In reviewing 401(k) plans, it’s apparent that too many times plans come to fruition from a smooth sales pitch rather than careful consideration of needs. It’s no longer surprising to see a 401(k) plan with fewer than 10 participants where substantial costs are passed on to each participant just for being part of the plan with no apparent benefit aside from the ability to have their contributions payroll deducted. The largest contribution might be a few hundred dollars a month, and there may or may not be matching contributions. There are limited investment options, which are often proprietary in nature, expensive, and sub-par in terms of quality. The total participant fees can be upward of 2-3%. I’ve seen a plan where one participant’s fee (for the right to be in the plan) was over 20% per year! Yikes!
Plans like the one described above are often not a good match for employees or the business. There are elevated administrative costs, various IRS filing requirements, and the additional responsibility related to choosing the setup of the plan from fees to services to investment selection.
How does this happen? Sometimes these plans are sold by a payroll company (or their partner) on the premise that it’s a nice benefit and it’s convenient. “We’ll take care of everything,” the rep will say. Or, “you’ll get a discount on your payroll by having the 401(k) plan through us.” A discount, convenience, and adding a benefit for employees which can also provide a tax break?! This pitch sounds like a win-win! Other times, plans are sold by a “financial advisor” as a great way to encourage employees to save and to provide a tax benefit to the business.
You might be thinking to yourself, “okay, so the 401(k) plan may not be a fit for every small business. I get it. But what are the other options for these businesses? And to bring it back to me, how do I know what’s a good fit for my business?”
An alternative for many small businesses who want to provide a savings vehicle for employees that incentivizes them to save is a Simple IRA. They are easy to open, contributions are payroll deducted into either a designated custodian or to a custodian of the participant’s choice, and the funds are invested according to the participant’s individual preference. This puts the participant in control, and it controls their fees and expenses.
Reporting requirements and costs are minimal for the business. This plan does require business contributions, either via match of up to the first 3% of the employee’s salary (if the employee chooses not to contribute, the employer does not match, and if the employee contributes more than 3%, the match is still only 3%) or via a non-elective contribution for all eligible employees (regardless of whether they contribute) of 2%.
This plan controls expenses and limits the responsibility of the plan administrator. The employee is responsible for choosing both the platform for the account as well as the specific investments within the platform. Depending on which option the employer chooses, this can also provide a good incentive for employees to save for retirement, as they can automatically double the first 3% of their salary by participating. Talk about motivation!
There are other alternatives to the 401(k) plan which we’ll cover in future posts. The exciting thing to take away is that there are many options to choose from that will keep expenses and administrative responsibilities down while still incentivizing employees to save! Have you assessed your plan recently? Or if you don’t have a plan, what are the biggest obstacles that are keeping you from starting one?