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 fourth 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.
The Thrift Savings Plan (TSP) is a 401(k)-like plan for federal workers. With 4.7 million participants and $443 billion in assets, the TSP is the largest defined contribution retirement plan in the United States. It is also the most efficient. TSP participants earn market returns while paying less than 0.03% of assets each year in plan administration and investment expenses.
Because of the TSP’s great size, no private sector 401(k) plan could ever hope to match its incredibly low expenses, but it is possible for any employer – no matter how small – to have a TSP-like 401(k) plan that earns market returns with low drag from expenses. I think highly-efficient 401(k) plans are the key to solving the small business retirement plan gap. They can be very cheap while protecting employers from fiduciary liability – making 401(k) plan sponsorship more attractive to small businesses.
Investments – Reliable Market Returns and Lower Fiduciary Liability
Except for its G Fund, the TSP uses passively-managed index funds for its fund lineup. These funds are the key to a highly-efficient 401(k) plan. Their investment objective is simple – earn highly-correlated market returns. This objective is different than most 401(k) plans, who try to “beat the market” with costlier actively-managed funds. The problem? Studies show most actively-managed funds fail to outperform comparable index funds, net of fees, over long periods of time.
Index funds also make it easier for 401(k) sponsors to meet their investment-related fiduciary responsibilities. These responsibilities boil down to picking three or more “prudent” investments – funds that meet their investment objective for a reasonable fee – that permit plan participants to sufficiently diversify their account. Because comparable index funds from any of the largest providers – including Vanguard, Blackrock, Schwab, and Fidelity – offer similar (market) returns and (low) fees, they make it easy for employers to avoid underperforming funds with excessive fees that increase their risk of being sued for the violation of fiduciary duty.
Advice – Target Date Funds for Low-Cost Professional Portfolio Management
Even when a retirement plan offers an all-index fund lineup, savers still need help picking the right mix of funds for their account. That is where TSP’s Lifecycle Funds come in. By investing 100% of their account in the Lifecycle fund that most closely matches their estimated retirement date, participants can have their account professionally managed.
Small business 401(k) plan sponsors can do the same by offering low-cost Target Date Index Funds (TDIFs). Using Vanguard TDIFs, a participant can pay 0.14% to 0.16% annually for advice – and that includes investment expenses! That’s far cheaper than human or “robo” investment advice.
Fees – What’s the “All-In” Fee for a Highly-Efficient 401(k) Plan?
In addition to investment selection, all 401(k) plans require three basic administration services – asset custody, participant recordkeeping, and third-party administration (a.k.a., compliance with the Employee Retirement Income Security Act, or ERISA). While the TSP is not subject to ERISA, it keeps other administration costs low by providing these services in-house, something that small firms are not able to do. Nevertheless, a growing number of firms – including Employee Fiduciary – are managing to provide these services to small businesses at a very low cost.
Unfortunately, this is not the case for all providers, as a recent survey we conducted shows. We found dramatically different fees charged to plans with less than $2 million in assets, ranging from 1.09% (or 109 basis points, in finance speak) to 2.87%. These “all-in” plan fees include investment expenses paid to asset managers and mutual fund providers investing the money.
So how can small business owners ensure they end up at the lower end of that fee spectrum? We reached the following conclusions from our study:
- Generally, brand name insurance and payroll company 401(k) providers are the most expensive, while lesser-known, “open architecture” (investment-agnostic) providers are the least expensive.
- The lower the asset-based fees a provider charges, the better. Fixed rate asset-based fees can explode plan expenses as assets grow.
- Nearly all of the insurance company 401(k) plans use variable annuities in their fund line-up. Variable annuities are basically mutual funds “wrapped” in a thin layer of insurance with additional fees and redemption restrictions. A “wrap” fee can be 1% or more, turning low- cost mutual funds into costly variable annuities.
By combining a TSP-like fund lineup and a low-cost administration services provider, employers can offer a highly-efficient 401(k) plan with an all-in fee that’s far below 401(k) plan averages.
TSP Efficiency Is the Key to Closing the Retirement Plan Gap
The TSP’s efficiency is the key to its greatness. Its low fees mean minimal drag on participant account returns. Any small business in the country can have a 401(k) that is comparable to the TSP. Will these plans pay the same low expenses as the TSP? No way, but they can still deliver highly-efficient returns – while reducing fiduciary liability and fees in the process. I think such 401(k) plans are the key to solving the small business retirement plan gap.
Eric Droblyen is President and Chief Operating Officer of Employee Fiduciary, which has provided companies and their employees low cost 401(k) plans since 2004.
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.