Which is better: a State-run IRA program, or a 401(k) plan?

Consider this not-entirely-imaginary work setting:

The employer has no retirement plan, and no payroll practice for retirement contributions.

The employer wants to allow its employees to save for retirement, but will provide no nonelective or matching contribution.

None of the employees, including the deemed-employee business owner, wants to save (and none can afford to save) more than an amount within the IRA contribution limit.

The business owner is the only worker who would be treated as a highly-compensated employee.

This small-business employer and its startup plan would have no purchasing power in negotiating fees for a retirement plan’s investments or services.  So, assume a recordkeeper’s and other service providers’ rack rates.

The employer is unwilling to pay any of the plan’s expenses; everything must be charged to participants’ accounts.

The employer will not consider an employer-sponsored retirement plan unless the employer can arrange the maximum delegation of fiduciary responsibilities—a pooled-employer plan or, for a single-employer plan, using a § 3(16) administrator, a § 3(38) investment manager (to select the plan’s investment alternatives), and a trustee, with all those services paid from participants’ accounts.

All employees live and work in a State that offers a State-run payroll-deduction program for IRA contributions.  The program allows Roth and non-Roth contributions.

The State’s arrangements cap the expenses of the State-run IRA program at 100 basis points (expressed yearly) of accounts’ assets.

This employer asks for your unbiased advice about whether it should arrange a 401(k) plan, or join the State-run IRA program.

Which do you advise, and what reasoning do you explain to support your advice?

Is the 100 (or less) basis points inclusive, or on top of, the investment fund management expenses?  Is the employer willing to work on or pay for analysis of least cost options?

What is the workforce like (especially with respect to sophistication, generally, not specifically with respect to investment decisions)?

Does the employer wish to allow (passively) or promote (actively) the idea of retirement savings?  You used the term "allow"  but nothing is preventing folks now from saving through personal IRAs within  the scope described, which is one reason for the questions.

QDROphile, thank you for giving me your time to think about this.  And thank you for asking smart follow-up questions to describe further my imaginary employer.

The charge of 100 basis points is distinct from, and in addition to, a fund’s expenses.  But the expense ratios of the funds in the State-run program range from 2½ basis points [0.025%] for a bond fund to nine basis points [0.09%] for target-year funds.

The employer would not analyze anything about investment alternatives, because it would delegate those decisions to a § 3(38) investment manager.

A plan sponsored by the employer would not qualify for collective trust fund units or for mutual funds’ institutional-class shares.

The workers have four-year college degrees, but are service workers, not knowledge workers.

The employer’s preference is to allow (passively) retirement savings, but providing employees the convenience of payroll deduction.

Now that I know that the employer is quasi imaginary, my fundamental question is quasi academic:  What is the employer trying to do?  Most employers would like to encourage retirement savings, but many are chary about involvement (e.g. potential liability) and expense (including indirect expense of administrative burden).  Your hypothetical has elements of these concerns.

I start from the easiest option that allows the employer to exhort employees to save within the IRA limits and make it automatic, without getting involved further in evaluations, payroll deduction IRAs (not state sponsored) : https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-payroll-deduction-ira#:~:text=Under a Payroll Deduction IRA,deduction to the financial institution.

If the employer wants to get more involved by trying to get a better or best solution (e.g. better investment options (whatever that means) or least cost maintenance), then it gets complicated.   I think the "What are you trying to do or avoid (e.g. potential liability for investment decisions, at the high end)" question is primary and there is no pat answer.

Pat answer:  As between your choices, the state run IRA involves the employer the least and is beyond reproach, except that may not be the best benefit for the employees or owner.  Better just to allow payroll deduction and let everyone fend for themselves if one is involvement  averse.

Here are my general rules (because there are always exceptions):

1. If a 401(k) plan is going to be deferral only, I recommend against it or prefer they go somewhere else. Past experience shows that they almost never work out successfully.

2. If an employer qualifies and the limits are acceptable. a SIMPLE IRA is quite often the best choice instead of a 401(k). I know that doesn't work here because of the employer contributions, but I still often recommend it.

3. While our industry exists because of "state" supplied rules, I'm generally opposed to state run programs.

I agree with @Bill Presson.  If an employer does not want to make employer contributions, and otherwise shows no inclinition to be involved with anything related to their plan, especially plan design, then that is a recipe for a plan to fail.  Someone has to make the employees aware of the benefits of saving for retirement and there is only so much that can be done with technology.  

QDROphile, Bill Presson, Pam Shoup, thank you for contributing your good thinking.

QDROphile, I like your logic path and reasoning.  To it, I’ll add this bit of law:

For an employer to offer the convenience of payroll-deduction IRA contributions without establishing or maintaining a plan, it can be burdensome to send money to many IRA providers.  But it’s a risk to limit employees’ choice of IRA providers.  See 29 C.F.R. § 2510.3-2(d)(1)(iii).  Interpretive Bulletin 99-1 tries to give some succor to limiting employees’ choice of payroll-contribution payees, perhaps even to as few as one.  But the Bulletin is not a rule or regulation.  That means a court need not defer to it.

Falling in with a State-run IRA program lets an employer limit its payee to just one.  Yet, an employer’s risk of fiduciary liability might be slight.

A court held that an employer that does no more than obey California’s law for its CalSavers program, including its implied-election provision, does not establish or maintain a plan.  Howard Jarvis Taxpayers Ass’n v. Cal. Secure Choice Retirement Savings Program, 443 F. Supp. 3d 1152 (E.D. Cal. Mar. 10, 2020), appeal filed, No. 20-15591 (Apr. 3, 2020).  The appeals court might reverse that decision.  Or an employer not in the Ninth Circuit might face a court’s decision that a State-run IRA program is an ERISA-governed plan.

But even with such a finding, a mere participating employer doesn’t face liability unless a court further finds (i) that the employer is a fiduciary for some particular function, (ii) the employer breached its fiduciary responsibility in performing that function; and (iii) that breach resulted in harm to the plaintiff’s IRA.  That conclusion follows from applying ERISA § 409’s statement of a fiduciary’s personal liability and ERISA § 3(21)’s definition, which makes a person a fiduciary only to the extent of its discretionary decision-making.

A court might not make the employer liable for an IRA’s investment result caused by using the IRA custodian and investment funds the State selected, which the individual affirmed by not opting out of payroll contributions and not periodically transferring amounts to another IRA.

Bill Presson and Pam Shoup, my thought exercise is about what, if anything, one might suggest to an employer that does not become a client.

And if an employer not ready to administer a retirement plan is subject to a State’s play-or-pay excise tax, falling in with a State’s program might avoid the tax while taking on a relatively lighter work burden and narrower risk.

A State-facilitated IRA might be a starter kit for those we haven’t yet persuaded.

Governmental employers are not eligible to sponsor a 401(k) plan unless it was established before May, 1986,  

The Vanguard STAR fund has a minimum of $1,000 for IRAs and the all-in fees are 0.31%. 

Their Target Retirement Funds have $1,000 minimums and the all-in fees are 0.15% or less.  

All of these funds, each on their own, provide ample diversification, likely much than any state plan could with a menu of choices.

If you can't beat these options as a default, then why are you bothering establishing a "plan"?

One more thought, and I hate to give the mistaken impression that I'm telling you all your business ...

To me, looking at the viability of a plan with the parameters you have discussed is like looking at buying a car with an eye only to the available colors it comes in.

If a company is being forced into retirement savings either because the state mandates it or because employees demand 401(k) savings ability, why doesn't the employer embrace the concept and selfishly benefit himself in a qualified plan and consider acceding to the state/employee demands as a justification to finally do this?

So, in my opinion, the key is to ask your hypothetical employer who does not want to make employer contributions for his employees:  I assume you are saving for yourself outside any retirement program.  You are doing that saving with after-tax dollars, which means you have to earn $1 to save 60 cents.  If you could put that savings into a retirement plan for yourself and pay less than 40 cents for your employees, why wouldn't you do that?  In other words, if you are agnostic as to whether you pay the government in taxes or your employees in contributions, why wouldn't you pay less dollars in employee contributions than you do in taxes?

I know that this is the fundamental question for any plan that you recommend to your clients.  But, a client that "doesn't want to contribute for his employees" is generally motivated by self-interest.  Why doesn't that self-interest help him having a qualified plan with employer contributions if he is better off financially????

FWIW. Hope this helps.  Have a happy, healthy, and prosperous New Year, everyone!

Ilene, I suspect almost every retirement-plans practitioner or service provider who regularly talks with small-business employers shares your thoughts.