Small businesses are not required to offer retirement plans under federal law, but that answer no longer settles the question. At least 17 states now require employers without a qualifying retirement plan to enroll their workers in a state-sponsored savings account, and a separate federal rule forces most brand-new 401(k) and 403(b) plans to include automatic enrollment. Whether you have a legal obligation comes down to what state you operate in, how many people you employ, and whether you already sponsor a plan.
Federal Law Does Not Require a Plan
The Employee Retirement Income Security Act of 1974 (ERISA) is the main federal law governing workplace retirement plans. It sets rules for how a plan must be run once it exists, but it does not force any employer to create one. A business with five employees or five thousand can lawfully offer nothing under federal law.
That voluntary framework is why coverage gaps opened up at smaller employers in the first place, and it is why states stepped in.
State Mandates Are Where the Real Requirement Lives
The bigger compliance issue for most small businesses is state law. At least 17 states operate active retirement savings programs, and most follow a mandatory auto-IRA model. If you do not already sponsor a qualifying plan, you must register with the state program and set up payroll deductions into a state-managed Individual Retirement Account for your workers.
States running active mandatory auto-IRA programs include California, Colorado, Connecticut, Delaware, Illinois, Maine, Maryland, Minnesota, Nevada, New Jersey, New York, Oregon, Rhode Island, Vermont, and Virginia. A few other states have enacted programs still in rollout, or use a marketplace model that connects employers with private providers rather than running the accounts itself.
Your financial obligation under the auto-IRA programs is minimal. You do not contribute money. Your job is administrative: register, set up payroll deductions, and transmit them on schedule. The accounts belong to the employees, who can opt out whenever they want. Default contribution rates in most state programs start around 5% of pay with automatic annual increases unless the worker changes the rate.
If you already offer a qualified plan like a 401(k), SEP IRA, or SIMPLE IRA, you are generally exempt from the state program. Most states still require you to confirm that exemption through an online employer portal. Ignoring the mandate and assuming your existing plan gets you off the hook is a common way businesses end up with penalty notices.
Which Businesses the State Rules Cover
Each state sets its own employee threshold, and those thresholds vary. Many states draw the line at five or more employees. Several now require participation from any business with even one worker. The count usually includes both full-time and part-time staff, though most programs only cover employees who have reached a minimum age (commonly 18 or 21) and worked for the company for a minimum period, often 60 to 120 days.
The number that matters is generally your W-2 headcount, not full-time equivalents. Sole proprietors with no employees and businesses that use only independent contractors are usually excluded, because the programs target workers whose wages are subject to state income tax withholding. If your headcount hovers near the threshold, check your prior year’s payroll records. Crossing the line even briefly can trigger a registration deadline you might otherwise miss.
These rules keep shifting. Several states that initially covered only larger employers have lowered their thresholds to include one-employee businesses. Checking your state program’s current requirements each year is the only reliable way to stay ahead of the changes.
Satisfying a Mandate With a Private Plan
If your state requires retirement plan access, you can comply either by enrolling in the state program or by offering a qualifying private plan. Private plans give you more control over design, contributions, and investment menu. The common options:
- A 401(k) is the most flexible. Employees can defer their own pay, employers can match or make profit-sharing contributions, and the plan can be designed around a wide range of goals. Any 401(k) started after December 29, 2022, must include automatic enrollment unless an exemption applies (see below).
- A SIMPLE IRA is designed for businesses with 100 or fewer employees. Employers must either match employee contributions up to 3% of pay or make a flat 2% contribution for all eligible workers.
- A SEP IRA is funded entirely by the employer, with no employee contributions. Administratively simple, but employees cannot put in their own money.
Any of these plans, if offered to substantially all eligible employees, will satisfy a state mandate and exempt you from the state auto-IRA. The plan has to meet the qualification requirements under the Internal Revenue Code, including nondiscrimination rules that stop you from stacking benefits toward owners and highly paid employees while shortchanging rank-and-file workers.1Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans
Automatic Enrollment for New 401(k) and 403(b) Plans
The SECURE 2.0 Act changed the rules for any 401(k) or 403(b) plan established after December 29, 2022. Starting with plan years beginning after December 31, 2024, these newer plans must automatically enroll eligible employees and include annual escalation. The initial default contribution rate must fall between 3% and 10% of pay, and the plan must raise that rate by at least 1% each year until it reaches at least 10% but no more than 15%.
Several categories of employers are exempt:
- Businesses that normally employ 10 or fewer workers.
- Employers in operation for fewer than three years.
- Any 401(k) or 403(b) established before December 29, 2022. These plans are grandfathered.
- SIMPLE 401(k) plans, church plans, and governmental plans.
Automatically enrolled employees can opt out or change their contribution rate whenever they want. If you start a brand-new 401(k) and none of the exemptions apply, automatic enrollment is not optional.
What Non-Compliance Costs
Penalties come from two directions: state fines for ignoring an auto-IRA mandate, and federal penalties for mismanaging a plan you already sponsor.
State fines for failing to register or facilitate payroll deductions generally start at a few hundred dollars per eligible employee. If non-compliance continues after the initial notice period, additional fines accumulate and can reach $750 or more per employee. Most state programs send multiple warnings before assessing penalties, so the businesses that end up paying are usually the ones that ignored repeated notices, not those that fumbled the initial registration.
Federal penalties look different. If you sponsor a 401(k) and fail to deposit employee contributions on time, the IRS treats the delay as a prohibited transaction, with an initial excise tax of 15% of the amount involved for each year the violation remains uncorrected.2Internal Revenue Service. Instructions for Form 5330 Late Form 5500 penalties apply on top of that, at $250 per day per return up to $150,000.3Internal Revenue Service. Penalty Relief Program for Form 5500-EZ Late Filers These consequences stack up quickly for an owner who set up a plan years ago and has drifted away from the paperwork.
Tax Credits That Make Starting a Plan Cheaper
If you are considering sponsoring a plan voluntarily (whether to satisfy a state mandate or otherwise), federal tax credits change the math considerably.
The small employer pension plan startup costs credit lets eligible employers claim up to $5,000 per year for three years to cover the ordinary costs of setting up and administering a new SEP, SIMPLE IRA, or qualified plan like a 401(k). For businesses with 50 or fewer employees who earned at least $5,000, the credit covers 100% of eligible startup costs up to that cap.4Internal Revenue Service. Retirement Plans Startup Costs Tax Credit
SECURE 2.0 added a separate employer contribution credit. Businesses with 50 or fewer employees can claim up to $1,000 per eligible employee per year for five years to offset the cost of actual employer contributions. The credit covers 100% of contributions in the first two years, then phases down to 75% in year three, 50% in year four, and 25% in year five. Employees earning above $110,000 in 2026 are excluded from the calculation.
These credits are dollar-for-dollar reductions in your tax liability, not deductions. For a business with 10 employees, the combined credits can cover most or all of the cost of launching and funding a plan for several years, which reshapes the decision for owners who assumed a 401(k) was out of reach.
What to Actually Do
Start with your state. Look up whether your state has an active mandatory retirement program, what the employee threshold is, and whether your current headcount puts you inside it. If it does, you have two paths: register with the state auto-IRA (free for the employer, usually under an hour of setup) or adopt a qualifying private plan and claim the exemption through the state portal. If your state has no mandate and you employ no one but yourself, no law requires you to do anything. If you already sponsor a plan, put your Form 5500 deadline, contribution deposit dates, and annual fee reviews on a calendar. The penalties exist to catch neglect, and the simplest defense is not being neglectful.