs Work

Though there are some minor variations, most state retirement programs operate similarly. Take California’s CalSavers program as an example:

• If you have 5 or more employees in California, at least one of whom is age 18 or older, you must participate in CalSavers
• You will be required to automatically enroll employees and withhold 5% of their pay for contribution to the state program
• Employee contributions are made on an after-tax basis
• Employees typically have just 5 investment options within the state program, often with management fees on those funds

The programs are meant to be easy and free for employers to facilitate. Contributions are handled by payroll deduction, and there are no employer contribution requirements. However, employers still bear some administrative burden of setting up payroll deductions, transmitting contributions, and managing the program. When you’re in an industry with a high turnover rate, these programs can become very complicated for employers to manage. Luckily, there’s an alternative option.

Why Consider a Custom Retirement Plan

While state programs aim to increase retirement coverage, a custom company retirement plan may be a better solution for many employers. Some key potential advantages include:

• Avoid State Program Requirements: By offering your own qualified retirement plan like a 401(k) or SIMPLE IRA, you are exempt from having to participate in the state-run program. This allows you to avoid the administrative confusion involved.
• Control Eligibility Requirements: With a custom company plan, you set the eligibility criteria for participating employees. For example, you could require 1 year of service to join the plan. This allows you to minimize short-term, high-turnover employees from needing to be covered initially.
• Tax-Deductible Contributions: Employee contributions to state programs are made on an after-tax (Roth) basis. But in a company 401(k) plan, any employer contributions you make are tax-deductible to your business.
• Better Investment Options: Many state programs limit participants to just 5 investment options within the plan, and the investment fees can be quite high (0.90% – 0.95% or more). With a custom plan, you can offer low-cost index funds and other options that may better suit your employees.

So while state-mandated programs increase accessibility, they come with trade-offs. For many employers, a custom company retirement plan can provide more flexibility, better tax benefits, and lower costs.

Making the Right Choice

As more states roll out these mandated programs, it’s critical for employers to understand the requirements and consider if setting up their own qualified retirement plan may be a better option. An experienced financial advisor can help evaluate your specific situation and customize a retirement offering that meets your needs and those of your employees.

Don’t simply go along with your state’s program without analyzing if a company-sponsored 401(k) or other retirement plan could be more advantageous from a cost, tax, and administrative perspective. Making the right choice upfront can lead to a better outcome for you and your employees.

Wrapping Up

We've since published a fuller guide to this decision, with the current contribution limits, the question of whether the owner can even participate, and the federal tax credits that change what your own plan actually costs: State-Mandated Retirement Plans vs. Your Own 401(k). Start there if you're weighing the two.