1. Overview

Many states have enacted or are in the process of enacting or implementing legislation requiring employers to facilitate their employees’ enrollment in state-sponsored payroll deduction individual retirement account (IRA) programs.  States with active programs include New Jersey, Connecticut and California, among others.  Implementation of New York’s “Secure Choice Savings Program” is expected to begin in late 2025.

Businesses that offer their employees an employer-sponsored retirement plan are exempt from these state mandates. 

Accordingly, business owners potentially subject to a state payroll deduction mandate generally must choose between two alternatives, each of which can have significant consequences for the business owner and employees: 

• they can register with the state program and facilitate employee participation in the program, including remitting payroll deductions to the state program, or
• they can adopt their own employer-sponsored retirement plan.

  
  In making this evaluation, small employers should take into account enhanced federal income tax credits that can significantly defray the cost of adopting and initially maintaining a new employer-sponsored retirement plan.

This article will:

• summarize some common characteristics of the state mandates,
• describe and illustrate the federal small employer “new plan” tax credits as enhanced by the SECURE Act and SECURE 2.0 Act, and
• suggest some factors that employers may consider in choosing between the two alternatives. 
  

2. Characteristics of State-Mandated Payroll IRAs

Although there are differences by state, most state programs share the following general characteristics:

• covered employers are required to register with the state program and either facilitate their employees’ enrollment in the program or certify an exemption from the program;
  
  • Noncompliance may trigger monetary penalties in some states, including New York (once its program has been implemented).
• after-tax Roth IRAs are typically used (although NJ permits a traditional IRA alternative);
  
  • Due to Roth IRA income limits, many owners and higher-paid employees will be ineligible to participate in the state programs
• employees are automatically enrolled in the program at a specified contribution rate of compensation (3 percent under the New York program), unless an employee affirmatively elects otherwise;
  
  • In general, there are no exemptions for part-time or seasonal employees or owner-employees.
• employee contributions are transferred to a payroll-deduction IRA that is established under the state program in the employee’s name; and
• the state selects investment firms and investments used by the program.

The state programs exempt very small (e.g., fewer than 5 to 25 employees, depending on the state), or new, employers.

Importantly, employers that maintain their own qualified retirement plan are exempt from the state mandates. 

3. Enhanced Small Employer New Plan Tax Credits 

A. Description of Tax Credits

The SECURE Act and SECURE 2.0 Act substantially enhanced the tax credits available for small employers that adopt a new tax-qualified retirement plan.  These tax credits include:

• Startup Cost Credit
• Contribution Credit
• Auto-Enrollment Credit

An employer qualifies as a small employer if it has 100 or fewer employees with compensation of $5,000 or more in the preceding year.  Small employers must also satisfy the following two conditions to be eligible for the Startup Cost Credit and the Contribution Credit:

• have at least one non-highly compensated employee (NHCE)[1] who is eligible to participate in the new plan, and
• have not maintained another qualified employer plan[2] for substantially the same employees during the preceding three years.

The three tax credits are summarized in the table below.

While an employer cannot claim a tax deduction for the portion of these costs taken as a tax credit, a tax credit is more valuable than a tax deduction.  When claimed as a tax credit, 100 percent of the applicable cost is a dollar-for-dollar reduction in the employer’s tax liability. 

An employer that adopted a new plan within the last five years can claim the relevant tax credits for whatever years remain available.

Eligible small employers use Internal Revenue Service Form 8881 (Parts I and II) to claim these tax credits.

B. Illustration of Tax Credits

Especially when used in combination, these credits can generate substantial tax savings over a period of years for an employer that adopts a new plan.  These tax savings may offset some or all of the costs of establishing and maintaining a new plan as illustrated by the following simple example.

Harold is the owner of Hoppy Harold’s, a popular craft brewery and brew pub located in Connecticut.  Hoppy Harold’s has 20 staff employees, none of whom have annual compensation over $105,000.  Harold heard about the CT payroll IRA mandate and the enhanced new plan tax credits.  Harold wants to adopt a new 401(k) profit sharing plan beginning in 2025, using the tax credits, to opt out of the CT mandate.  The plan will include a “safe harbor” employer contribution to facilitate the plan’s compliance with federal income tax rules.  This means that Hoppy Harold’s will make an annual contribution to the plan equal to 3 percent of each eligible employee’s compensation. 

* The availability of additional profit sharing allocations for Harold is dependent on the employee demographics of Hoppy Harold’s.

** This amount is the sum of the following amounts:  401(k), Safe Harbor and Profit Sharing.

This simple example illustrates the following:

• In addition to satisfying the CT state mandate exemption, Harold is able to save a substantial amount for himself ($62,500 in this example) in a tax advantaged way.  Net of the contribution tax credits, 71% of all amounts Harold contributes to the plan in the first 4 years goes to his benefit (65% in the fifth year).
• Any costs Harold incurs to set up and maintain the plan for the first 3 years are directly offset, up to $5,500 per year ($5,000 start-up credit plus $500 auto-enrollment credit).
• By establishing a new qualified retirement plan, Hoppy Harold’s can claim a total of $107,750 in related tax credits over the next 5 years.
  

4. Comparison of State Mandates and Employer-Sponsored Qualified Retirement Plans

In navigating the increasingly complex retirement savings plan landscape, employers need to carefully and proactively evaluate their alternatives.  Here are some factors employers should consider in deciding whether to adopt a qualified retirement plan or default into a state-mandated IRA program:

5. Conclusions

The retirement savings plan environment is more complicated than ever.  Until recent years, employers could delay or avoid making retirement savings plan decisions for their businesses with no real consequences other than losing out on a valuable annual tax deduction.  With the advent of state-based payroll IRA mandates, “no decision” may trigger participation in an applicable state-based program.  Successful employers may find that offering a qualified retirement plan, with the help of the new enhanced tax credits described in this article, is a more beneficial strategy across the spectrum of tax, human resources and other business considerations.  

Andrew E. Roth, JD, LLM (taxation), is a partner of Danziger & Markhoff LLP with more than 35 years of experience as an ERISA attorney. Andy is a frequent lecturer in the areas of pension, profit-sharing, and employee benefits law. He has substantial experience in designing and implementing qualified plans for business owners that maximize deductible contributions on their behalf. He is admitted to practice before the U.S. Tax Court, the Federal District Courts for the Southern and Eastern Districts of New York, and is a member of the New York State Bar Association. He can be reached at (914) 220-8033 or ARoth@dmlawyers.com. 

Mark T. Hamilton, JD, LLM (taxation), is a partner of Danziger & Markhoff LLP with more than 30 years of experience as an employee benefits and executive compensation attorney.  He is admitted to practice in New York and is a member of the American Bar Association and the New York State Bar Association.  He can be reached at (914) 220-8038 or MHamilton@dmlawyers.com