Fishing For The Right PensionChristopher Farrell
In large corporations these days, retirement plans are so ubiquitous that employees tend to regard them not simply as a benefit but as an inalienable right. Last year, some 97% of companies with more than 5,000 employees offered their workforce the most popular retirement option, "defined contribution" plans such as 401(k)s.
The same report showed an entirely different world at smaller companies, though. According to Access Research Inc., a benefit consulting firm based in Windsor, Conn., just 19% of companies with fewer than 100 workers had defined contribution plans, in which benefits are a function of a worker's or employer's contributions rather than years of service or salary. But things are changing fast: In an unheralded yet unmistakable trend, smaller companies are swiftly joining the private retirement system.
A key reason is demand by employees. "To attract and retain good people, smaller companies are looking to offer a better benefit package, and today, that often means including a pension," says Ray Marcinowski, senior vice-president at Fidelity Institutional Retirement Services Co. Many small companies these days are high-tech enterprises, and their educated workforce expects a pension. Casualties from Corporate America's restructuring waves are finding employment in smaller businesses and startups, and these big-company refugees are used to participating in a pension. Another important factor is well-publicized worries about the financial soundness of Social Security and retirement security with the aging of the baby boom generation.
Demand for pensions by small business has sparked a brutal struggle for market share among mutual-fund companies, insurance companies, banks, and other pension product providers--especially as the market for medium and large companies approaches saturation. "We're all duking it out in the big companies and middle market. It's a zero-sum game," says Joseph P. Healy, a vice-president at T. Rowe Price Associates Inc. "Small business is the unplowed frontier."
What kind of pension makes the most sense for small businesses? A simplified employee pension (SEP)? A salary-reduction simplified employee pension (SARSEP)? A 401(k)? "It really boils down to, how far do you want to wade into the swamp?" says Matthew R. Luoma, director of taxation at Janus Capital Corp. "How much complexity are you willing to live with, and what tradeoffs are you willing to make?"
An SEP is the cheapest option available, with minimal fees and paperwork. But it requires immediate vesting--employees can take the money with them if they leave--an anathema to those employers who prefer some financial barriers to their employees leaving. The SARSEP allows employees to defer part of their salary to the pension plan. But it is limited to businesses with no more than 25 employees, and rapidly expanding companies can easily outgrow a SARSEP. Employers also must ensure that the amounts deferred by highly compensated employees are no more than 125% of the average percentage of compensation deferred by low-paid workers. Another step up in complexity and cost is the 401(k) profit-sharing plan, a product so popular that it almost has become synonymous with retirement planning today. And that's not all.
BARE BONES. Traditionally, the small-business retirement market was dominated by insurance companies and banks. Since it's far more expensive to sell and service a small-business pension plan than a large-company plan, the traditional providers offered pension services to small businesses as part of an overall financial relationship, from group insurance to commercial loans. Mutual-fund companies, eager to grab more money to manage, have transformed the small-business retirement market by pushing "turnkey" systems, complete with standardized forms for implementing a plan in accord with IRS regulations, record-keeping services, and investment options. Yet bare-bones does not mean chintzy. T. Rowe Price's Century Plan, designed for small business, offers daily account valuation, semi-annual nondiscrimination testing, quarterly participant statements, and up to eight investment options out of more than 30 mutual funds.
SHOP AND COMPARE. The price of offering employees a retirement benefit has dropped sharply in recent years. It costs a small business with 100 employees and $300,000 in deposits an average of $1,200 to set up a 401(k). Ongoing costs per participant average $76 a year (consisting of a $49 record-keeping fee, $18 investment fee, and $9 trustee fee), according to Joseph W. Valletta, a principal at HR Investments Consultants, publishers of the 401k Provider Directory. But prices vary a lot. When Joshua Moritz, executive vice-president at DMTG Inc., a small direct-marketing advertising agency based in New York, started investigating retirement options last fall, brokerage houses, insurance companies, banks, and others eagerly made proposals--and the price for setting up a retirement plan fell from around $2,500 to $800. "There is a tremendous amount of interest, and if you shop around it gets very competitive," says Moritz.
Still, there are a lot of pitfalls for the unwary. The Chicago law firm Novack & Macey recently established a 401(k) plan for its 16 lawyers and 16 staffers. Warns Eric N. Macey: "Service people will sell you 2 or 30 or 3,000 different investment options. But as you increase the options, you also increase the administrative costs." He also worries about legal risks: "You've got to be real careful. We don't recommend investment choices [to employees] because we are concerned about liability. We have the plan people go over choices with individuals." Indeed, with retirement-related lawsuits on the rise, he advises taking out insurance, because "there is so much litigation potential among disgruntled employees."
Retirement benefit plans require a huge time commitment, too. Government regulators expect managements and owners to spend a lot of time communicating with and educating their employees about their retirement plans. And pension contribution calculations set limits on deferrals by better-paid workers if a company's overall participation rate is low. Yet lower-paid employees are often reluctant to set aside precious dollars into a retirement savings program, even if it is tax-sheltered.
Boosting participation among employees is not always easy. Look at Pape' Group Inc., a holding company based in Coburg, Ore., with 1,100 employees scattered around the West Coast. Late last summer, the company changed its existing 401(k), with a separate trustee, administrator, and investment manager for a "bundled" one-stop product offered by Fidelity Investments, the mutual-fund giant. Soon after, Pape' videotaped a 401(k) Fidelity training session for its administrators. The company then used the video at meetings it held in the evenings and at work in different parts of the West Coast last fall. Spouses were encouraged to attend the pension planning meetings, too, says Lee Wood, personal services manager at Pape'. The payoff: Participation rose from 581 to 771, and monthly contributions nearly doubled.
There's no question that adopting a pension plan at a small business can be a major headache. But to retain a valued workforce, owners of small businesses really have no choice. The good news is that, unlike the situation just a few years ago, there are now legions of eager vendors who can make the process as painless as possible.
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