Chapter 19
Offering a 401(k) Plan
IN THIS CHAPTER
Considering employees’ needs and fees
Finding a provider to suit you
Picking investment vehicles and advisors
Deciding on a plan
Pooling with other employers
Letting employees know about the plan
In this chapter, I focus on 401(k) issues that affect small employers from a one-person show to a partnership to a small family-run business to small businesses with fewer than 15 regular, full-time employees.
Meeting the needs of both the company and the employees can be a delicate balancing act. It becomes especially tricky because there are many ways plans can be set up, and lots of financial service companies are vying for retirement-plan business.
This chapter is written to help you clarify the choices. If your company doesn’t have a plan, check out Chapter 18 for information about starting a plan. In fact, I strongly recommend doing this before you consider the 401(k) choices here unless you’re over 50 and are able to contribute the 2021 $26,000 maximum contribution.
Managing retirement funds is a serious matter that can potentially expose the employer to liability. Employees have a very strong interest in the plan. After all, their retirement security is at stake!
First Things First
A 401(k) plan is a big deal to administer. You need an operational structure that begins with deducting contributions from employees’ paychecks and goes on to handle everything up to and including benefit distributions for departing employees.
When you set up a 401(k) plan, you’ll probably have an eye on the bottom line — how much your company has to pay to set-up and run the plan. After all, the cost has to fit into your budget. However, getting the best deal for your company shouldn’t be the major issue when you set up a plan for you and your employees. The best financial deal for your company may prove to be very expensive if it results in a lot of employee dissatisfaction and possibly a lawsuit.
The IRS and DOL both have the right to audit any employer’s 401(k) plan. Such an audit is like a tax audit. Everything is reviewed to see whether the plan is operating within all the applicable laws and regulations. See the nearby sidebar, “An audit is never good news” for a cautionary tale.
The next sections point out important issues to consider — government regulations and money.
Prioritizing employees: Being a fiduciary
ERISA, the Employment Retirement Income Security Act, includes many requirements for retirement plans and the people who run them. One of those requirements is that a company’s decisions about plan investments must be made considering solely what’s in the employees’ best interest — in other words, the plan administrator has a fiduciary obligation. You don’t run a 401(k) plan to benefit yourself or even your company; you run it to benefit your employees.
Many employers have the misperception that selecting an organization or organizations to run a 401(k) plan gets them off the hook with legal requirements and potential liability. Folks, this just ain’t so. You can’t get out of this responsibility by hiring someone else. It’s like paying someone to prepare your tax return: If that person makes a mistake, you’re still the one held responsible by the IRS. A financial advisor or someone else may share the fiduciary responsibility, but the employer has the ultimate responsibility.
A CEO once asked how he can avoid having fiduciary responsibility. I told him the only way was to not have a 401(k) plan. Regulations have changed since then enabling an employer to reduce but not eliminate its ERISA fiduciary responsibility.
IRA-based plans are not subject to ERISA regulations, so you don’t have fiduciary responsibility if your retirement plan is an IRA.
You must monitor the performance of investments offered by your 401(k) plan and make changes when appropriate. Changing plan providers can be a big deal, so do this only if you have a good reason. (For example, your provider may leave the business or be sold, you may outgrow the relationship, the funds may perform badly, be too expensive, or service may be bad.)
Exploring the world of fees
Who pays the plan fees and how are key considerations of any retirement plan? Participant-paid fees are deducted directly or indirectly from 401(k) accounts and reduce investment return. One sure way to improve the investment return is to reduce the fees paid by the participants.
Some organizations’ representatives may tell you that you don’t pay any fees. Don’t fall for this line. (You’d be surprised how many intelligent businesspeople do!) There are substantial services associated with running a 401(k), and companies don’t provide these services for free. The question isn’t whether a specific plan provider gets paid, but how and how much it gets paid.
Revealing the fees (or not)
Retirement plan providers charge fees in one of two ways:
- Directly: You’re presented with an invoice.
- Indirectly: Fees are deducted from assets in the plan.
Direct-billed fees are easy to track because they leave a paper trail in the form of invoices. However, asset-based fees may be hidden because they’re paid as automatic deductions from the return investors receive on their mutual funds or other investments. The participant has a lower return because these fees are taken out.
Indirect fees have no direct connection to the actual value of the services provided because they’re based on the value of the investments. The fees increase as plan assets grow even though no additional services are provided. Over time, the total fees can become quite excessive unless you renegotiate them.
These fees are buried, so sales representatives can tell companies that they don’t pay any fees. This statement is true in the sense that you don’t write a check to the particular financial organization. However, money is deducted from the participants’ accounts, reducing the value of the accounts.
Fund management fees must be disclosed in the prospectus for retail mutual funds (those available to all investors) but not for other types of investments that may be offered to 401(k) participants. The prospectus includes only the investment management fees. It doesn’t include information about other 401(k)-related fees. The provider may deduct additional fees directly from the plan.
The Department of Labor (DOL) requires all employers to disclose all fees before participants join the plan. Not surprisingly, higher-cost providers are usually reluctant to disclose their fees, while lower-cost providers are happy to do so. As a result, the DOL Section 408(b)(2) fee-disclosure forms providing the mandated fee information are often difficult to understand.
Larger employers also try to comply with the Department of Labor Section 404(c) regulations, which can provide some relief from fiduciary liability for participant-directed investments. Complying with Section 404(c) isn’t required, but Section 408(b)(2) fee disclosure is required. These regulations require employers to provide participants with sufficient information to make informed investment decisions. It’s obviously difficult to make informed investment decisions without knowing what fees are paid. As an employer, be aware that if your employees aren’t fully aware of the fees charged to them, it can result in failure to comply with Sections 404(c) and 408(b)(2).
Fees are expressed in basis points, with one basis point equal to 0.01 percent, and 100 basis points equal to 1 percent. Here’s an example of how higher fees can affect participants’ accounts. Say your plan has 100 participants and $2 million worth of assets. If it’s run with fees of 75 basis points (0.75 percent) or less, including all investment and administrative services, the fees total $15,000 or less. However, if a service provider charges fees of 200 basis points (2 percent), annual costs will total $40,000 (2 percent of $2 million). The $25,000 difference goes to the plan provider rather than to the 401(k) participants’ accounts (that’s $250 less, on average, for each participant), and this shortfall will get bigger along with account balances each year.
Unfortunately, many employers are only concerned about the fees the company pays. These employers fail to realize that they must also effectively manage the fees that participants pay. A good financial deal for the company doesn’t have to result in a bad deal for employees. Those with the largest account balances (usually owners and/or senior executives) are impacted the most by high participant fees.
The level of fees participants pay is determined largely by the way the plan is structured and whether you, the employer, pay the non-investment fees. As the employer and sponsor of the plan, you determine how the plan is structured and who pays the non-investment fees.
The participants may pay as much as 2.75 percent for the same funds that are available via another plan provider for as little as 0.15 percent. The way the plan is structured has the biggest impact on the fees the participants pay. More about that later.
Paying — participant versus employer
Assume employees are participants in different 401(k) plans that include the S&P Fortune 500 fund as one of the investments. One of the plans is structured so that all fees are paid by participants. This plan has a recordkeeper, investment advisor, and a third-party administrator. The total fees paid by the participant are 2.5 percent for the S&P Fortune 500 fund.
The other plan is structured so that all non-investment fees are paid by the employer. The fee these participants pay for this fund is 0.04 percent.
A participant in the first plan with a $10,000 investment in the S&P Fortune 500 Index fund pays $250 in fees during the current year. A participant in the second plan with $10,000 invested in the same fund pays only $40 in the current year. The investment return is reduced by the fees that are paid; therefore, the participant with the 2.5 percent fee will receive a 2.46 percent lower investment return resulting in a much smaller nest egg.
Which plan would you rather participate in?
The best option for the employer is to pay all non-investment fees. The government will help you do that. This will enable you to offer a plan that will cost participants, including the owners, as little as 0.08 percent instead of 1.5 to 2.75 percent of your account balances annually in fees.
Keeping fees at a reasonable level
Your plan should give participants at least as good a deal as they can get investing on their own outside the plan. The only way to accomplish this for a small employer is for the employer to pay all the non-investment fees, which means you need to carefully consider all the fees charged to the plan.
For example, an investor — call him Joe — can buy essentially any mutual fund through an IRA and pay only the regular management fee charged by the mutual fund company. Joe can do research and find funds that cover different investment categories (large-cap stocks, short-term bonds, ETFs, CDs, and so on) and are among the top performers. It doesn’t matter if they’re from different fund families, because Joe can invest with different fund companies or go to a fund supermarket such as Charles Schwab, Vanguard, or Fidelity. In short, Joe has a lot of investment freedom in his IRA. Joe should be able to get at least as good a financial result through his 401(k) — a broad range of quality funds with total fees equal to what he would pay investing in his own IRA.
He can, in fact, invest in index target date mutual funds (increasingly the most popular 401(k) investment option) for as little as 0.08 percent. The same type of funds offered in a small employer’s 401(k) can cost between 1.5 and 2.75 percent, unless the employer pays all the plan’s administrative fees. Paying 2.75 percent in annual fees instead of 0.08 percent greatly reduces the value of a 401(k) even when there is a matching contribution. A 50 percent matching employer contribution is a great benefit; however, paying 2.67 (2.75 minus 0.8) more in fees each year for 30 years of participation in a 401(k) plan greatly reduces this wonderful benefit.
Choosing a 401(k) Provider
Getting good advice is challenging for small employers starting a 401(k) plan because the major service providers and qualified financial advisors want plans with $10 million or more of plan assets. Plans with $1 million to $10 million in assets are targeted by insurance companies offering bundled packages that usually involve a financial advisor and third-party administrator. The total fees paid by the participants for this combination of service providers usually are in the 1.75 to 2.75 percent range. The market is much more limited for small employers who are starting a plan that doesn’t have any assets.
Employers commonly make bad decisions when they pick their first provider, but they get smart after changing providers a time or two. Employers who are with the top providers tend to change less frequently. Managing the administrative process during a change of providers is challenging for many reasons. Use the information I have provided in this book to select the best plan for your business and to set it up, so it is good for your business and the participants.
Getting up close and personal — why you shouldn’t
Small employers are commonly sold a 401(k) plan from someone the business owner knows. In such instances, the business owner typically agrees to whatever their friend or acquaintance recommends, so it’s not an informed decision.
A personal friend who is a broker, financial advisor, or 401(k) consultant can add value to the selection process and to your participants, but you need to know what you’re buying and have solid reasons for your decision. All costs should be revealed, so you and your participants can evaluate costs versus the services the friend provides.
The most common mistake employers make is to let a personal relationship, rather than economics, influence the selection of a 401(k) plan provider. I have heard stories from participants about bad plans that were run by a friend/nephew/cousin of the boss. Participants are often afraid to complain for fear of losing their jobs.
Unfortunately, higher-cost 401(k) products are usually sold through personal relationships. Blindly buying a 401(k) product from a friend without comparing it to others isn’t a good way to handle the ERISA fiduciary requirement of picking investments that are solely in the best interest of your participants. Thoroughly checking the quality of the investments and all direct and indirect costs is in the best interest of all parties involved — including you.
Streamlining the process with outside help
Fees and investment options are not the only things to consider when setting up a 401(k) plan. Streamlined administrative processing is important especially to small businesses that don’t have the staff to take on these tasks. Following are ways to streamline the administrative process:
- Complete online enrollment of participants.
- Automate payroll deduction of employee contributions, including the data needed to make the payroll deductions.
- Compute the amount of employer matching and other contributions.
- Submit employee and employer contributions and investment splits to the record keeper electronically.
- Monitor maximum employee and employer contribution limits.
- Provide participants with unlimited online access to account information, including investment information and the ability to change their contribution rate and investments.
- Automate distribution of all required information to participants, including all the information that must be provided to a participant leaving the plan.
- Complete Form 5500, an annual reporting form for 401(k) plans to provide specific information to the IRS and DOL. The specific requirements have been and still are in a state of flux; therefore, check the requirements each year.
Currently Form 5500 is required for plans with 100 or more employees, Form 5500-SF is required for 401(k) plans with less than 100 employees, and Form 5500-EZ for a one-participant plan with $250,000 or more of assets. An audit is required if your plan has 100 or more participants. If an audit is required, hire an independent accountant to provide that service.
You can hire a payroll service that integrates these and other 401(k) services with your business’s payroll processing. Paychex and APD are the two largest companies providing these and other human resource and benefit outsourcing services for small and medium-sized businesses. One of these businesses can provide all the support you need to start and run a 401(k) plan with or without using a financial advisor. There are also smaller regional firms that can provide 401(k) support; however, you’ll probably need an investment advisor and third-party administrator.
Online 401(k) service providers were created to help small businesses start their plans. The employer pays the fees needed to set up and administer the plan. Guideline (www.guideline.com) is one such provider. Their fee for setting up a plan is $500, and the administrative fees are $49 per month plus $8 per active participant per month. Their annual administrative fees for a plan with 10 active participants are $1,548 ($49 plus $8 times 10 times 12).
Guideline also offers
- A wide range of mutual funds including six managed portfolios that are invested in Vanguard mutual funds that cost only 0.15 percent
- Direct links to some payroll companies making it easier to streamline the administrative process
Guideline also offers two other levels of service with higher fees and a wider range of plan design options and other additional services. The monthly fee is $79 or $129 for these two tiers, and the active participant fee is still $8 per month.
The $49 base fee option is a good alternative for a new 401(k) plan. Giving participants access to the structured portfolios provides participants sufficient investment flexibility at a cost of only 0.15 percent. That’s certainly much better than the plans offered by most of the major service providers that are in the small employer market.
When you contact Guideline or any other 401(k) service provider, keep in mind that their primary goal is to sell you their services, which requires getting you to buy a 401(k) plan — even if an IRA-based plan may be a better alternative.
Going to a third party (the second one was lame)
Another option for a business starting a 401(k) is to retain an independent full-service third-party administrator (TPA). A TPA can provide all the services needed to set up and administer a 401(k) other than choosing and overseeing the investments.
The TPA can suggest the investments, but you must decide which investments to offer. The TPA can also recommend an investor advisor if you want someone to help you pick and manage the investments; however, finding a good advisor is difficult for a plan without any assets unless you’re willing to pay a fee for this service.
The fee a TPA charges is a bit higher than an online service provider’s, but you gain greater plan design and investment flexibility because a TPA enables you to pick any investments that are legally permitted. The plan can be structured to give each participant access to a brokerage account so that everyone has an opportunity to pick their own investments, choosing from thousands of mutual funds, stocks, bonds, EFTs, CDs, and more.
Trident Retirement Services, LLC, is an independent TPA that purchased a TPA I co-founded and managed for many years. Their fee for setting up a 401(k) plan is $1,000. Their annual administrative fee is $2,500 plus $50 per participant. The annual total is $3,000 for a 10-participant plan. The fees are higher for a plan with a brokerage account structure. Their website is www.trident-retirement.com.
TPAs specialize in this business, so they’re usually good at it, but you still need to be as discerning as you would be with any other supplier of a product or service. For example, a TPA may have strong ties to a major financial organization and may encourage you to use 401(k) funds offered by that company. Make it clear early on that you want investment flexibility. If a particular TPA can’t give you the investment flexibility you need, consider another one. As a reminder, a TPA that services 401(k)s is interested in selling you a 401(k) and isn’t likely to suggest considering an IRA-based plan alternative.
Choosing Investments and Advisors for Your 401(k) Plan
The quality of the investments offered in your 401(k) is the most important consideration when running a 401(k) plan. Unfortunately, many other issues commonly overshadow the quality of investments when companies decide how to run their 401(k)s. I recommend putting investing at the top of the list.
Most service providers in the small employer 401(k) market offer mutual funds from the same mutual fund families; therefore, a wide range of similar investments should be available regardless of the organization you select to set up and administer your plan.
A fund family is a group of mutual funds offered by an investment company. If you invest only at T. Rowe Price, for example, you’ll be limited to funds in the T. Rowe Price family. This choice may be fine with you, or you may prefer to own funds from other companies as well.
Most 401(k) service providers offer mutual funds from a number of fund families; make diversity of investment choice a priority when selecting a service provider.
Your 401(k) plan should make a wide range of funds available to participants so that they can properly diversify among the various classes of investments. The funds your 401(k) offers in all investment categories (asset classes) should have track records placing them in the top half among their peers or even higher.
Fees for these investments shouldn’t be more than what the fund company would charge an investor outside a 401(k). Consider using only plan providers that openly and willingly explain the fees that the employer and participants pay.
401(k) products can be packaged in many different ways, making it difficult to evaluate the various alternatives.
Small business seeking a 401(k) advisor
Determining the number and type of investment choices you want your plan to offer is an important first step in setting up a 401(k) plan. Most employers with millions in assets use an investment advisor to help make these decisions. If you’re in this situation, an investment advisor can help you select the funds, choose a service provider, and provide the support participants need. It’s common for businesses to seek an investment advisor when their plans grow from nothing into millions of dollars.
I strongly recommend considering an advisor with years of experience who specializes in the 401(k) market and 401(k) plans.
I also strongly recommend retaining a fiduciary advisor who complies with the Securities and Exchange Commission (SEC) standards that became effective in June 2019.
These standards require an advisor to
- Act in your best interest
- Act with undivided loyalty and utmost good faith
- Provide full and fair disclosure of all material facts, defined as those “a reasonable investor would consider to be important”
- Not mislead clients
- Avoid conflicts of interest (such as when the advisor profits more if a client uses one investment over another) and discloses any potential conflicts of interest
- Not use a client’s assets for the advisor’s own benefit or the benefit of other clients
Get a written agreement with the advisor that
- Explains the services that will be provided
- Explains how the advisor is compensated
- States that all services provided will be as a fiduciary following the SEC’s fiduciary advisor standards
Selecting the investments
The funds you choose should depend largely on the needs of your participants, including factors such as how many participants you have and their level of investment knowledge.
For example, if most of your participants aren’t very interested in or knowledgeable about investments, offer fewer than ten funds so that they won’t be overwhelmed. However, this limited menu won’t satisfy the investment-savvy folks who are used to sorting through thousands of funds when they invest outside the plan. The easiest answer is to give the investment-savvy participants an unlimited fund menu by offering a mutual fund brokerage window. Most 401(k) service providers are able to include a mutual fund window or a full brokerage account that gives participants a wider range of investment choices than a typical limited menu.
Figuring out what types of funds to offer
Participants should have the opportunity to invest in large-cap, mid-cap, and small-cap stocks as well as a bond or stable value fund. (I discuss investment classes and funds in Chapter 13.) A money market fund isn’t a good long-term option, but it is a good place to park money during uncertain times. An international stock fund is another alternative many participants like. You should also provide a mix of managed and index stock funds and value and growth funds.
It’s important to give participants the opportunity to diversify their investments. By this, I don’t just mean that you should offer both stocks and bonds (or other fixed investments), although this is certainly true. I mean that you should offer different types of investments within the stock and bond categories.
After you decide what types of funds to offer, you’re ready to consider the specific funds to use. Use an independent investment consultant or research to help you through this process because you can’t always rely on the descriptions that come from the fund company.
Another approach if you’re starting a plan and want to keep it simple, is to include only Target Date Funds (TDFs) for investing and a money market fund for parking money short term. TDFs are mutual funds geared toward and named with a target retirement year, such as 2025, 2040, and so on. Each fund holds a wide array of different stocks and bonds. A participant can easily invest in one of these funds without having lots of investment knowledge.
An easy way out if you’re starting a plan is to use a payroll provider such as Paychex or an online 401(k) service provider like Guideline and to include only TDFs or other structured funds.
Participants need to understand these are funds that will go up and down in value — sometimes substantially.
Establishing your investments in this manner gives you substantial fiduciary liability protection. The Pension Protection Act of 2006 includes a provision for Qualified Default Investment Alternatives (QDIA). Participants who fail to submit their investment options can be placed into QDIA. TDFs qualify as QDIAs. As a result, limiting your plan’s investments to TDFs limits your liability exposure because participants are limited to QDIA investments. Doing so also greatly reduces your responsibility to provide sufficient information to participants to help them make informed investment decisions because they won’t be building their own portfolios. They don’t need to know the difference between large-, mid- and small-cap stocks, and so on because the investment vehicles are determined by the company offering the TDF.
Many financial advisors aren’t thrilled about TDFs because they eliminate the need to hire a financial advisor to help pick and oversee a 401(k) investment menu. Picking index TDFs offered by Charles Schwab or Vanguard enables you to provide solid investment alternatives to your participants with fees in the 0.08 to 0.14 percent range rather than the 2 percent and up fee range that is typical with small employer 401(k)s.
Wrapping Up a Package of 401(k) Plans
Some providers offer to run 401(k)s without charging employers any fees. Not surprisingly, these providers win most of the business. You may wonder how they can survive without charging you a fee. The answer is that your plan does pay fees, indirectly. (Check “Revealing the fees (or not)” earlier in this chapter.) In this section, I help you understand the most common ways 401(k) products are packaged.
Major mutual fund companies such as Fidelity, Putnam, T. Rowe Price, and Vanguard control a large segment of the 401(k) business. These fund companies offer full-service (bundled) 401(k) products that provide everything you need. If your plan is large enough and has high average account balances, Fidelity, Putnam, and T. Rowe Price will run the plan without charging any fees other than the normal fund management fees. (Fund management fees are deducted by the fund company, reducing participants’ returns.) Vanguard actually reduces its fund management fees for larger investors. As a result, it may charge participants fees for non-investment 401(k) services such as record keeping and compliance testing. (All fee information was correct at the time of writing, but it may, of course, change.)
For example, the funds you select with Fidelity, Putnam, and T. Rowe Price may charge investment fees averaging around 90 basis points (0.90 percent). If your plan has $30 million of assets, the fees are $270,000 per year. The fund mix you select with Vanguard may average 30 basis points (0.30 percent), or only $90,000. This is why Vanguard may have to charge additional fees for non-investment services.
The fees for non-investment services can be paid from plan assets — in other words, they can be paid from participants’ accounts rather than by the employer. Assume that Vanguard charges $15,000 in addition to its $90,000 in investment management fees. That’s a total of $105,000. If this money is deducted from plan assets, the total cost to the participant rises to 35 basis points (0.35 percent) — still much lower than what the other fund companies charge.
The point is that you don’t have to select higher-priced funds for your participants in order to give yourself (the employer) a break from paying fees. If you select funds with lower investment management fees, any additional administrative fees can be paid by the plan rather than by you, the employer. This can substantially reduce the cost to participants without changing your cost. This is an example of a win-win strategy for both participants and employers.
Of course, fees aren’t the only reason for selecting a particular investment. The ultimate goal is to get the best investment return for your participants, which means that you must consider the actual net return after expenses.
The previous example is just that — an example. The situation for your particular company may be different. Be sure to do thorough research before selecting the firm or firms to provide 401(k) services for your company.
Most of you run plans that are a lot smaller than $30 million. Your plan may be so small that none of the fund companies I mention earlier in this section want to handle it. For example, assume that your plan is in the $1 million to $5 million range. The people calling you get paid for selling 401(k) plans. They usually represent a group of providers offering a product that carries additional asset-based fees (fees charged as a percentage of the assets in the plan) to cover the compensation paid to the broker and other costs of the provider. These additional charges are usually around 100 to 150 basis points (1 to 1.5 percent). When these fees are added on top of the fund management fees, the total fees are typically in the range of 200 to 250 basis points (2 to 2.5 percent).
If your plan has $5 million of assets, 200 basis points is $100,000 per year — a substantial sum. These fees come directly from plan participants. It’s amazing that business-savvy senior executives, who are paying the largest share of these high fees, are willing to accept this result. Your smaller business can avoid large fees with an IRA-based plan, which I talk about in Chapter 18.
One alternative for avoiding these high fees is to hire a third-party administrator (TPA) to run your plan. (See the section, “Going to a third party (the second one was lame)” earlier in this chapter for more info.) Typically, a TPA charges about $15,000 annually for all non-investment services for a plan with $5 million of assets and 200 participants. Say your current provider is charging 200 basis points (2 percent), or $100,000, in fees for the bundled plan. Further assume that the investment management fees total $50,000 (100 basis points), and the provider charges an additional $50,000 (100 basis points) for non-investment services. You can replace the provider with a TPA that lets you keep the same funds in your plan and lower the total cost of the plan from $100,000 to $65,000 ($50,000 plus $15,000). The additional $35,000 would go directly to your participants.
You may be able to find other ways to lower the plan’s costs even further, such as working with the TPA to select lower-cost and better-quality funds.
Joining Up: MEPs, PEPs, and PPPs
How would you like to be part of an MEP (a multiple employer plan), a PEP (a pooled employer plan), or a PPP (a pooled plan provider)? Getting involved in any of these acronym plans gives you and your employees access to a traditional, safe harbor, or QACA 401(k) — the same plans you can choose from if you set up a plan on your own. I talk about the various plans you can offer in Chapter 18.
Benefits of both MEPs and PEPs include the potential for reduced fees, simplified administration, reduced liability, and potential savings.
As a business owner, you’re likely to be approached by MEP and PEP marketers at some time. Don’t assume that what they’re offering is better than what you can do on your own. Check out alternatives rather than making what appears to be an easy decision. MEP and PEP organizations want you to start a 401(k) rather than consider IRA-based alternatives.
Here is my sales pitch: For a one-time, $200 fee, I will help you decide what type of retirement plan is best for your small business and help you choose one of the 401(k) alternatives or one of the IRA-based alternatives. I have no financial stake in what you decide or in the organization where you decide to set up the plan. I will also help you set up the plan you pick.
Seeking common ground: MEPs
MEPs have been around for many years. A multiple employer plan is a retirement plan initiated by two or more unrelated employers. They’re available to businesses within a similar industry — auto dealers, construction companies, and so on. The National Auto Dealers Association (NADA) has supported a plan for its members for many years. NADA has assumed the responsibility of selecting the service provider and overseeing their services including pricing. If the structure is already in place, you can move more quickly into the plan set-up stage.
A major problem with an MEP is what’s known as the “one bad apple” rule. Under this rule, all employers participating in the MEP face consequences if one of the members does something that results in disqualification.
If a plan is disqualified, it loses its tax-favored status. Both the employer and participants suffer tax consequences when this happens. The one bad apple rule can also impact all other employers and participants included in the MEP. The Secure Act provides protection from this rule, hopefully eliminating this problem.
If you belong to a professional association for your business, check whether one of the membership perks is easy entry into an MEP. Likewise, the ability to join an MEP may be reason enough to become a member of a trade association. I’ve known auto dealers who joined NADA mainly because it was an easy decision about a retirement plan.
Connecting PEPs and PPPs
A PEP is required to follow the same set of regulations and requirements as an MEP except it may include businesses from different industries. A PEP must be administered by a pooled plan provider (PPP), which is a financial service company or other entity registered with the Secretary of Labor and the Secretary of the Treasury.
PEPs were included in the Secure Act and became effective on January 1, 2021. The “one bad apple” rule that has been a negative for MEPs doesn’t apply to PEPs. PEPs are required to file a single Form 5500 for the PEP, thus eliminating the need for each adopting employer to file a Form 5500. This is a huge plus for employers with 100 or more employees because the Form 5500 requires an independent audit of the 401(k) plan for such employers. Because PEPS are new, they will evolve over time and will grow in popularity if the entities running them deliver the expected benefits.
A 401(k) Is a Terrible Thing to Waste: Educating Employees
If you run your plan on your own, an area where you’ll need help is investment education for your employees. One of the many Section 404(c) requirements is to provide adequate information for employees to make informed investment decisions. The TPA that you select may be able to run investment education meetings, but many 401(k) plans don’t offer education. If yours doesn’t, you’ll have to look elsewhere.
You can check out investment education services via a web search. I don’t know any of them; therefore, I can’t recommend one. I do recommend, however, finding one that doesn’t offer financial services and/or products. That way you don’t have to worry that the reason you’re being offered a product is because the organization has an interest in offering other services to your participants. Stick to one that provides only educational services.