State and National Legislation Provide Opportunities for Sponsors of Smaller Plans

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The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 aimed to expand access to retirement savings by introducing group employer plans (PEPs). One of the main purposes of PEPs is to make it easier for small employers to offer pension plans by allowing multiple unrelated employers to participate in the same pension plan. Since then, legislators have continued their efforts to close the pension plan coverage gap, particularly among small employers. The Securing a Strong Retirement Act of 2022, also known as “SECURE 2.0”, passed the House earlier this year and similar proposals are now progressing in the Senate. It aims to expand coverage by encouraging employers to adopt automatic enrollment and escalation features, expanding the range of profitable plan types available to small employers, and offering generous incentives for employers to start a new plan. of retirement.

House lays the groundwork for auto-enrollment and expanded small business support

Under the proposed auto-enrollment provision, most new 401(k) plans are expected to offer auto-enrollment with an initial rollover rate of between 3% and 10%. Coupled with an automatic escalation that caps at a deferral rate of 10% (or 15% for Safe Harbor plans), the changes offer employers the opportunity to combat the typical inertia that can prevent eligible employees from register. By automatically starting salary deferrals, newly eligible employees can start accumulating meaningful retirement savings without having to take any additional steps.

While employers have always had the option of offering automatic enrollment, many smaller employers in particular had reservations about acting on behalf of their employees without affirmative consent. However, research has consistently shown that very few plan participants choose to opt out of auto-enrollment plans. Instead, they greatly prefer the ease of having enrollment handled for them, knowing they’re on the path to retirement savings. In fact, studies show that more than 90% of participants in automatic enrollment remain in the plan, whereas the participation rate is only 60% when employees must join voluntarily, and even lower among new employees. hired.

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

eligible expenses up to $5,000 for each of the first three years. For employers with less than 50 employees, SECURE 2.0 would double the start-up tax credit, increasing the rate to 100% of eligible costs up to $5,000 for each of the first two years a plan is offered, phased in phased out over a period of five years. Employer contributions up to $1,000 per employee would also qualify for an additional tax credit.

Senate response captures momentum of SECURE 2.0

The Senate’s response to SECURE 2.0 is accompanied by 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 commissions. The essence of many SECURE 2.0 provisions appears in one form or another in the Senate versions, though they may not be as strong. The EARN Act, for example, similarly extends small business tax credits, offsetting 75% of qualified start-up costs for sponsors with 25 or fewer employees, compared to the 100% tax credit of the House version for companies with less than 50 employees.

Some of the discrepancies are more stark, with the Senate bills not going as far to impose automatic registration provisions as the House version. For plans that choose to offer automatic enrollment, however, the EARN Act offers tax credits. Both bills, meanwhile, encourage automatic re-enrollment, where prospective participants who initially opted out of their plan would periodically be subject to automatic re-enrollment. The extent and speed with which auto-enrollment continues to grow will be left to the reconciliation committee.

Safe Harbor plans are also getting some attention, with EARN introducing two new types of Safe Harbor plans. The first would apply to plans that offer certain auto-enrollment, escalation, and matching features. The second is a new type of 401(k) “starter” that has contribution limits similar to an IRA but in a 401(k) structure. These plans would be subject to non-discrimination tests. Finally, RISE & SHINE provides additional relief for smaller plans by reducing certain audit requirements for the plan group model, a so far little-used feature of the SECURE Act 2019. With this amendment, plan groups become an attractive and cost-effective option that can help expand coverage among smaller employers.

Pivotal moment for plan sponsors

SECURE 2.0 comes at an opportune time in the expansion of pension legislation. While there is unlikely to be a federal mandate in the near future, many states are advancing their own pension plan mandates. California requires employers to sponsor a retirement plan or help employees enroll in the state-administered IRA program, CalSavers. Since July 1, this initiative has expanded to include the state’s smaller businesses. Other states, such as Illinois and Oregon, have similar programs that are in various stages of implementation.

To comply with the mandates, employers can use the public plan or a private sector plan of their choice. Even if an employer decides not to use the state program, rolling out the state-based plan can help overcome employer inertia: once a small business owner already takes the time to To explore options within the terms of reference, much of the groundwork is already underway. place to then offer a traditional employer-sponsored pension plan.

Virtually all 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 behalf of the employee. For these reasons, 401(k) plans are not only more likely to be successful in building retirement savings, but also more attractive to the employer, and especially to small business owners. Employers can take advantage of higher contribution limits and take advantage of tax-deductible employer matching provisions to retain talent in a tight labor market. And while state plans are free to employers, small employers who set up a 401(k) retirement plan are eligible for significant tax incentives that offset adoption and administration costs during the first few years. years of a plan. Combined with the more robust features of a 401(k) plan, this might be enough to entice employers to sponsor a 401(k) retirement plan, rather than settling for the state option.

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

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

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