State Retirement Mandate or Your Own 401(k): Which Costs a Small Employer Less After the Credit?
A state auto-IRA costs an employer little. A 401(k) costs more, but the federal credit can cover much of it for a few years. The math depends on how much you contribute.
Short answer: there is no single winner. A state program costs the employer the least in time and money. A 401(k) can cost close to nothing for the first few years because of the federal credit, then more as the credit steps down. How much more is your choice, because employer contributions are voluntary.
What each path is
Many states now require employers to register for a state-run auto-IRA unless they offer a plan of their own. Deadlines, size limits and penalties differ. Our state mandate guide lists them. California is one example. Its Franchise Tax Board states a penalty of $250 per employee with its first notice and a further $500 per employee if you do not comply within 90 days of that notice, per its CalSavers page.
Your own 401(k) is a qualified plan you set up and pay to run. It can earn the federal credits in 26 USC 45E. A state auto-IRA does not earn them, because it is not an eligible plan you set up. Our article on state auto-IRAs and the startup credit explains why registering also does not block them.
Check your state's rules on whether offering your own plan lets you skip the state program. Rules differ by state.
The credits in short
- Startup credit. 100% of qualified startup costs for employers with 50 or fewer employees, 50% above that. The yearly limit is the greater of $500 or the lesser of $250 per eligible non-highly compensated employee or $5,000. It lasts three years. Source: section 45E(a), (b) and (e)(4).
- Contribution credit. Up to $1,000 per employee, at 100% in years one and two, then 75%, 50% and 25%. Employees paid over $110,000 in 2026 are left out, per IRS Notice 2025-67. Source: section 45E(f).
- Auto-enrollment credit. $500 a year for three years, under section 45T.
The credits are nonrefundable. The costs they cover also lose their deduction under section 45E(e)(2).
A worked example
This is an illustration for a fictional company, not a promise. A company has 25 employees. Twenty-two are not highly compensated. Twenty earn under $110,000 and get an employer contribution of $1,000 each, $20,000 a year. Plan fees and administration are $3,000 a year. The company has no earlier plan.
Year one startup credit: the limit is the lesser of $250 x 22 = $5,500 or $5,000, which is $5,000. Costs are $3,000 at 100%, so the credit is $3,000.
Year one contribution credit: $20,000 x 100% = $20,000.
Spending against credit, by year:
- Year 1: spend $23,000, credits $3,000 + $20,000 = $23,000, left to pay $0
- Year 2: spend $23,000, credits $23,000, left to pay $0
- Year 3: spend $23,000, credits $3,000 + ($20,000 x 75% = $15,000) = $18,000, left to pay $5,000
- Year 4: spend $23,000, startup credit ended, credit $20,000 x 50% = $10,000, left to pay $13,000
- Year 5: spend $23,000, credit $20,000 x 25% = $5,000, left to pay $18,000
- Year 6: spend $23,000, credit $0, left to pay $23,000
Compare that with the state program, where the employer does not run a plan. The employer cost there is the payroll work of registering and remitting deductions. Check your state's employer page for exactly what it asks of you.
What changes the answer
The contribution is optional. In the example, $20,000 of the $23,000 is the match. Cut it to $10,000 in year four and the cost left to pay falls sharply. State programs are built around employee savings. Confirm on your state's employer page whether it asks anything of you beyond payroll deductions.
Your tax situation. The credit is nonrefundable. If you owe little tax, you use it slowly and carry the rest forward. The lost deduction on credited costs also changes the net math. Your CPA models both.
Your headcount. Past 50 employees the rates fall. See our article on the credit for 51 to 100 employees.
What you want from the plan. A 401(k) can help you hire and keep people. A state program gives employees a way to save without an employer plan. Neither is better for every business.
Next steps
Run the free Federal Money Check to see which credits may apply. Read the retirement credit overview for the full rules.
If you do not have a CPA, you can find one at RetirementCPAs.com. Disclosure: RetirementCPAs.com and Reimbursa are both operated by Aptelligence LLC.
Reading the example
The example assumes $3,000 of plan fees every year and a $1,000 match for 20 people. The startup credit covers fees for three years. After that, fees are a normal cost.
Take the match away and the picture changes. With fees only, the example company pays $3,000 a year. The startup credit of $3,000 covers all of it in years one to three. From year four the company pays the $3,000 itself.
The mix matters because the contribution credit steps down. It covers all of a match in years one and two, three quarters in year three, half in year four and a quarter in year five. A company that sets its match with that schedule in mind can plan its cost. A company that wants the full match for staff for the long run should plan on paying for it once the credit ends.
The numbers also ignore the lost deduction and your tax rate. Section 45E(e)(2) removes the deduction for costs that the credit covers. In the example, $23,000 of year-one costs is credited, so it is not also deducted. Your CPA turns the gross numbers into after-tax ones.
Questions to ask before you choose
- Does my state let me skip the state program if I offer my own plan?
- What will a plan provider charge in fees each year?
- How much can I afford to contribute after the credit steps down?
- Did my business or a related business have a plan in the last three years?
This is general information, not tax advice. Your CPA confirms the numbers.