Update: Due to COVID-19, the deadline for employers with more than 100 lives was extended to September 30, 2020.
The State of California has instituted a mandatory payroll deduction IRA program known as CalSavers which will be effective in 2020.
What is CalSavers?
CalSavers is a state-run retirement plan for employers who do not offer an employer-sponsored retirement plan to their employees. With CalSavers, employers facilitate payroll deductions from their employees’ paychecks to send to the state-sponsored plan.
The payroll deductions for employees begin at 5% of their gross pay. These amounts are subject to automatic increases of 1% per year until the savings rate reaches a maximum of 8%. The deductions occur after tax, and the contributions are sent to a Roth IRA administered by CalSavers. Employees may also change their contribution percentage or opt out of the program entirely.
Roth IRAs are after-tax contribution Individual Retirement Accounts. An employee can make a withdrawal from a Roth IRA at any time. The contributions withdrawn are tax-free because they were contributed on an after-tax basis. However, the earnings are subject to income tax and additional penalty taxes unless the withdrawal takes place after the employee is age 59-1/2 and the Roth IRA was initiated at least 5 years before the withdrawal. Because the investment earnings in a Roth IRA grow on a tax-deferred basis, the ability to take a tax-free withdrawal once these conditions are met provides a savings advantage when compared with other after-tax savings investments.
The standard contribution limit for a Roth IRA is $6,000, with an additional $1,000 in contributions available for employees over the age of 50. However, the IRS also sets income eligibility rules for Roth IRAs each year. For single employees who earn more than $122,000, the maximum contribution amount is reduced according to their gross income. For married employees, the maximum contribution is also gradually reduced once their combined gross income reaches $193,000. Eligibility to contribute to a Roth IRA is phased out completely for single employees earning $137,000 or more and married employees earning $203,000 or more. Employees with income over these limits will need to proactively opt out of the program.
CalSavers maintains and manages the Roth IRA accounts and investments. The employer has no responsibility for the accounts. Their responsibility is to:
- Register and provide employee data to CalSavers.
- Make automatic payroll deductions and send them to CalSavers.
- Keep track of the employee contributions.
What are the investment options?
The first $1,000 for each employee is automatically invested in the CalSavers Money Market Fund. Savings over $1,000 are automatically invested in the CalSavers Target Retirement Funds based on when the employee will meet the retirement age of 65. These funds are invested in a mix of stock and bond funds, with a greater allocation to stocks for younger employees. The investment mix of the funds gradually shifts from stock to bonds as employees approach age 65.
CalSavers also offers both bond and equity funds for employees who want to take a more active role in their investments under the plan.
State Street provides the CalSavers investment funds. Ascensus College Savings Recordkeeping Services, LLC is the program administrator. Annualized expenses range from 0.92% to 0.84% of assets depending upon the investment fund.
What do California employers need to do now?
CalSavers will contact employers several months before program participation becomes mandatory. At that time, employers that already offer a retirement plan can certify that they are exempt from the program.
To be exempt from the state-run plan, an employer must sponsor one of the following types of retirement plans:
- 401(k), Profit Sharing or Pension Plan qualified under section 401(a) of the Internal Revenue Code
- Qualified Annuity Plan under section 403(a)
- Tax Sheltered 403(b) plan under section 403(b)
- Simplified Employee Pension (SEP) Plan under section 408(k)
- Simple IRA plan under section 408(p)
- Deferred compensation plan under section 457(b)
There currently isn’t a mechanism for employers who sponsor a retirement plan to proactively advise CalSavers that they should be exempt.
CalSavers is in a pilot phase with a select group of employers before it becomes a state-wide requirement. This phase concludes on June 30, 2020, at which time employers without existing plans must take part according to the following timeline:
- September 30, 2020 – Employers with more than 100 employees
- June 30, 2021 – Employers with more than 50 employees
- June 30, 2022 – Employers with more than 5 employees
How can retirement plans benefit owners and employees?
The CalSavers program will provide employees the opportunity to accumulate retirement savings. Business owners who don’t already have a retirement plan should consider adopting a plan of their own before defaulting into the program.
A company-sponsored plan provides distinct advantages for a business owner or executive’s own retirement savings. They allow for special testing to provide greater contributions to owners and executives as long as a minimum employer contribution is made for eligible employees. In addition, all employer contributions made to a company-sponsored retirement plan are tax deductible. Employer contributions help employees accumulate enough to retire and, at the same time, pay for themselves in tax savings for the company.
Below are sample maximum tax-deductible contributions allowed for an owner or executive with a combined 401(k) profit sharing and cash balance pension plan arrangement:
|Age||401(k) Profit Sharing||Cash Balance||Total|
For more on how qualified retirement plans can help you and your employees reduce their tax bills while becoming retirement-ready, the Aldrich Retirement Solutions team is ready to help.