There’s been much talk recently concerning the lack of 401k accessibility. If one looks at the data, though, we see two important facts. First, despite the growing use of auto-enrollment, a surprisingly large number of eligible employees are not taking advantage of making tax deductible contributions to their 401k plan. Second, for all their value in attracting quality employees, an equally surprising large number of companies fail to sponsor 401k plans. Curiously, the same source may be responsible for both of these facts.
According to the government report “Retirement Plan Coverage by Firm Size: An Update” (by Irena Dushi, Howard M. Iams, and Jules Lichtenstein, Social Security Bulletin, Vol. 75, No. 2, 2015), based on the latest available data (2012), only 61% of all firms offer defined contribution (“DC”) plans and only 45% of all workers participate in DC plans. Those numbers may look startling, but they grow starker when one separates the data between firms with more than 100 employees and firms with fewer than 100 employees. Of companies with more than 100 employees, 72% offer a DC plan and 53% of the employees participate. By contrast, only 40% of the companies with fewer than 100 employees offer a DC plan and only 28% of their employees participate.
Similarly, the DOL’s Bureau of Labor Statistics (“BLS”) news release dated July 24, 2015 (“Employee Benefits in the United States – March 2015”) revealed only 66% of private workers had access to retirement benefits. While that headline number might shock, the internals prove more insightful. Only 51% of the private industry companies with fewer than 100 workers offered retirement benefits and those companies experience only a 35% participation rate. In comparison, 84% of the companies with 100 or more workers offered retirement benefits and 65% of that segment of the workforce participated. Looking at the largest cohort of companies with 500 workers or more, 89% of those companies offered retirement benefits with 76% of the workforce participating.
In any determination of public policy, the question should focus on why, for large companies (i.e., 500 or more workers) 9 out of 10 employees have access to retirement plans while in small to mid-sized companies (i.e., few than 100 workers) only 1 in 2 employees have access to retirement benefits. It is not a question of lack of vehicles; it is a question of behavior. Why to larger companies seem to be motivated to offer retirement plans while small to mid-sized companies seem to have less motivation.
Why are small to mid-sized companies less likely to offer 401k plans?
One cannot argue the facts, and the facts state small to mid-sized companies do not offer retirement plans at the same rate as larger firms. Why is this so? Stephen Rischall, co-founder of 1080 Financial Group in Los Angeles, California, says, “The cost to administer 401k plans prevents many small businesses from setting them up – the smaller the plan the larger the cost as a percentage of total plan assets.”
It’s true larger firms incur much greater costs in terms of actual dollars than smaller business. For many small businesses, however, even a few hundred dollars consumes a much larger percentage of annual revenues than those larger dollar figures account for in larger firms. “There is a cost to 401k plans that small business owners may not be able to take on,” says Breanna Reish of TriCord Advisors, Inc. in Riverside, California. “Third Party Administration fees alone can run over $1,000 per year. Not to mention the cost of paying an employee to submit contributions & handle participant paperwork.”
While cost may be the primary issue, it is not alone. “The number one reason is they think it’s expensive, they think it’s going to be too costly and they can’t afford it,” says Nathan Boxx, associate financial consultant at Fort Pitt Capital Group LLC in Pittsburgh, Pennsylvania. “There are not only costs associated with a service provider, advisor, CPA, or party administrator, but also the employee contribution or matching component. Secondarily, small to mid-sized business owners are concentrating on growing their business. They view their business as their largest, most productive asset.”
Think of all the tasks the owner of a smaller business must undertake. The burden of sponsoring a retirement plan can appear daunting. “Small business owners have a lot of tasks that they need to juggle on a daily basis,” says Reish, “adding a 401k is like another ball when they have plenty on hand as it is. Even though an owner can pair up with an advisor to guide them through the process, it still takes time to set up and maintain.”
Kevin Haskell, vice president of retirement plan services at Summit Financial Corporation, based in Burlington, Massachusetts, says, “Small companies, especially, are laser-focused on their business. Sustaining and (hopefully) growing it, servicing clients, responding to competitors, and managing personnel is a full time job. Establishing a retirement plan may be on the to-do list, but misperceptions of ‘it’s too complicated to setup’ or ‘it’d be too costly’ push this item further down the list. Also, there may be a healthy awareness of the potential liability associated with establishing a plan. With the stronger enforcement of ERISA rules, no longer is it acceptable to take a position of ‘well, I put a retirement plan in place, if employees want to use it fine. If not, that’s not my concern. I don’t have time to oversee.’”
The fiduciary liability associated with the duties of plan sponsor can often act as a disincentive for small business owners. In many ways, the fear of regulatory intricacies offers a far greater impediment than do the fear of fees. “The reluctance is in small part due to perceived cost,” Murray Carter, Executive VP at CSG Capital Partners of Janney Montgomery Scott in Washington DC. “However, it is more due to the complexities and time commitment that is real and perceived. Many of these companies don’t have a dedicated HR professional and the liabilities of having a plan that is overseen by someone who hasn’t had experience with plans in the past is not something they want to take on.”
While the objective owner can identify ways to overcome these barriers, those solutions can bear a cost they sometimes have a difficult time justifying. Tom Zgainer, Founder and Chief Executive Officer at America’s Best 401K in Scottsdale, Arizona, says, “The perception among some employers, certainly small ones under 25 employees, is that the cost of annual administration, the needed adherence to compliance and regulations, and potential employer contributions, are offset by an uncertainty as to how many eligible employees will actually welcome the benefit and take advantage of the opportunity to defer a portion of their wages. This is a factor often overcome with a solid educational programs thought the advisor or provider, however employers often feel this will be ‘another thing they have to do’.”
Owners of small businesses are quick to realize when you can’t afford a Cadillac, settle for a Chevy. There are alternatives to 401k plans, many of which shift the costs and fiduciary burden to the individual employee. Indeed, for owners who have no interest in saving for their own retirement (a different kind of fallacy best addressed in a different article), these alternatives represent the easiest way to wash their hands of the entire issue so they can concentrate on “things that matter right now.”
Paula Friedman, Managing Director of Employer Retirement Plans at McLean Asset Management Corporation in McLean, Virginia, says, “Small to mid-sized companies are less likely to offer 401k plans for a few reasons. The ones I hear most often are: Uncertain about future cash flows and don’t want to commit the resources until the company is more stable; Don’t want to pay the fees the come with plan vendors; Cannot commit to making employer contributions until the company is more established; They are still small enough to qualify for a SIMPLE IRA or another low-maintenance retirement plan option; Owners do not think employees will use it (usually an assumption and not based on a survey or direct feedback); Typically the owners of small to mid-size companies are wearing multiple hats and are not willing to dedicate the time or effort required to establish and operate a 401k plan; and, Owners of small to medium size companies have most of their assets tied up in the business, making them unable to maximize their own contributions.”
Reluctance to Sponsor a 401k: Does Size Really Matter?
Ironically, there may be a greater incentive for the smallest of the small companies to sponsor 401k plans. While government data fails to bear out this notion, there’s a certain intuitive sense to it that makes it worth exploring. “Single owner businesses may be willing to establish a 401k because the process is easier, cheaper and only involves one person,” says Reish. “They are not bogged down with paperwork and keeping their workforce up to date on plan offerings.”
Friedman says, “We have quite a few clients with this profile. These are situations that typically arise in a professional services firm or medical practice. These employers usually have sufficient and predictable cash flows and want to avoid income taxes whenever possible. They are able to maximize their own contributions to the IRS limits with a minimal deposit for the rest of their staff to meet compliance requirements, making it cost-effective and beneficial to offer a 401k plan. In this scenario, the employees are usually on the lower end of the pay scale relative to the owner(s) and have been with the firm for a number of years. Since employer contributions are based on a percentage of compensation, owners can reward their tenured staff without worrying about breaking the budget.”
Astute accountants have long advised these very small business to utilize various forms of retirement plans to maximize tax savings. “A small, closely held business can have a plan designed to set aside on a tax favorable status a substantial amount of money for the benefit of the owner by providing reasonable contributions to employees,” says Haskell. “These plan designs can also be utilized in conjunction with a defined benefit plan so that even higher levels of benefits can be provided to owners with little or no additional contributions. With larger plans, you can’t provide this same level of contribution without having larger funding costs.”
There remain several problems with these strategies in terms of our overall subject. First, they tend to place tax reduction (primarily for the owner) ahead of retirement saving for employees. “Very small businesses are more likely to set up a 401k if the owners are highly compensated and seeking a tax deferral,” says Rischall. “It is easier to design a somewhat discriminative plan with multiple tiered matching for very small groups. While these plans may cost significantly more to administer, these arrangements allow owners to defer large amounts of earned income with hefty matching contributions from the business. Their employees, on the other hand, will most likely never receive the full benefits of the tiered matches because it often times includes restrictions such as 20+ years of service.”
The second issue is the potential ramifications should the firm grow. Such growth can increase costs of the plan in several ways. “The very small plans are easy to set up with a number of somewhat simplified options available,” says Carter. “The fear, of course, for a company is the regulatory burden and then the added cost of the required audit as they grow past the 100 employees.”
While Boxx believes it’s more likely to see a larger employer offer plan, he does see it as beneficial for smaller businesses to have a plan. He says, “The business owners could maximize their contributions and minimize the cost to contribute for employees. With more employees, there is a larger matching component. As the number of employees at smaller businesses increase, the ability to contribute to your own plan, minding the tax efficiency, is reduced.”
Together with the annual audit fees, the costs associated with matching employee deferrals can add up quickly. “Larger firms with 100 or more employees will characteristically require a larger employer contribution due to the size of the staff,” says Friedman. “An employer contribution equal to a small percentage of compensation adds up quickly when you are multiplying it across a significantly larger employee base. In addition, large plans require an annual audit by an independent CPA firm, which adds to the total cost of offering the plan. While employees working at larger companies tend to expect a retirement plan, companies need to increase the budget to accommodate the additional expenses associated with offering the plan.”
The Real Concern: Fiduciary Liability
There’s no question size impacts the costs related to the plan, both in terms of total dollars and the percentage those dollars represent with regards to both plan assets and firm revenues. There is one concern, though, that has very little to do with size. “The risks and fiduciary responsibility of the employer are the same for all 401k plans,” says Rischall. “This makes it more difficult to manage for a smaller employer with fewer resources. 401k advisers can offer services to share or off-load certain fiduciary responsibilities, but it entails an additional cost. Larger companies have resources to better manage the participation and administration of a 401k plan internally.”
“Fiduciary risk is a risk that does not discriminate based on the size of company or plan,” says Boxx. “So the billion dollar plan has the same risks and liability as the one dollar plan. Regardless of the plan size or company size you still have to make sure you are following a prudent profit and doing your due diligence.”
Despite this reality, many potential plan sponsors remain completely unaware as to the extent of their potential liability. Carter says, “I have found that most plans do not understand the full scope of their fiduciary liabilities. The small to mid-sized company doesn’t have the experienced staff to handle many of the complexities of having a plan. Thus, it becomes even more important to have a strong team supporting them. Whether that is the Record Keeper, TPA, or Advisor, the small/mid plans need support and guidance that they far too often aren’t receiving. It is too easy to miss important deadlines, erroneously complete documents and neglect/ignore necessary plan reviews. With a larger company comes a more experienced and deeper staff. They also tend to get more concierge treatment from their team of providers. As with most things the bigger you are the more support and services you are offered. Unfortunately the smaller company that needs more help is often lumped in with the masses and are treated more like a ‘number’.”
Worse than not knowing your fiduciary liability is a false sense of security. Consider it the opposite of a “too big to fail” attitude. It’s more like “too small to get caught.” Even after considering all their other priorities, small business owners may falsely conclude they don’t have to take their compliance duties seriously. “Small to mid-sized companies require owners and employees to wear multiple hats,” Friedman. “This means that there may not be a dedicated team of people devoted to working with employee benefits. In smaller firms, we typically see the business owner and possibly one or two key employees involved in the plan operations. Given how many other tasks and priorities require their attention outside of the retirement plan, there is limited time available for ongoing monitoring of the plan vendors and investment options. Often we find that smaller employers worry less about mitigating fiduciary liability since they do not feel that their employees will report them to the Department of Labor or IRS.”
Just because smaller companies don’t have access to the resources of larger companies doesn’t mean there aren’t viable alternatives when it comes to offering retirement benefits. “Larger companies tend to have more resources, including more personnel dedicated to monitoring the organization’s retirement plan than smaller organizations,” says Haskell. “Larger companies tend to have an advisor that will oversee the plan and who will conduct routine due diligence meetings and provide employee education. Larger companies also tend to have investment committees that work with the Plan Sponsor to make sure all investments are prudent and all fees are reasonable based on the services being offered. Like health benefits, a robust retirement plan is an essential factor in a company’s ability to attract and maintain top talent. Smaller and mid-sized companies may not have the bandwidth or appetite to take on the fiduciary liability of overseeing a retirement plan even though they recognize the importance of having one. However, there are many plan design options that mitigate compliance risk, eliminate the chance of failing discrimination testing, and help produce better outcomes for participants. Plan record-keepers and qualified third-party administrators continue to streamline administrative processes, thus allowing plans to operate more efficiently.”
The role of third parties in this equation cannot be understated. “Every plan,” says Zgainer, “no matter the size, has the same rules to follow: Submit deferrals in a timely manner, keep the census up to date, distribute required disclosure notices throughout the year, etc… Of course more time will need to be taken with larger companies, however there are ways to mitigate that. Partnering with a payroll company that will send the payroll/census files to your recordkeeper will help. Engaging the services of a 3(38) investment manager will significantly reduce the plans sponsors need to address, and be liable for, many required tasks not related to their lane of expertise.”
Ironically, the very thing being proposed to make retirement plans more accessible to private company employees may hurt those private company employees who currently enjoy the advantages of retirement benefits like a 401k plan. Haskell says, “The assertive push of legislatures to sanction state-run retirement plans may dissuade some small-to-mid employers to setup and sponsor their own plan. In effect, the thinking being, ‘why go to the trouble, when I can pass it off to the state?’ From the company’s standpoint, enrolling in a state-run plan that would eliminate any liability or fiduciary obligations they would otherwise incur by establishing an employer-sponsored plan would seem to make sense. However, from an employee’s point of view, there are more questions than answers: Where would money be invested and will I have suitable investment options? Will my contributions be comingled with other state funds? Why aren’t these state plans subject to the same ERISA laws that govern private employer plans?”
Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s every 401k plan sponsor and service provider wants and needs to know.
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