State, national legislation provide opportunities for smaller plan sponsors

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 aimed to expand access to retirement saving by introducing Pooled Employer Plans (PEPs). One of the main goals of PEPs is to make it easier for small employers to offer retirement plans by allowing multiple unrelated employers to participate in the same retirement plan. Since then, legislators have continued their efforts to close the retirement plan coverage gap, especially among smaller employers. The Securing a Strong Retirement Act of 2022, also known as “SECURE 2.0,” passed in the House earlier this year with similar proposals currently progressing through the Senate. It seeks to expand coverage by encouraging employers to adopt automatic enrollment and escalation features, by expanding the range of cost-effective plan types available to small employers and by offering generous incentives to employers to start a new retirement plan.

House lays groundwork for auto-enrollment, expanded aid for small businesses

Under the proposed automatic enrollment provision, most new 401(k) plans would have to offer automatic enrollment with an initial deferral rate between 3% and 10%. Coupled with automatic escalation that tops out at a 10% deferral rate (or 15% for safe harbor plans), the changes present an opportunity for employers to combat the typical inertia that can keep eligible employees from enrolling. By automatically starting salary deferrals, newly eligible employees can begin to accumulate meaningful retirement savings without needing to take additional action. 

While employers have always had the option to offer automatic enrollment, many small employers in particular had reservations about acting on their employees’ behalf without affirmative consent. However, research has consistently shown that very few plan participants choose to opt out of auto-enrollment plans. Rather, they widely prefer the ease of having enrollment handled for them, knowing they are being put on a path to retirement savings. In fact, studies show that over 90% of automatically enrolled participants stay in the plan, whereas the participation rate is only 60% when employees have to opt in voluntarily, and even lower among newly hired employees. 

In addition to requiring automatic enrollment for new plans, the House version also offers new incentives for employers to offer a plan. Employers with fewer than 100 employees that start up a new retirement plan are already eligible for a tax credit that covers 50% of  

 qualified costs up to $5,000 for each of the first three years. For employers with fewer than 50 employees, SECURE 2.0 would double the startup tax credit, raising the rate to 100% of qualified costs up to $5,000 for each of the first two years of offering a plan, phasing out gradually over a period of five years. Employer contributions up to a limit of $1,000 per employee would also be eligible for an additional tax credit.

Senate response captures momentum of SECURE 2.0

The Senate’s response to SECURE 2.0 comes with the introduction of two new bills, the Enhancing American Retirement Now (EARN) Act and the Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg (RISE & SHINE) Act, which were recently approved by their respective committees. The essence of many SECURE 2.0 provisions appear in some form or another in the Senate versions, though they may not be as robust. The EARN Act, for example, similarly expands small business tax credits, offsetting 75% of qualified startup costs for sponsors with 25 employees or fewer, compared to the House version’s 100% tax credit for companies with fewer than 50 employees. 

Some discrepancies are more striking, with the Senate bills not going so far to mandate automatic enrollment provisions as the House version. For plans that do choose to feature automatic enrollment, though, the EARN Act offers tax credits. Both bills, meanwhile, encourage automatic re-enrollment, where would-be participants who had initially opted out of their plan would periodically be subject to automatic re-enrollment. How much and how rapidly automatic enrollment will continue to expand will be left to the reconciliation committee.

Safe harbor plans also receive attention, with EARN introducing two new safe harbor plan types. The first would apply to plans that provide certain automatic enrollment, escalation and matching features. The second is a new type of “starter” 401(k) that has contribution limits similar to an IRA but in a 401(k) structure. These plans would not be subject to nondiscrimination testing. Finally, RISE & SHINE offers additional relief for smaller plans by lessening some audit requirements for the Group of Plans model, a so far little utilized feature of the 2019 SECURE Act. With this amendment, Groups of Plans become an attractive, cost-effective option that can help to expand coverage among small employers.

Crucial timing for plan sponsors

SECURE 2.0 comes at a timely juncture in the expansion of retirement plan legislation. While there is unlikely to be a federal mandate in the near future, many states are pushing forward with their own retirement plan mandates. California requires employers to sponsor a retirement plan or help employees enroll in the state-administered IRA program, CalSavers. As of July 1, this initiative has expanded to include the state’s smallest businesses. Other states, like Illinois and Oregon, have similar programs that are in various stages of implementation. 

To comply with the mandates, employers can use the state-run plan or a private sector plan of their choice. Even if an employer decides not to use the state program, the rollout of the state-based plan can help overcome employer inertia: Once a small business owner is already taking the time to explore options under the mandate, much of the groundwork is already in place to then offer a traditional employer-sponsored retirement plan.

Virtually all the state plans are IRAs. Compared to an employer-sponsored 401(k) plan, IRAs have lower annual contribution limits. They also do not allow employers to make contributions on the employee’s behalf. For these reasons, 401(k) plans are not only more likely to be more successful at building retirement savings, but more attractive to the employer as well, and especially for small business owners. The employers can take advantage of the higher contribution limits, and leverage tax deductible employer matching provisions to retain talent in a tight labor market. And although the state plans are free for employers to use, small employers who set up a 401(k) retirement plan are eligible for significant tax incentives that offset adoption and administration costs during the initial years  of a plan. Combined with the more robust features of a 401(k) plan, this could be enough to nudge employers into sponsoring a 401(k) retirement plan, rather than settling for the state option. 

Even in the absence of a federal mandate, these forces can be expected to increase as more states roll out their mandates, or potentially pass new ones, spurring employers to consider the role retirement plans play in their compensation strategy. While some employers will be content with the state plan, many will opt for private sector solutions that offer more design features and other advantages. In states without mandates, meanwhile, the potential passage of comprehensive retirement plan legislation later this year would usher in generous incentives for employers to adopt a plan.

Catherine Reilly is the Director of Retirement Solutions at Smart. Prior, Catherine was Global Head of Research for the defined contribution team at State Street, responsible for thought leadership and strategic development. Previously, she was Chief Economist of Pohjola Asset Management in Finland ($40 billion assets under management) and a Management Consultant at McKinsey & Co., Inc in the Helsinki office. Catherine is a CFA charter holder.