When Expanding Retirement Plan Access Makes Employers Think Twice
Federal and state lawmakers deserve credit for trying to make retirement plans available to more American workers. Too many employees, particularly those working for small businesses, reach retirement with little more than Social Security and whatever they managed to accumulate on their own.
The problem is not the goal. The problem is that legislators keep trying to achieve it by placing more responsibility on employers.
Every new retirement plan mandate brings another eligibility rule, payroll procedure, notice requirement, and opportunity to make an expensive mistake. Large corporations have human resources departments, benefits specialists, lawyers, and consultants. Small business owners often have none of them.
For many small employers, the person responsible for retirement plan compliance is also responsible for hiring employees, making payroll, paying vendors, negotiating leases, and keeping the doors open.
Congress may believe it is expanding retirement plan coverage. In practice, it may be giving small employers another reason not to establish a plan at all, or even to terminate an existing one.
The Long-Term Part-Time Employee Problem
Historically, many 401(k) plans could exclude employees who did not complete at least 1,000 hours of service during a 12-month period. The original SECURE Act changed that by creating a new category of “long-term part-time employees.”
Initially, employees generally had to be permitted to make salary deferrals after completing at least 500 hours of service in three consecutive 12-month periods. SECURE 2.0 shortened that period from three years to two for plan years beginning after December 31, 2024. The provision was also extended to ERISA-covered 403(b) plans.
The objective is understandable. Someone who works 10 or 15 hours per week for the same employer over several years should have an opportunity to save through payroll deductions. But consider what this means for a small employer.
The employer must track hours for part-time employees across multiple years and understand how the rules apply to rehired employees, breaks in service, eligibility dates, plan entry dates, and different employee classifications. Records may need to be retained for workers who leave and later return.
Although employers generally are not required to make matching contributions for employees who qualify solely under the long-term part-time rules, they must identify them and give them an opportunity to defer compensation. Failure to do so may require corrective contributions and formal remediation under IRS procedures.
The IRS advises plan sponsors to review employee census data carefully and correct situations in which employees were not offered a timely opportunity to participate.
To a member of Congress, tracking 500 hours may sound simple. As financial planner working in the small business retirement plan space, I can attest that, to a restaurant, retail store, medical practice, or construction company with seasonal and part-time workers, it is far from simple.
Automatic Enrollment Is Not Automatic Administration
SECURE 2.0 also generally requires many new 401(k) and 403(b) plans established after December 29, 2022, to use automatic enrollment beginning with the 2025 plan year. Covered plans generally must enroll eligible employees at an initial contribution rate between 3 and 10 percent, followed by annual increases until the rate reaches at least 10 percent, subject to a 15 percent ceiling. Employees may opt out or choose another rate.
There are exceptions, including certain businesses with 10 or fewer employees, employers that have been in business for less than three years, governmental plans, and church plans. Existing plans generally are grandfathered.
Again, the policy rationale is sound. Automatic enrollment increases participation because many employees who would never complete an enrollment form will continue contributing once deductions begin.
But automatic enrollment does not make plan administration automatic.
Someone must determine eligibility, provide notices, establish payroll deductions, process opt-outs, implement annual increases, and correct mistakes. Payroll and recordkeeping systems do not always communicate perfectly. An election may not be implemented. A deduction may begin late. An automatic increase may be missed.
Each seemingly minor error creates another compliance problem for the employer.
State Legislatures Compound Plan Complexity With New Mandates
A growing number of states, including my home state of Hawaii, are attempting to close the retirement coverage gap through state-facilitated IRA programs.
The objective is to give private-sector employees without an employer-sponsored plan a way to save through payroll deductions. Covered employers generally must register, provide employee information, and facilitate payroll contributions for employees who do not opt out.
Because employers are not required to contribute, these programs are sometimes portrayed as effectively “free” to employers. But “no employer contribution” is not the same as “no employer cost.”
Employers still must coordinate payroll, transmit deductions, process changes, respond to employee questions, and document compliance. Outside payroll providers may charge additional fees, while employers handling payroll internally must learn another system.
The state-sponsored account is an IRA, not an employer-sponsored qualified retirement plan. It does not offer the same contribution limits, plan design flexibility, employer matching opportunities, or potentially broader investment choices available through a 401(k). Yet the employer is still conscripted into administering the payroll connection.
If state legislators took the time to consult with small business owners in their communities, I suspect many would hear that these mandates impose very real friction and tangible costs.
The irony is that mandatory state programs may cause some employers to choose a minimalist state IRA arrangement instead of adopting more generous plans such as safe harbor 401(k)s. An employer with an existing plan may eventually conclude that maintaining it is no longer worth the complexity. As federal obligations such as long-term part-time eligibility and automatic enrollment accumulate, some employers may decide that the lower-cost state alternative is preferable.
Incentives Work Better Than Mandates
Lawmakers seem to assume that retirement savings problems can be solved by adding employer requirements. This ignores the basic economic concept of friction costs. Most small business owners may not have an academic background in economics, but I assure you they are very much aware of the financial impact of each new regulatory mandate.
A retirement plan remains voluntary for most private employers. If establishing one requires too much expense, administrative attention, or legal exposure, an employer can simply decline to do it. If maintaining an existing plan becomes too burdensome, the employer may freeze or terminate it.
Congress has expanded tax credits for small employers that establish retirement plans, which is a constructive approach. But the value of those incentives can be undermined when plans become harder to administer year after year.
A better policy would emphasize genuine simplification: safe-harbor designs with minimal testing, standardized notices, integrated payroll systems, straightforward eligibility rules, and correction procedures that do not require a benefits lawyer to understand.
Federal and state lawmakers should also remember why IRAs and Roth IRAs exist. These accounts were created specifically to encourage individuals to save for retirement, including workers without employer-sponsored plans.
Instead of imposing additional mandates on small businesses, policymakers could provide stronger incentives for workers to save on their own, including federal or state matching contributions, tax credits, or above-the-line deductions for IRA and Roth IRA contributions.
As a financial planner, I want more Americans to save for retirement. As a small business owner with eight full-time and part-time employees, I want that too. But good intentions do not guarantee good outcomes.
If legislators continue adding complexity, recordkeeping duties, and compliance risk for small businesses, they may discover that efforts to expand retirement plan coverage have produced the opposite result.
The easiest retirement plan for a small employer to administer is still no retirement plan at all.
