Choosing Between a State‑Mandated Retirement Plan and a 401(k): A Guide for Small Business Owners

If you're a small business owner in a state with a retirement plan mandate, choosing between a state-run program and a private 401(k) is more than checking a legal box—it’s a strategic decision that can influence your company’s bottom line, your employees’ long-term financial security, and your ability to attract and retain top talent. With more than half of private-sector workers now participating in 401(k) plans—and with small employers increasingly looking for ways to differentiate themselves—offering the right retirement plan can give your business a meaningful competitive edge.

State-mandated retirement programs are designed to expand access to retirement savings with minimal employer burden. They’re simple and cost-free for employers, but also limited—often capping contributions, restricting investment choices, and lacking flexible features. In contrast, a private 401(k) plan offers greater versatility: higher contribution limits, broader investment options, customizable plan designs, and features like participant loans and hardship withdrawals. Eligible small businesses may also qualify for substantial tax credits under SECURE 2.0 when they start a 401(k).

The choice between a state-run program and a private 401(k) becomes much easier when you understand how the two compare. Below are the key factors every small business should consider.

The Characteristics of State-Mandated Retirement Plans

Except for Massachusetts, state-mandated retirement plans are structured as Roth IRAs, meaning contributions are made with after-tax dollars and qualified distributions are tax-free. These plans are easy to administer but come with important limitations. Common features include:

• • Auto-enrollment: Employees are automatically enrolled at a default contribution rate (typically 3%–5%), with the option to opt out or change their rate.
  • Payroll deductions: Contributions are funded through after-tax payroll deductions facilitated by the employer.
  • Employer role: Employers are not fiduciaries. Their primary role is to register with the state program and facilitate deductions—no employer contributions or plan administration are required.
  • Exemptions: The smallest or newest businesses are often temporarily exempt, depending on state rules.

These Roth IRAs are subject to standard IRS rules, including lower contribution limits and income-based eligibility. Investment choices are generally limited to a small menu of index or target-date funds, and employer contributions are prohibited in most cases.

For a state-by-state summary of the state programs, including name, web address, covered employers, plan type, automatic enrollment features, deadlines, and penalties for non-compliance, click here.

How State-Mandated Retirement Plans and 401(k) Plans Compare

To choose the best plan for your business, it’s important to understand how state Roth IRAs and private 401(k) plans differ across key areas:

Employee Contributions

• • State Plan (Roth IRA):
    • Only after-tax contributions are allowed.
    • IRA contribution limits apply. For 2025, the limit is $7,000 for 2025 ($8,000 if 50 or older).
    • An employee’s eligibility to contribute is based on their modified adjusted gross income (MAGI) and tax filing status. For 2025, the Roth IRA income limits are:
      • Single filers: Contribution eligibility phases out between $150,000–$165,000
      • Married filing jointly: Phase-out range is $236,000–$246,000
  • 401(k) Plan: Pre-tax or after-tax contributions are allowed subject to the higher 402(g) limit—$23,000 for 2025 ($30,500 if 50 or older). All eligible employees can contribute, regardless of income.

Why it matters: A 401(k) enables significantly higher retirement savings potential for employees and business owners.

Employer Contributions

• • State Plan (Roth IRA): Employer contributions are not permitted.
  • 401(k) Plan: Employers can offer matching contributions or nonelective contributions up to the 415(c) limit annually. For 2025, the 415(c) limit is $70,000 ($77,500 if 50 or older).

Why it matters: Employer contributions can boost employee participation, improve recruitment, and reduce business tax liability.

Investment Options

• • State Plan (Roth IRA): Limited to a basic menu of low-cost target-date or index funds selected by the state.
  • 401(k) Plan: Can offer a broad selection of mutual funds, ETFs, and potentially brokerage windows or stable value funds.

Why it matters: A broad investment lineup allows employees to tailor their portfolios to fit unique financial goals, time horizons, and risk tolerance.

Plan Features

• • State Plan (Roth IRA):
    • No participant loan or hardship withdrawal options.
    • Employee eligibility, automatic enrollment, and auto-escalation rules are fixed by state law.
  • 401(k) Plan:
    • Can offer participant loans and hardship withdrawals.
    • Customizable rules for employee eligibility, automatic enrollment, auto-escalation, contributions, and distributions.

Why it matters: 401(k)s support a broader range of employee financial needs, including emergencies, debt management, and long-term planning.

Employer Responsibilities

• • State Plan (Roth IRA): Employers only facilitate payroll deductions. Plan administration and fiduciary responsibility lie with the state or provider.
  • 401(k) Plan: Employers have fiduciary responsibilities, must comply with IRS qualification requirements (including nondiscrimination testing), and file annual Form 5500. However, much of the work can be outsourced to a third-party administrator (TPA) or recordkeeper.

Why it matters: While 401(k)s require more involvement, many providers make administration manageable, and the flexibility they offer can be worth the added effort.

Costs and Tax Incentives

• • State Plan (Roth IRA): No cost to employers (except for potential payroll system integration). No employer tax benefits.
  • 401(k) Plan: Provider costs vary, but are often offset by SECURE 2.0 tax credits:
    • Up to $5,000/year for plan startup (for three years)
    • Up to $1,000/year per eligible employee for employer contributions
    • Additional credit for auto-enrollment features

Why it matters: Many small businesses can launch a 401(k) at little or no net cost.

Which Retirement Plan Is Right for Your Business?

A state-mandated retirement plan may be the simplest way to meet your legal obligation—but its contribution caps, income limits, and limited features may not meet your employees’ needs or your business goals.

A 401(k) plan, while requiring more involvement, offers greater flexibility, higher savings potential, and meaningful tax benefits. With the help of SECURE 2.0 incentives, even small employers can afford to offer one.

Ultimately, the right plan depends on your business size, goals, and workforce. If you’re weighing your options, we’re here to help you evaluate costs, compliance, and design flexibility to find the best fit for your team.