In an effort to address Californians’ growing inability to save for retirement, the state of California has implemented an initiative known as the CalSavers Retirement Savings Program, which requires businesses with five or more employees to implement a retirement plan before June 30, 2022. This initiative reinforces the notion that if employees have access to automatic retirement savings contributions made through payroll, it will create a habit of saving for retirement, thus alleviating the reliance on social security during retirement.
Employers have the option to set up a retirement plan or opt into the state-sponsored CalSavers Retirement Savings Program to avoid penalties. This article will highlight the pros and cons of setting up an employer-sponsored retirement plan vs. utilizing the state-sponsored plan.
All California businesses received a notification requiring CalSavers registration if a retirement plan is not currently in place during the past two years. Businesses that do not comply with this regulation by not implementing a retirement plan or enrolling in the CalSavers Retirement Savings Program 90 days following the June 30, 2022 deadline will be assessed a fine of $250 per eligible employee. If non-compliance persists beyond 180 days, an additional penalty of $500 per eligible employee will be assessed. It’s important to note that eligible employees are defined as employees at least age 18 and have an employee status based on California law. There isn’t a distinction between full-time and part-time employees. And the number of employees is based on your average employees throughout the previous calendar year by taking the average number of employees you report to the Employment Development Department on your previous four filings for the prior year.
Now let's take a closer look at the difference between implementing a retirement plan versus utilizing the CalSavers plan. The CalSavers plan has set a fee of .85% to .95% paid by plan participants, consisting of a .05% going to the state to administer the plan, 0.75% going to the plan administrator or custodian, and .25% to .15% depending on which investments you choose. The fee covers the following administrative costs: maintaining participant accounts, oversight of the plan investments, providing customer service, recordkeeping, online and phone services, and operating expenses of the underlying funds. Participants are automatically enrolled in the plan at a rate of 5% of gross pay up to a maximum of $6,000 after-tax annual contribution. The first $1,000 will default into a money fund, and subsequent contributions default into target-date funds based upon the employee’s age. The annual contribution rate will automatically increase 1% each year to a maximum 8% contribution rate. The employee will have 30-days to opt out of the plan. Participants can refuse plan entry or elect to contribute up to 8% of gross pay and utilize a menu of investment options ranging from BNY Mellon’s balanced core bond, global equity and money market funds, and State Street’s target-date funds. These funds have net expense ratios of .05%.
Setting up a retirement plan instead of the CalSavers plan offers favorable benefits for employees and will create a competitive advantage for the employer. The most important aspect of an employer-sponsored plan is the maximum contribution being $20,500 for 2022, with an additional $6,500 catch-up contribution for employees age 50 and older. Most W-2 employees have limited tax strategies available to them. Access to a qualified plan adds one of the most common tax mitigation strategies available. The plan may also allow pre-tax or Roth post-tax contributions. Roth contributions allow the participant to pay income taxes, resulting in tax-free investment growth for life. Pre-tax contributions allow employees to reduce their taxable income by the amount contributed to the plan, possibly lowering taxable income into another tax bracket. Each participant’s financial situation is different, and the plan provisions should provide solutions applicable to cover most situations. It is recommended to work with a financial advisor before determining how much to contribute to your employer-sponsored qualified plan to maximize the benefit of enrolling in the plan.
The fees associated with administering the plan are usually covered by the employer, which can be significant. Participants incurring the cost of the CalSavers plan reduces the rate of return of the participants' invested assets. Cutting a fraction of the fees over a 20 to 30-year time horizon can result in thousands of dollars lost. Also, the expense ratios of the investment options can be lower than the option within the CalSavers plan. Most plan providers have open-architecture investment options, which allow the plan sponsor to choose from an unlimited universe of investment funds. Rather than settling for 1 or 2 particular fund families such as State Street and BNY Mellon, the plan sponsor may choose the best performing funds by asset class.
The CalSavers program has great intentions meant to provide automatic payments into a retirement account for the benefit of employees lacking access to an employer-sponsored retirement plan. It misses the mark from a participant’s perspective by limiting annual contributions to $6,000 and restricting pre-tax contributions, which is significant in a state with the highest state tax and State And Local Tax (SALT) limitations. With the help of the IRS, the program encourages employers to implement a plan by providing a tax credit of up to $16,500 over the first three years of implementing a new retirement plan. Also, excluding defined benefit plans, an employer matching credit equal to the applicable percentage (100% in the first and second years, 75% in the third year, 50% in the fourth year, and 25% in the fifth year) of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000. The full additional credit would be limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees. This is a tremendous form of assistance to employers as employee benefits are a cornerstone in recruitment and retaining employees. Second to compensation, employee benefits are the leading cause of The Great Resignation. The current job market is grappling with costing employers on average 3 to 4 times an employee’s compensation to replace, retrain and retain.
Our team of advisors is available to help determine the best approach an employer should consider when implementing a retirement plan. We collaborate with plan custodians, auditors, and third-party administrators, providing professional support for plan sponsors and participants. We offer an un-bundled, open-architecture platform that gives clients the flexibility to customize their plan. Highline Wealth Partners works with plan sponsors to streamline their responsibilities and provide valuable retirement plan options for our client's employees.