A recent study by SurePayroll, a company that provides payment services, found that more than 70% of small firms didn’t offer a 401(k) plan to their employees. That comes at a time when American workers as a whole have more cash than ever in 401(k) plans—an average of $80,600 as of the second quarter of this year, according to Fidelity Investments.
Why the disconnect? “There are perceptions [the plans] are hard to administer, expensive to start,” says Andrew H. McIlhenny, co-founder of Firstrust Financial Resources, a financial advisory firm in Philadelphia. “Additionally, many small companies may not feel they or their employees would see much benefit due to a lack of interest in participating.”
Why offer a plan: The obvious reason is to attract and retain workers. Following salary and health coverage, retirement benefits are the third-most-important factor in driving employee loyalty in small businesses, according to a 2012 MetLife study.
Owners can participate in the plans as well, and they can be set up for companies that are essentially sole proprietorships. That can be important, considering that a business owner can put more money away in a 401(k)—up to $17,500 per year (and up to $23,000 for those 50 or older)—than in an IRA, which has a limit of $5,500 (or $6,500 for those 50 or older).
On top of that, small businesses can get a credit up to $500 per year for the first three years to offset the costs to establish and administer the plan.
What they cost: Every plan comes with fees, which employers often pass along to workers. Record-keeping expenses generally range from 0.25% to 1% of the money in the plan, while investment-management expenses will vary depending upon both the manager and the investment choices.
Add it up, and costs can easily reach 3%. In addition, any plan with more than 100 participants must undergo an annual audit, which can add to the cost.
There are also plans that charge a flat fee. For example, the Online 401(k) has plans for small businesses (up to 100 workers) that start at around $1,200 annually, plus a $4 monthly charge per employee.
One potential drawback to these types of arrangements: They may not be attractive to new participants. Since everyone in the plan is paying the same amount in fees, it can mean that an employee who’s just starting out in the 401(k) is shelling out just as much as somebody with years’ worth of accumulated assets.
What help they offer: Service is another important consideration, since many small firms may need help introducing the 401(k) plan to employees and providing ongoing investment advice. In such instances, the small-scale financial professional may be a better option than the giant fund company, says Brooks Herman, head of research at BrightScope, which rates 401(k) plans. That’s because the large firms are probably “not coming by the office” to speak to workers, he says. “It’s more like, ‘Here’s a number to call a phone bank.’ “
What structure works best: It’s tempting to offer a robust plan with a large number of investment choices. But it’s also critical not to go overboard.
“If you give them too many choices, they may not make the right choices,” says Neil Smith, executive vice president of Ascensus, a retirement-plan provider.
Many financial professionals suggest capping the selections to no more than about a dozen funds, covering the major investment categories. Just as important, say the pros, is to offer a balanced or target-date fund—one that invests in both stocks and bonds—for employees who would rather not determine the investment mix themselves.