More than half of the 55 million Americans who are not offered a retirement plan through their employers work for small businesses. While some see this longstanding coverage gap among small firms as an unsolvable problem, others see a market opportunity. This is the sixth blog post in a series that will feature perspectives from entrepreneurs and intra-preneurs in both the for-profit and non-profit sectors who are using technology and other innovations to reach this hard-to-serve population. We hope that the resulting insights will help other market players and federal and state policymakers better understand what it will take to achieve a truly universal retirement savings system in the US.
It is now well known that most Americans who lack retirement coverage work for small businesses. But what is less well understood is that many of these individuals work for employers who actually do offer a plan. The problem is the retirement plans they offer are often poorly designed – resulting in average employee savings of about half that of employees at larger companies.
On the question of why small employers don’t offer plans in the first place, the answer is clear: the administrative burden of running a plan is overwhelming.
Today, a 401(k) plan is regulated by the IRS and the Department of Labor. That’s a lot of powerful government regulators looking over your shoulder. Big businesses have the internal resources to carefully comply with all of the regulations, but small company management teams take on that risk themselves.
Tracking employee eligibility, approving loans, meeting employee communication requirements, making payroll deferrals within the specified time frame – these are all regulated elements to a defined contribution retirement plan.
This may sound simple, but imagine you are the founder of a fast-growing retail chain. You need to be able to not only track each employee’s hours, but also be able to estimate when they will become eligible for the company’s 401(k) – and in many instances, send them the required 401(k) information a specified number of days before they work enough hours to become eligible for the plan. You should also find a way to educate them on the investment options; maybe you’ll pull them off the floor on particular days to provide this education. If they routinely make changes to their savings rates, you’ll get individual emails from your 401(k) provider with instructions on these changes, and then log into your payroll system and make the updates, one by one, to their deferral rates within the DOL’s regulated timeframe. And you are liable for mistakes that cost them money. And if they leave the company, which many likely will do, you need to help your provider get the necessary paperwork done to remove them from the plan.
We haven’t even gotten to the part where you are responsible, as a fiduciary, for picking and monitoring the investment options in your company’s plan. Or, making sure that you are providing enough investment options or fund categories so that participants can invest according to their risk tolerance and time horizon. Oh, and it’s not a bad idea to write up an investment policy statement, and to regularly benchmark the 401(k) plan as well.
So it’s no wonder small businesses owners often decide not to offer a plan at all.
Even those who do offer retirement plans – and many do try to provide this service to their workers –- often offer plans that are poorly designed and thus fail to maximize participation or savings.
Small firms end up paying more in fees since they have less purchasing power than larger companies. Employees at smaller companies typically pay fees between 1.5% and 2% of assets versus employees of larger companies who usually pay below 0.50%. That extra 0.72% a year in fees for the small business employee could result in $390,000 less at retirement.
Small businesses’ employees are hurt by more than just steep 401(k) fees. Traditional 401(k) plan design may inadvertently discourage employees from saving, as employees must opt-in to participate. This means that they must not only know about the plan, but must take action to sign up for the plan. Today, the best-designed plans use automatic, opt-out enrollment to increase participation, and then something called automatic escalation to ensure workers increase their savings rate over time. These features have been proven effective, and yet many employers, including roughly three-quarters of small firms, still do not use them.
Traditional 401(k)s also put the onus on employees to make complex investment decisions. Just as small business owners are not often equipped to select a fund lineup for their plans, small business employees are typically not prepared to understand the difference between actively managed and passively managed funds, or between total stock market funds and growth funds. When my company, ForUsAll, takes over advising existing 401(k) plans, we often find that many employees have incorrect investment exposure for their ages.
ForUsAll, along with several other technology startups (read their thoughts here and here), are reimagining the 401(k) using modern design strategies. The limitations of the current system can be overcome by putting the end users, the small business owner and their employees, first.
Technology enables 401(k) systems to be designed in a way that automates manual tasks like calculating employee eligibility or links payroll systems with 401(k) recordkeeping platforms. Regulatory work and compliance testing can also be automated.
Finally, we believe that the traditional “chat and chew” 401(k) sessions championed by traditional advisors have become obsolete, and a well-designed electronic communication flow can deliver effective employee education. Coupled with easy to understand qualified default investments that automatically select age-appropriate funds for new participants, the employee onboarding experience can be seamless and easy for both the company and employee, and get employees saving for retirement.
These technology-facilitated simplifications can mean more small employers offering plans, and, for those already offering, higher participation rates and better savings outcomes.
Despite decades of trying, incumbent 401(k) providers have not succeeded in closing the small business retirement gap. My firm has decided to focus our efforts on improving “broken” small business 401(k) plans – retirement plans that are paying egregious fees, that suffer from low employee participation and savings rates, and that expose the business to excessive regulatory work and risk. I’m confident that new players like ForUsAll and others can combine technology with a customer-first mindset to crack the code.
Shin Inoue is the CEO of ForUsAll, a next-generation small- and mid-sized business 401(k) advisor. Prior to ForUsAll, Shin was Director of New Business at Financial Engines, a pioneer in democratizing access to high quality, personalized investment advice that today manages more than $100 billion in retirement assets. He led the design & development of Financial Engines’ two flagship products, including the managed accounts product, which is generally considered the first, and most successful, robo-advisor.
The views and opinions of the author are his own and do not necessarily reflect the view of the Aspen Institute Financial Security Program or its funders.