As a small business, it is up to you to choose to have a retirement plan or must you do so? The legal answer is that it depends on where you’re located. The practical answer is that in today’s tight job market, you need to have a plan to attract and retain valued employees. Understand what you may or must do when it comes to retirement plans for your employees—and you as the owner.
State mandates for retirement plans
While the federal government doesn’t (as yet) require you to have a retirement plan for your staff, an increasing number of states have mandated that for-profit companies do so. Have your own plan or enroll employees in the state plan. The failure to do so can result in penalties. Currently, state retirement programs are active in California, Illinois, Oregon, and Washington, with some poised to start later this year. Programs have been enacted in other states and cities and legislation is under consideration in many other locations. The rules vary considerably from state to state. For example, California’s mandate—which is active—applies to employers with 5 or more employees. New Jersey’s mandate—which is pending—applies to employers with 25 or more employees.
Employers don’t make contributions on behalf of employees. For most states, employees make their own after-tax contributions to state-run Roth IRAs unless they opt out of participation. In Massachusetts, contributions are made to a state 401(k) multiple employer plan (explained later). The employer’s responsibility is to enroll employees in the state plan, withhold employee contributions, and deposit the funds in the plans.
If you’re in one state but your employees work remotely from another state, it appears you must follow the state mandate where the employees are located. Because state mandates are so new, all of the wrinkles haven’t been ironed out yet.
Choosing your own retirement plan
You escape the mandate in all states if you have your own qualified retirement plan for employees. The type of plan is up to you. Most small businesses use a 401(k) plan or a SIMPLE IRA because the bulk of the funding is on employees’ shoulders. The IRS has a booklet with a side-by-side comparison of all types of retirement plans.
Having a retirement plan involves costs and responsibilities. For example, as a recent U.S. Supreme Court decision noted, an employer sponsoring a 401(k) plan has “a duty to monitor all plan investments and remove any imprudent ones." The DOL has a guide on fiduciary responsibilities.
Shifting the retirement plan's administrative burden
Small businesses may shy away from retirement plans not only because of the cost of contributions, but also because of the administrative burden. Payroll adjustments must be made to ensure that employee contributions are withheld from pay. Employee contributions must be timely added to the plan. For example, the Department of Labor requires that the employer deposit employees’ elective deferrals (employees’ contributions) to the plan as soon as the employer can, but no later than the 15th business day of the following month; there’s a 7-day safe harbor for plans with fewer than 100 participants. Annual information returns must be usually filed. And through all this, the employer usually has fiduciary responsibility; if something goes wrong, the employer is on the hook.
Small businesses may use a pooled employer plan (PEP), which is a 401(k) plan in which multiple employers are put together and the plan managed by a professional administrator. (This is a type of multiple employer plan—MEP—in which two or more employers put their employees into a single plan.) The administrator of the PEP, as the term implies, assumes the administrative burden of managing things and relieving the employer of most of the fiduciary duty. While employers pay for this administration, the costs are lower than what they might otherwise have to pay because of economies of scale. Because PEPs are new (registration only started in 2021), they’re not readily available, but are expected to become more widespread. Currently, Paychex has a PEP for which it acts as the administrator.
Small businesses may find alternatives to PEPs that reduce administrative costs and burdens. For example, ADP 401k Essential offers investment fiduciary support and administrative fiduciary oversight with costs competitive with PEPs.
If your state mandates that you have a retirement plan for employees and you’re subject to the mandate (i.e., not exempt), be sure to pay attention to enrollment dates and other rules so you avoid penalties. Better yet, consider setting up your own retirement plan or using a PEP for which you can deduct employer contributions and may also qualify for federal tax credits for this action. Confused? Talk with your CPA or other benefits adviser.