Annual surveys consistently show that a fair number of Americans are not prepared for retirement. Indeed, A General Accounting Office report issued in March 2019 showed that 48% of all households headed by someone 55 years old or older had no retirement savings set aside.
In response to what appears to be a serious problem, a small handful of states have launched their own retirement plans. These plans are available to private sector workers who do not have access to employer-sponsored plans. It seems like a good idea until you dig into the details, at which point you might wonder if state-sponsored retirement plans are necessary.
There are not many state-sponsored plans available right now. But the handful that do exist do not offer anything that employees cannot do for themselves – with the possible exception of automatic payroll deductions. If a lack of automatic deductions is the only thing stopping someone from saving for retirement, then a state-sponsored plan does the trick. Otherwise, these plans seem to be nothing more than a duplication of services.
How Company-Sponsored Plans Work
A typical company-sponsored retirement plan is structured as a 401(k), according to Dallas-based BenefitMall. A 401(k) plan is a defined contribution plan that pays future benefits based on the performance of the plan over time. Plan managers invest member contributions with the ultimate goal of returning higher value through capital growth.
In a practical sense, 401(k) plans are simple to understand. Employees contribute to their plans through payroll deductions. Employers often contribute something too, but they are not necessarily required to. Once an employee becomes fully vested in the company plan, all the funds in his or her account are 100% owned by that employee. Disbursements are made from the account during retirement.
How State-Sponsored Plans Work
Though it is hard to say for sure, it appears as though all the state-sponsored plans are structured as Roth IRAs. A Roth IRA is an individual retirement account that is funded with after-tax dollars. In other words, an employee pays all the required income taxes through payroll deductions. After those taxes are assessed, further deductions are utilized as contributions to the IRA.
Just like with an employer-sponsored plan, payroll deductions for state-sponsored plans are automatic. Once employees sign up, they do not have to remember to do anything else. They don’t have to check on their accounts (although they should) or run deposits down to the bank.
To the extent that automatic payroll deductions encourage people to save for retirement, state-sponsored plans work. But employees can open their own Roth IRAs without the state’s help. And if they don’t like how a Roth IRA is structured, they can open a standard IRA instead. They can make their own contributions as they see fit.
Providing the Proper Motivation
At the end of the day, state-sponsored retirement plans really aren’t necessary. They don’t accomplish anything that employees could not otherwise do for themselves. So why set them up? Because they provide motivation. That really is the key selling point.
Enrolling in a state-sponsored retirement plan requires a one-time decision. After that, everything is handled by the payroll department without any employee input required. On the other hand, setting up an IRA outside of a state-sponsored plan requires employees to become active participants.
Only a small number of states offer their own private sector retirement plans right now. But if things go well, it is not beyond the realm of possibility to see the concept spread. Who knows? Five years from now every state in the union might have a plan in place.
