How State Retirement Plans Benefit Employers and Employees

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Across America, many workers need access to retirement savings options. This is especially true for employees of smaller companies. To help address this problem, some states have enacted legislation requiring employers to offer a state-mandated retirement plan. Learn more about these plans and the benefits of a state retirement playthrough this detailed Article.

Tax Breaks

While it’s still too early to know how well state-run programs will perform, it’s clear that they can offer some benefits. First and foremost, they help more Americans save for retirement, which is critical since the national savings gap — that gap between income needed in retirement and available savings — is widening.

For example, many states provide tax breaks that make saving through a state program less expensive than keeping in a private employee’s plan like a 401(k). Some of these tax breaks are even available for retirees.

For example, New York provides a property tax exemption for seniors, which helps lower their housing costs. One of the critical benefits of a state retirement plan is that contributions are typically pre-tax for participating employees. In 2016, 83 percent of private industry workers and 87 percent of state and local government workers had their contributions to the state retirement plan taken out of paychecks before being taxed.

State programs can be an excellent way for employers to satisfy mandatory retirement laws. Depending on your business, however, consider alternatives to these state-sponsored options.

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Benefits of Retirement Plans

Employers and employees must understand their options as the retirement savings landscape shifts. A growing number of states have mandated retirement plans that require employers to offer a specific type of plan or face a fine.

In 2018, 83 percent of state and local government employees participated in a defined benefit (DB) pension plan or had access to one. DB pensions provide retirees with a steady stream of periodic payments over their lifetimes, based on a formula that may

include a portion of their final average salary, years of service, and age at retirement.

Many DB plans also include cost-of-living adjustments to keep the benefits from depreciating over time. States also sponsor more than 5,500 local government retirement systems that cover active public employees and former workers who have earned benefits but have yet to receive payments.

Locally administered plans account for only about 60 percent of assets and members, compared to 82 percent in state-administered systems. In the private sector, defined contribution (DC) plans are the most popular, with about 57 percent of all full-time workers participating in 401(k) or similar arrangements in 2018. However, only 16 percent of private-sector employees participate in traditional pensions, which pay annuity-style distributions based on a fixed percentage of the final average salary for a defined service period.

Participation

In the wake of a retirement landscape that has seen pensions disappear from the private sector and Social Security appear fragile, many states are introducing new state-sponsored programs. These programs are designed to help employees save for their future and can often be more cost-effective than individual plans.

Most state and local government workers are enrolled in defined benefit (DB) pension plans. These traditionally defined benefit plans provide retirement benefits based on a formula that includes a person’s years of service, age when they retire, and final compensation (average salary over a career).

Most of these plans also have automatic cost-of-living adjustments, which maintain the purchasing power of an employee’s retirement income. State-mandated plans, such as California’s CalSavers, are 401(k)-style-defined contribution plans allowing employees to automatically defer a percentage of their paycheck into their accounts.

This money is then invested in mutual funds selected by the employee, who can change their investment allocation anytime. Unlike most private-sector retirement savings plans, these investments are typically made on an after-tax basis.

For employees in a state that requires participation in a state-run program, such as New York’s Secure Choice Savings Program, the employer must offer a qualified retirement plan that is at least as good or better than the state’s program. Employers with less than ten full-time employees in New York City who don’t offer a qualifying retirement plan are not required to participate in the program.

Investment Options for Retirement

Many states have passed laws requiring private-sector businesses of a specific size to automatically enroll their employees into a state-sponsored retirement plan or sponsor a qualifying private plan. For example, California’s CalSavers program, which launches in 2023, will require businesses of at least five employees to participate or offer a qualifying retirement plan alternative.

These programs are similar to traditional pensions in that they are primarily funded through contributions from employers and employees. But they also benefit from investments. The annual investment income earned by these funds helps offset the actuarial estimates of future liabilities that state and local governments must make to cover current and past unfunded worker benefits.

The investment options offered under these state-run plans can vary, but they are generally designed to be simple and user-friendly. For example, customers can select from a one-step investing program or invest their contributions into the WSIB Total Allocation Portfolio, which is invested in stocks and bonds managed by the Washington State Investment Board.

Small business owners need to understand the details of these state-run programs. Doing so can help them decide whether a state-run option is the best way to meet their needs and help employees save for retirement.