It would be imprudent to write about retirement plans today without acknowledging the financial and employment concerns the country is facing. Stories abound about the diminishing value of retirement accounts, and a small number of companies have opted to reduce or eliminate their corporate contributions. When the markets and employment levels are consistently going up, it is easier to see that tax-deferred growth can pay enormous “dividends.” But, even in a flat market, the inherent tax advantages of qualified retirement plans still provide a tremendous incentive for the use of such tax-preferred vehicles, and, as noted above, the need to rely on organized retirement tools is never going away. Even 401(k) plan participants who are laid off still have access to their retirement funds.
According to the U.S. government, there are some 6.3 million small businesses without any form of an organized retirement savings plan. But more importantly for insurance agents, many of these companies may now be ready to consider such a plan. This shift in attitude comes at a time when new Internet-based 401(k) technology, along with changes in approved retirement plan practices, have converged, offering significant growth opportunities for agents who choose to add 401(k) plans to their small-business service mix.
When launching such an effort, agents may benefit from some historical perspective. For decades, small-business owners have believed 401(k) plans were too expensive and too difficult to administer and exposed them to too much liability. As a result, 25 percent of business owners polled by Fidelity in 2006 did not know of any plans designed for companies of their size.
However, today, agents can offer small companies a variety of solutions from a new breed of online 401(k) providers. At the same time, they can point out that the liability and procedural concerns previously raised by business owners have been effectively removed by the Pension Protection Act of 2006 (PPA). These regulations provide a variety of safe harbors, which can limit an employer’s liability related to plan design, allowable contributions, and investment options.
Another market factor in the agents’ favor is the growing recognition by small-business owners and their employees that they alone are accountable for building up their own retirement savings.
New breed of solutions
Small-business owners often find their largest concern about any employee benefit plan is cost, followed by enrollment and administration challenges, employee retention, ability to attract new employees, and securing employees financially. Online 401(k) plan features enable agents to offer retirement benefits that respond to each of these issues.
The online 401(k) platforms have been created by a new breed of retirement plan providers. They are in the business of developing proprietary Web-based software that they use to create online plans for small businesses. As such, they perform all of the required setup, administration, calculation, reporting, and record-keeping services. The significant cost savings these plans offer are achieved because one online provider can administer plans for a large number of companies, making the initial setup costs and annual administration fees very low. So, a small business only needs the ability to connect to these software applications via the Internet in order to enter basic plan and employee information. The software does the rest.
A small company opting for an online plan will recognize its advantages as soon as it begins to set up the plan, which can be accomplished in a matter of minutes. Using a sequence of fill-in-the-blank templates, a representative can enter the required company information, plus specific plan provisions related to employer and employee contribution levels, vesting schedules, and investment options to be offered.
Once the plan is in place, additional software guides the company through processes of entering employee census information and tracking employee eligibility, enrolling employees, and processing scheduled contributions. To provide additional assistance, most online providers also have staff available to provide assistance by telephone or Web chat, if needed.
However, the majority of these online providers do not market plans directly to businesses. Their primary role in the marketplace is to develop privately labeled online plans for financial service organizations, such as banks and insurance companies, whereby those institutions market them through their existing distribution channels.
Employees need help, as well
The mere presence of a 401(k) retirement plan is often not enough to spur all employees into action, as most employees have a disappointing track record when it comes to retirement savings.
The Center for Retirement Research says more than 60 percent of workers may not be able to maintain their standard of living in retirement because of their lack of retirement savings. More than half of all working Americans have less than $50,000 saved for retirement, and 40 percent of Generation X consumers (ages 27 to 42) have saved less than $25,000 — with another 20 percent reporting no savings at all. So it should be of no surprise that the U.S. Department of Labor reports that one-third of all eligible employees fail to participate in their employers’ 401(k) plans. In addition, a Watson Wyatt survey showed that half of all employees of firms with 401(k) plans who earned between $10,000 and $25,000 do not participate.
So, how does a small business address this very real problem? One action proven effective and encouraged by the PPA legislation is for companies to simply go ahead and enroll all employees in the 401(k) plan — through an automatic enrollment election. Then, it is no longer a question of whether employees choose to participate, but rather if they will elect not to participate. This can be accomplished quickly by uploading a standard employee census through a Web interface, whereby all employees are set to a default participation rate — say 3 percent of pay. In fact, the nonprofit Retirement Survey Project reports that companies with automatic enrollment show participation rates of 80 to 90 percent — versus less than 70 percent for elective enrollment plans. However, under the PPA’s automatic enrollment rules, employees must be given a 90-day grace period to change their automatic enrollment — with absolutely no tax implications. So, the online providers are uniquely positioned to handle this kind of plan provision.
But as smart retirement planning demands that employees continue to increase their 401(k) contributions, the PPA also allows employers to create what is called a qualified automatic contribution arrangement (QACA). Under this additional safe harbor, every participant’s deferral rates are automatically increased each year according to a schedule stipulated when the plan is set up. Then, the online plan software automatically calculates these deferrals every year, making the scheduled changes for every employee.
So, whether employees join their 401(k) plan on their own or are automatically enrolled, individual employees can use the Internet or a telephone voice response system to set up their accounts and make their initial investment selections. Once enrolled, employees have 24/7 online access to review their accounts and make investment changes as they wish.
Nevertheless, many employees are poorly prepared to take full advantage of the retirement savings potential. In a 2006 survey, The Scarborough Group found that 90 percent of 401(k) plan participants interviewed were categorized as naive to some extent about investing. As a result, the PPA allows an employer to appoint a financial professional to serve as a fiduciary advisor to meet with participants.
These advisors can explain the plan, the investment options offered, and how each employee might structure their individual portfolios to meet their retirement objectives. When an advisor is serving a small business with an online plan, the provider usually offers the advisor a secure, password protected access to the plan so they can better serve the participants.
Still, a surprisingly high number of participants avoid making their own investment decisions and instead pass that responsibility on to their employer. In the past, small-business owners have viewed this as an unwanted liability. But thanks to the PPA, this is no longer the case. Companies can place its employees’ contributions in any investment designated as a qualified default investment alternative (QDIA), and be provided with yet another safe harbor to remove the potential for legal liability. The PPA establishes the guidelines for an investment to qualify.
To warrant the protection of these new safe harbors, under the PPA, employers are also required to make a minimum contribution to each employee’s account. However, a separate participant vesting schedule can be created for these corporate contributions. If an employee leaves the company before becoming fully vested in the employer’s portion of their account, those funds remain in the plan.
Insurance agents preparing to aggressively sell online 401(k) plans to the small business market should be prepared for intense competition. Banks, credit unions, financial consultants, and brokerage firms are among the segments of the financial services market that see the potential for these products. Professional and trade associations are offering plans to attract members, some state governments are exploring government-provided plans for small companies, and one major retailer has even been rumored to be considering a small-business 401(k) product. Because participant contributions are deducted from each paycheck, an increasing number of payroll service companies are now offering online 401(k) plans.
Nevertheless, with only 17 percent of small businesses offering plans today, there would appear to be ample opportunity for everyone who takes the time to understand the true retirement needs of the market and appreciate the ability of a properly managed online 401(k) plan.
Mark Gutrich is president of ePlan Services. He can be reached at 303-567-8940 or [email protected].