On Pointe – 401(k) Edition
What is with the Mystery of State Mandated Retirement Plans? Are they like a “box of chocolates and you don’t know what you’re going to get!?!?”
Yes, I am having a little fun with this On Pointe. Why not, right!?!?
But the topics surrounding State Mandated (or Sponsored) Retirement Plans are a bit more serious…
There is a mystery about what the plans are, how effective, and what is the actual offering. We’ve been researching these plans for months and some still lack clarity. The other confusing part is they vary from state to state. Yet, in general, these state plans appear like 529 College Plans, SIMPLE IRAs, and Roth IRAs.
And you know how there is always that mystery “chocolate” in the box? There is a real twist towards the end of this On Pointe. Specifically with one of our comparisons that defeats the purpose for a business to offer a plan… can you guess what that is?
Let’s start with some comparisons you may be familiar with.
Are State Mandated Retirement Plans more like 529 Plans? Kind of… maybe?
529 Plans are sponsored by the states. While it may seem odd to compare a college savings plan with retirement plans, there is a good reason. Many states modeled their retirement plans with similar aspects to 529s.
A quick refresher on the 529 College Savings plans… they enable people to save money for a beneficiary and pay for education expenses. You can withdraw funds tax-free to cover nearly every type of college expense.
So, how are 529’s College Savings Plans compared to State-Sponsored Retirement Plans?
First, both vehicles can provide tax-deferred savings growth. But one difference is that 529 has higher contribution limits. And they have the ability for accelerated gift tax exclusions for even more savings. Plus, there are possible state tax credits available with 529s.
Other similarities include being sponsored by a state and they use a single investment manager.
One stark difference between 529 Plans is you can invest in other state plans. So, if you have a favorite fund company or investment manager in another state, you can open your 529 in the same state.
This is not the case with State Mandated Retirement Plans. Your only option is what your state is offering you. Unless you start your own retirement plan…
2 other differences are higher contribution options and possibly better tax savings with 529s. Unfortunately, the state retirement plans offer no tax credits or employer contributions to reduce some tax burdens.
Ok, but what about comparing it to actual retirement plans?
Let’s try the SIMPLE IRA or the Savings Incentive Match Plan for Employees…
A quick refresher on SIMPLEs… they allow employees and employers to contribute to traditional IRAs set up for employees.
Yes, both SIMPLEs and State Mandated plans have tax-deferred growth, but SIMPLEs also offer pre-tax savings. State plans are mostly after-tax savings.
Also, SIMPLEs allow for employer contributions. Not so with State plans. Why is this important? Employer contributions offer favorable tax treatment for businesses. This is a win-win for employers and employees.
Contribution limits? Most states max out at $6k while a SIMPLE is $13,500. If you are serious about retirement, you’ll need the ability to create more tax-deferred savings. While I support people saving what they can, $6k (or $7,000 for people aged 50 or older) is too limited to build a robust retirement.
Another advantage of SIMPLE IRAs is you have much more flexibility with investments. If your plan is set up as a brokerage account, you’ll have access to most investments. At least as much access per your broker-dealer. You can also set up SIMPLEs through your favorite fund company. Best yet, you can move the plan to any other fund company should you need to.
What are the comparisons to Roth IRAs?
The State retirement plans are also closely correlated to Roth IRAs. Similar contribution amounts… $6k. Both are post-tax only… And most important, both have employee income limits.
WHAT? Yes, employees making more than $135k a year will not be able to have a Roth IRA or a state plan. Higher-wage employees will HAVE to opt out and find another alternative for their savings.
This is where the state plans have some real flaws. Especially as it relates to a retirement plan being a true benefit for company employees and employers.
The twist is you should not limit which employees can participate based on income. As an employer, you’re offering a plan to attract talent. It makes it exceedingly difficult to attract executive-level talent if they’re excluded from the retirement plan. This is part of the reason businesses go through the time and expense to start plans!
What about savings? Higher-wage employees and employers will need higher savings rates for retirement to replace current income. I might argue that all employees should have the option for higher savings. These state plans limit savers to $6k ($7,000 for people aged 50 and over).
What about investment options? Like the SIMPLE, Roth IRAs can be opened as a brokerage account or through a fund company. Greater flexibility and options. This is not the case with the State Plans. Some plans offer only 4 choices for investing! This is insufficient…
The good news is you’re not limited to your state’s retirement plan offering. You can set up SIMPLE IRAs, SEP IRAs, and my favorite (because of customization) 401(k).
A positive with these State Mandated Retirement Plans is businesses will offer a plan. The best part is businesses are not limited to their state’s plan. Businesses do have choices and we can help evaluate which plan is best for you.
Now you can tackle that box of chocolates knowing what’s on the inside, right?!?!?
Don’t worry, we’ll be writing more about these State Mandated Retirement Plans!
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