With more than 45 million U.S. workers not having access to a retirement plan through their employer, several U.S. states are taking the lead to address this retirement savings crisis. California, Illinois, Connecticut, Maryland and Oregon have all passed legislation to implement a mandatory state-run Individual Retirement Account (IRA) for employers who do not sponsor a retirement plan. Each state has added an auto-enrollment feature to these plans, where employers will be required to automatically enroll each of their employees at rates between 3% and 5% of their income. Employees will have the ability to opt-out but penalties will apply to those employers who do not comply in offering an IRA.
Safe harbor guidance, ERISA and the consequences for 401(k)
As of August 2016, the U.S. Department of Labor provides states with “safe harbor” guidance. The purpose of safe harbor guidance is to aid the states in implementing an auto-enrollment IRA. The safe harbor guidance will exempt them from the Employee Retirement Security Act of 1974 (ERISA), which all qualified employer-sponsored retirement plans are subject.
While a payroll-deducted IRA through an employer would not normally be subject to ERISA, adding an auto-enrollment feature would require that arrangement to follow ERISA. In other words, the auto-enrollment feature offered by the states mentioned above would make participating employers subject to the same requirements as other qualified employer-sponsored plans, such as 401(k) plans.
Being subject to ERISA means more administrative requirements, such as nondiscrimination testing and IRS form 5500 filings. These additional requirements would eliminate the primary advantages for employers to participate in the state-run IRA over sponsoring a 401(k) plan. The general sentiment in the retirement industry is that the Department of Labor’s safe harbor guidance provides the state-run IRAs with an unfair advantage - one that could potentially negatively impact 401(k) plans.
What’s to come from state-run retirement plans
On May 4, Congress repealed the Department of Labor rule that permitted state-run IRAs to avoid ERISA. While California and Oregon have already stated that their programs will proceed, it will be interesting to see how this impacts states that have not yet passed legislation to implement their own state-run retirement plans. In addition, how will the federal government handle plans like the ones found in California and Oregon that do not currently comply with ERISA?
TriNet will be monitoring changes in retirement benefits laws to stay on top of the current information.
Other options for offering retirement savings benefits
Ultimately, the big winner may be the multiple employer 401(k) plan (MEP), which has been gaining momentum[KR1] as a popular option to help solve the retirement coverage issue for small employers. MEPs currently have bipartisan support in Congress.
A MEP allows two or more unrelated employers to participate in the same plan. Under this arrangement, an outside entity serves as the plan sponsor and assumes an ERISA 3(16) fiduciary role. As a 3(16) fiduciary, the plan sponsor accepts total responsibility for the operation of the 401(k) plan. These responsibilities include:
For many small employers, the MEP offers a good solution[KR2] . Smaller companies who take advantage of a MEP can offer their employees a retirement plan without having to take on the administrative responsibilities. In addition, the administrative costs are often lower in a MEP.
One challenge for a small business in respect to a MEP can be the annual nondiscrimination testing. Even if the outside entity serves as plan sponsor and assumes the fiduciary role in respect to the plan, the businesses in the MEP are tested separately for nondiscrimination purposes. One of the tests checks whether a plan is “top heavy.” A top-heavy plan is one in which the total value of the plan accounts belonging to key employees (such as owners and officers) is more than 60% of the total value of the plan assets as of the last day of the prior plan year. Top-heavy plans can trigger required contributions from the employer on behalf of non-key employees. For a lot of small businesses, this risk makes a 401(k) plan, even a MEP, prohibitive.
Another option is the payroll deductedion IRA (PDIRA). In this model, an employee establishes an IRA (either a traditional or a Roth IRA) with a financial institution. The employee then authorizes a payroll deduction for the IRA. The employer’s responsibility is to transmit the employee’s authorized deduction to the financial institution responsible for the PDIRA. The PDIRA is probably the simplest retirement arrangement available. No plan document needs to be adopted, the employer has no filing requirements, only employees make the contributions and it can be provided by any size business. A business that is facing challenges in respect to nondiscrimination testing for a 401(k) plan may wish to consider facilitating a PDIRA for its workers.
To learn more about TriNet’s MEP or PDIRA offerings, or any of our other benefits services, please contact us at 888-874-6388.
This communication is for informational purposes only; it is not legal, tax or accounting advice; and is not an offer to sell, buy or procure insurance.
This post may contain hyperlinks to websites operated by parties other than TriNet. Such hyperlinks are provided for reference only. TriNet does not control such websites and is not responsible for their content. Inclusion of such hyperlinks on TriNet.com does not necessarily imply any endorsement of the material on such websites or association with their operators.