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More States Are Embracing Employer-Sponsored IRAs

Americans younger than 59½ will have a second chance to take money from their retirement accounts without paying a tax penalty — if they meet a new condition.

Employees who don’t have access to an employer-sponsored retirement plan such as a 401(k) can open their own Individual Retirement Accounts (IRA). Most don’t, though, but some states are now requiring employers to open an IRA for their employees.

The National Institute on Retirement Security (NIRS) reports that nearly 40 million people — representing 45 percent of working-age households — have no 401(k) or IRA plans. The Center for Retirement Research at Boston College discovered that roughly a third of these people would be primarily reliant on Social Security benefits for income, with many also having to use a safety net program such as Medicaid.

A retirement account is especially beneficial to low-income workers. According to the Schwartz Center for Economic Policy Analysis at the New School in New York, while about half of workers aged 25 to 64 in the top 10 percent of earners have access to an employer-sponsored retirement plan, the number drops to 23 percent for the bottom 50 percent of earners.

Politicians discussed the possibility of a federal automatic IRA plan after a 2007 Brookings Institution report about the potential for universal retirement security was released. When it became apparent that no federal legislation would be approved, eight states passed legislation starting in 2017 to require employers who do not offer a retirement plan to automatically enroll workers in a Roth IRA and more states have followed.

Currently, California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, Oregon, and Washington have mandated programs and Maryland will start signing up employers this year. New York and Vermont have voluntary programs.

The following states also have introduced mandated Roth IRAs: Arizona, Colorado, Indiana, Iowa, Kentucky, Louisiana, Maine, Minnesota, Nebraska, New Hampshire, North Carolina, North Dakota, Ohio, Rhode Island, Utah, Virginia, West Virginia, and Wisconsin.

Some of these plans assess penalties for employer non-compliance. For instance, in California, Illinois and Oregon, employers that do not offer a retirement savings program like a 401(k) but have more than a certain number of employees must enroll with the state program by a deadline or face a fine. In California that fine is $250 for each employee.

Roth IRAs are funded with after-tax dollars and typically allow for withdrawals of contributions without penalties. This is extremely important if someone has an emergency medical expense. These funds also are portable, meaning that the employee can keep putting money into the account even if they change jobs.

The basic features in each of the mandatory state programs include:

  • Employers who do not offer a tax-qualified retirement plan must automatically enroll their employees in a private sector payroll deduction Roth IRA.
  • Employees may at any time opt out or choose a higher or lower contribution rate than the default of 3 or 5 percent, although California’s rate is 8 percent.
  • Employers cannot provide matching funds since federal guidelines prevent anyone other than the individual account owner from contributing to the accounts.
  • Employers have no fiduciary responsibilities since the state contracts for a private sector record-keeper/third-party administrator (TPA). The TPA manages the program and contracts with private sector asset managers to make low-risk investments.

One concern some observers have is that employers could decide it’s enough to offer only Roth IRAs and not offer the kinds of IRAs that include employer contributions.