Small Business Owners Could Be Required to Offer IRAs

William Freedman

Topics: Retirement

Last week, we took a look at how House Resolution 5376 -- known as the “Build Back Better Act” or the “reconciliation bill” -- might affect self-directed IRAs. (Short answer: negatively.) But that’s not the only concern readers of this space might have about this legislation.


That’s why we felt the need to follow up today with a look at one more codicil in the 2,468-pager. If the Democratic majority on the House Ways and Means Committee has its druthers, there could be a mandate requiring employers to offer individual retirement accounts. You read that right: Not an incentive to offer 401(k)s -- a requirement to offer IRAs.


Where we’re at

We outlined H.R. 5376 as best we could last week, but it might be helpful to recap, especially since there’s been some incremental change as Democratic moderates and progressives appear to be tiring of their tug-o’-war over the bill and coming to some sort of confluence.


The bill that finally gets introduced for a floor vote is likely to call for around $2 trillion in new spending, that is, somewhere in the middle between what the Biden administration suggested and what the moderates endorse. It would then head to the Senate, where it needs 51 votes. Its most likely path to passage would be a party-line vote, with all Republicans voting against and all Democrats voting for, including a tie-breaker from Vice President Kamala Harris.


If you're looking at the PDF version of the bill, skip down to page 1321. If not, here's the TLDR version of the part of "Subtitle B -- Retirement, Part 1 -- Automatic Contribution Plans and Arrangements," which caught our attention:


  • Effective January 1, 2023, businesses with more than five employees and don’t offer any other ERISA-qualified plan must automatically channel 6% of the pay of each participating employee to a new, employer-sponsored IRA.
  • The match requirement will be stair-stepped up annually until it reaches 10%.
  • This applies to virtually all employees over 21 with two years of service unless they opt-out.
  • These IRAs will be Roth by default, although the employee can elect to convert it to a traditional plan.
  • Employers can take advantage of a special tax credit to cover the expense of setting up the plans.
  • The Treasury Department reserves the right to impose further regulations and advisory notes once the law is in effect.


Failure to comply carries a tax penalty of $10 per day per employee through the non-compliance period -- adjusted for inflation, of course. But don't worry. The tax will be waived if the error is corrected within 9½ months. And if you can prove your error was due to ignorance rather than contempt, the maximum penalty tops out at $500,000 per year.

(One might quibble that $10 per day is a fine, not a tax, but only by using the t-word instead of the f-word can this provision be included in a reconciliation bill.)


What we’re hearing

We should have seen this coming.

“In some respects, this would be similar to the autoenrollment plans now in operation or under implementation in Oregon, California, Illinois, and elsewhere,” according to actuary Elizabeth Bauer. "But there are crucial differences. In the first place, under the new federal mandate, employers would be obliged to select a specific IRA in which to enroll their employees, rather than merely forwarding payroll deductions to the state. Second, the various state programs have had extended phase-ins; the federal mandate applies to all employers with five or more employees from day one. Third, the program requires employers [to] choose ...only those [IRAs] in which there is an option to convert the account balance into an annuity at retirement."


It should be noted that GOP members of Congress are having none of it.


“Main Street now faces an onerous new mandate from Washington and a tax penalty if you don’t comply,” stated Rep. Kevin Brady (R-Texas), the ranking Republican on Ways and Means. “Small business owners know this is yet another, or feels like another, war on work.”


Still, according to Forbes personal finance writer Ashlea Ebeling, this section’s goal is to "create 62 million new retirement savers and would add an additional $7 trillion in retirement savings over a 10-year period. Nearly all—98%—of these new savers would be folks who earn less than $100,000 per year."


She notes that employees who are offered a plan at work are 12 times more likely to save for retirement than those who do not, so it’s a powerful incentive. Even so, there are those who question whether automatic enrollment is the best option. There’s some concern that whatever benefit is realized by this enforced thrift would be offset by the cost of greater debt. That concern might be unwarranted.


Granted, not everybody should be saving 10%, but a Harvard University-National Bureau of Economic Research study looked into it. Researchers note that “when the U.S. Army began automatically enrolling newly hired civilian employees into the Thrift Savings Plan ..., automatic enrollment increases cumulative contributions to the plan by 4.1% of annual salary, but we find little evidence of increased financial distress.”


Credit scores, delinquencies, and overall debt load remained constant.


At the close

There's little doubt -- at least to us -- that this mandate will be accretive to employees, at least in the short term. H.R. 5376 even includes some free cash to them, so they have a stake with which to open up their employer-sponsored Roth IRAs.


So why must they opt out? If it's such a good deal, shouldn't they have to opt-in?


Another sticking point is the mandate. After all, there’s no mandate to sponsor a 401(k), but most medium-sized to mega-cap companies offer them because you can’t attract decent talent without one. Maybe a positive incentive rather than a tax penalty would do the trick in convincing smaller companies to follow suit.


While it’s fortunate that the bill’s authors understand that it’s expensive to set up a retirement plan, they chose a tax credit for a solution. And while that’s one possible way to defray the cost, it seems inefficient for every five-employee storefront in America to have an IRA set up for each worker. There are already ERISA-qualified multiple employer plans, so why not offer an incentive for these small firms to join together to offer one of those?


For that matter, why not just increase both the FICA tax and the Social Security benefit by 10%? We’re not advocating this, but it would be a whole lot less of an administrative lift.


Finally, there’s the whole macroeconomic dimension. The Federal Reserve will need to be quite precise with its monetary policy going forward to ensure that the fiscal policy now under consideration doesn’t lead to higher prices once all those new IRA holders start taking distributions. We want to support thrift as a virtue, but nothing can erode savings worse than inflation.

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