Retirement Security: Challenges and Prospects for Employees of Small Businesses
Released: 2013-07-16T00:00:00

Letter

Small Employers Face Challenges Helping Their Workers Save for Retirement

Complex Rules, Resource Constraints, and Financial Instability Contribute to Low Rates of Plan Sponsorship by Small Employers

As we reported in March 2012, retirement plan sponsorship is low among small employers, which may reflect the challenges employers face in establishing and maintaining a plan. Our analysis of available Labor and IRS data found that about 14 percent of small employers sponsored some type of plan in 2009. As shown in figure 1, the smallest employers—those with 1 to 4 employees—had the lowest sponsorship rate at 5 percent but even employers with 26 to 100 employees had a sponsorship rate of 31 percent. To put this in context, about 50 percent of the private sector workforce at any one time participates in an employer-sponsored pension plan. Also, small employers paying average annual wages of $50,000 to $99,999 had the highest rate of plan sponsorship at 34 percent while small employers paying average wages of under $10,000 had the lowest sponsorship rate at 3 percent.

When we met with small employers and other stakeholders, they identified a variety of factors as challenges to sponsoring retirement plans or as reasons for terminating existing plans. One commonly cited concern focused on the multiplicity of plan types and the burden of paperwork and administration. For example, some small employers and retirement experts said that the broad range of plan types and features made it difficult for small employers to compare and choose plans. Another small employer who previously sponsored a 401(k) plan with a company match said the amount of required plan paperwork, including generating annual reports, was a key reason he terminated it.

Other areas of concern for small employers centered on a sponsor’s fiduciary responsibilities with respect to managing or controlling plan assets. Specifically, some small employer sponsors found the fiduciary responsibility of selecting investment fund choices for their plans particularly challenging. A small employer with a 401(k) plan described the difficulties of selecting investment options with an appropriate balance of risk for a workforce that includes both younger and older workers. Moreover, a number of stakeholders said some small employers may not have an adequate understanding of their fiduciary duties and are not always aware of all their legal responsibilities. One service provider explained that some small employers mistakenly believe that all fiduciary responsibilities and liabilities are transferred to a service provider when they are hired. Another expert noted that some small employers have an exaggerated sense of the possible liabilities that being a fiduciary carries, and may avoid sponsoring a plan out of fear of being sued by their employees.

In addition to these challenges, smaller or newer firms may be unwilling or unable to sponsor plans because they lack sufficient financial resources, time, and personnel. For instance, smaller employers noted that startup and ongoing costs involved with maintaining a plan, costs associated with reporting and testing requirements, administrative fees paid to an outside party, and any employer requirements to match employee contributions were barriers to plan sponsorship. Small employers also expressed the need to reach a certain level of profitability before they would consider sponsoring a plan and that general economic uncertainty makes them reluctant to commit to such long-term expenses.

Low employee demand for an employer-sponsored plan may also be a challenge for small employers. For example, a number of small employers stated that employees prioritized health care benefits over retirement benefits. One small employer thought that, given the limited funds available to contribute towards benefits, his employees would prefer those resources be applied toward lowering the employees’ share of health insurance premiums. Small employers emphasized that offering health care benefits was necessary to attract quality employees. Additionally, some small employers, such as those who described having a younger workforce, stated that their employees were less concerned about saving for retirement and, as a result, were not demanding retirement benefits. Other small employers told us that employees, particularly those with low pay, do not have any interest in retirement benefits because they live paycheck to paycheck and are less likely to have funds left over to contribute to a plan. For example, one small employer discontinued his plan when too few of his employees—most of whom he described as low-wage—participated in the plan. Another small employer noted that even senior-level managers in his business did not participate in the plan. However, a retirement expert stated that while some employees might not be interested in participating in a retirement plan, he believed the perceived lack of demand to be exaggerated. He added that he believed some businesses may use lack of employee demand as an excuse when the small employer was not interested in sponsoring a plan.

In March 2012, we made a recommendation to Labor to convene an interagency task force with the Department of the Treasury, IRS, SBA, and other appropriate agencies to review, analyze, and address the challenges small employers face in helping ensure retirement security. The agencies generally agreed with this recommendation, however, Labor disagreed with one aspect of our recommendation, which was for the task force to create a single webportal for federal guidance. We believe consolidating plan information onto one webportal could benefit small employers, mainly because federal resources are scattered across different sites. We also made a recommendation to the Department of the Treasury to collect additional information on IRA plans.

Participants of Small Employer 401(k) Plans are Likely to Pay Higher Fees

Small employers are more likely to sponsor 401(k) plans and participants of these plans tend to pay higher fees than larger plans. According to our analysis of Labor and IRS data, out of slightly more than 712,000 small employers that sponsored a single type of plan in 2009, about 46 percent sponsored a 401(k) plan, 40 percent a SIMPLE IRA, and the remaining employers sponsored other types of plans, including DB and non-401(k) Experts have identified low contribution rates as a profit sharing plans.key problem facing workers seeking to secure an adequate retirement income. In 2011, the average account balance of 401(k) plans with 100 or fewer participants was about $59,000. This may reflect the challenges facing participants in small plans of not only contributing faithfully, but also investing prudently and avoiding high fees.

Regarding fees, plans with fewer than 100 participants account for the majority of 401(k) plans, and these plans usually pay higher fees. According to industry experts and research, plans with fewer participants generally have lower plan assets, and therefore pay higher fees as a percentage of assets than plans with more assets or older plans that have grown their assets over time. Service providers and an industry expert we met with noted that administrative fees to start a 401(k) plan can be significant for small plans. Additionally, representatives of a retirement industry organization said that it may be difficult for sponsors of small plans to negotiate for lower fees because assets in these plans are modest.

In April 2012, we reported that participants in smaller plans typically pay higher fees than participants in larger plans. Specifically, our nationally representative survey of plan sponsors found that participants in plans with fewer than 50 participants paid an average of 0.43 percent of their plan assets annually, while participants in larger plans—those with more than 500 participants—paid 0.22 percent for record keeping and administrative services. On top of these fees, participants likely paid other plan fees. For example, according to survey results, in about 69 percent of small plans, participants paid all of the investment fees (see fig. 2 for additional details), which ranged from less than 0.01 percent to 3.24 percent of assets.

32 disclosure of service providers’ direct and indirect compensation; and before regulations to disclose certain plan and investment-related information, such as fees, to participants and their beneficiaries in participant-directed individual accounts were in effect. 29 C.F.R. §§ 2550.408b-2 and 2550.404a-5 (2012).

GAO-12-325. This work was conducted before Labor finalized regulations regarding 33 For further details on the design of our 401(k) plan sponsor survey on fees, see GAO-12-325.

Little Information Available About Current MEPs and Their Potential to Increase Small Business Sponsorship

As we reported in September 2012, little is known about the employers that participate in MEPs, or even the number of MEPs by type, in part because the federal government no longer collects these data. As of 2009, the most recent data available for our September 2012 report, MEPs represented only a small portion of the pension universe. Specifically, DB MEPs represented 0.7 percent of all DB plans, about 6.0 percent of all DB assets and 5.0 percent of all DB participants. DC MEPs represented about the same percentage of all DC plans, assets and participants. In our September 2012 report, we found smaller employers in MEPs were mainly participating in association-sponsored MEPs. Two associations told us their participating employers averaged between 20 and 60 employees. However, one MEP sponsored by a PEO reported that the typical participating employer in its plan was small as well. In particular, little data exist on the current number of PEO or open MEP plan types, their asset size, the number of participants, or the participating employers. Relative to other MEP types, PEO and open MEPs are the newest, and may be the only types actively marketing their MEPs to participating employers.

MEPs have been suggested by PEO and open MEP representatives as a viable way for small employers to reduce their administrative responsibility for their pension plans. Several MEP representatives said MEP administrators can complete the record keeping and the annual testing, and can submit required filings such as a single Form 5500 for the MEP on behalf of all the participating employers. Furthermore, employees can more easily move among employers in the plan. For example, in a DB MEP sponsored by an association, as long as a participant remains an employee of an employer within the association, participants can change employers and continue earning vesting service credit in the same plan. A small employer sponsoring a single employer plan can also contract with a service provider to perform administrative functions, but a couple of interviewees said employers not already offering plans might find it easier and faster to join a MEP than to create their own single employer plan. MEPs have also been suggested by some as a possible means to lower the costs of plan sponsorship, since participating employers can pool assets to obtain lower pricing available to larger plans. One expert we spoke with said that certain association plans have been very effective at offering efficient, cost-effective retirement options for their members. Furthermore, a couple of interviewees said MEPs may also reduce costs for employers since they will not need to spend money to create an initial plan document, as they would in establishing a new single-employer plan.

As we found in September 2012, another possible benefit of MEPs, according to some MEP marketing material, is reducing participating employers’ fiduciary liability since the MEP administrator takes on some fiduciary duties. However, it is not clear how much relief from fiduciary liability a MEP can provide to participating employers, and it is not clear that such relief is unique to MEPs. For example, small employers may also be able to receive a similar degree of reduced fiduciary liability by using a service provider to administer the employer’s own plan. Because small employers may not be familiar with how to manage a plan, reduced fiduciary liability may be an attractive feature for them, and, in our March 2012 small employer report, small employers identified possible fiduciary responsibility as a barrier to sponsoring a pension plan. However, while MEP representatives and MEP marketing materials sometimes stated otherwise, participating employers retain some fiduciary responsibility, according to Labor officials. At a minimum, participating employers must still select a MEP to join and monitor a plan’s investments and fees, which Labor considers a fiduciary function.

Overall, no consensus existed among MEP representatives and pension experts on the potential for MEPs to substantially expand coverage. Large associations can provide the option of joining a MEP to their members. That option is unavailable to small employers not part of a membership organization looking out for their interests. The extent to which small employers can join a MEP may depend on whether a MEP is actively marketed and sold, since one pension expert observed that small employers do not extensively research pension plans or actively seek them out. Additionally, employers who choose to become part of a MEP for the first time may already have been providing a plan for their employees. While a couple of the MEP representatives we spoke with specifically targeted employers without plans, several targeted businesses with existing plans.

From Labor’s perspective, their primary regulatory concern centers on one type of MEP, the open MEP. During our review for our September 2012 report, Labor issued an advisory opinion stating that one particular open MEP did not constitute a pension plan under ERISA because it was not established or maintained by an employer or an employee organization. Labor determined that, in the case of this MEP, participating employers did not constitute a bona fide employer group or association, sufficient to be considered an employer sponsoring the arrangement, because, among other things, they did not exercise sufficient control over the plan. As a consequence of this guidance, the participating employers in that open MEP were instead determined to each be the sponsors of their own, individual plans. Association MEP representatives told us Labor’s guidance had no affect on their plans.

As a practical matter, Labor’s ruling is being treated by many as meaning that individual participating employers in an open MEP have to comply with any reporting, auditing, and bonding requirements on an individual rather than aggregate basis. In our September 2012 report, we noted that a number of compliance-related questions were left unanswered for open MEPs. treatment, IRS might still consider an open MEP to be one plan rather than a series of individual plans. In an effort to remove confusion for plan sponsors, we recommended Labor and IRS coordinate their interpretations and develop compliance-related guidance. Labor and IRS generally agreed with our recommendations on coordination.

Additionally, we noted that, for purposes of preferential tax Labor’s expectation is that the recently issued opinions on open MEPs will serve as guidance to the pension industry at large. However, despite the ruling on open MEPs from Labor, pension experts and MEP representatives told us that broader policy questions remain. The opinion did not provide Labor’s view on the potential of open MEPs to lower plan costs or expand coverage, but we were told by MEP representatives and pension experts that open MEPs will continue to receive the attention of policymakers for that reason. At this time no one knows for certain how many open MEPs there are, who is in them, or how they may affect future pension coverage. Pension experts cautioned that any legislative change allowing certain open MEPs should ensure that there are appropriate safeguards to protect plan participants.

GAO-12-665.

Labor officials said the potential for inadequate employer oversight of a MEP is greater than for other pension arrangements because employers pass along so much responsibility to the entity controlling the MEP. Labor officials noted that potential abuses might include layering fees, misusing assets, or falsifying benefit statements. One pension expert agreed that there is potential for MEPs to charge excess fees without the enrolled employer being aware. While Labor officials acknowledged that single employer plans could be subject to similar abuses, they cautioned that the way a MEP is structured and operated could make it particularly susceptible to abuses.can be important. Representatives of MEPs maintained by associations we interviewed said they had an appointed board made up of association members who served as the named fiduciaries of the plan. Most of these associations required board members to also participate in the MEP. However, the extent to which open MEPs have or would have such structures in place is unclear. Given the limited knowledge some plan sponsors have of the fees they pay and their fiduciary responsibilities, it would appear that some such governance structure or related safeguards is warranted to protect employer and participant interests.

For this reason, the structure of a particular MEP Labor’s lack of data to identify different MEP sponsor types or any employers participating in MEPs limits the agency’s ability to protect MEP employers and participants. To ensure Labor has information needed to oversee MEPs, in September 2012, we recommended that Labor gather additional information about the employers participating in MEPs, potentially through the Form 5500, which is the primary source of pension plan information for government oversight activities. Labor officials said the number of participating employers or the names of participating employers could be useful oversight information. The agencies generally agreed with our recommendation on gathering additional MEP-related information and said they will consider MEP-related changes to the Form 5500 as part of their regular evaluations. We consider this an important first step, and await any proposed or scheduled changes to data collection.

Concluding Observations

For workers at small employers, building an adequate level of income for retirement is becoming increasingly challenging. Particularly for small employers, the low level of plan sponsorship means that many of their workers may enter retirement with little or no income outside of Social Security. Small employers also face some greater challenges to sponsorship than larger employers and they often have less time, fewer resources and personnel to handle them. The potential advantages of multiple employer plan design are appealing in this context, however, current data and information, as well as other safeguards, will be necessary to ensure that small employer interests are protected and promises to participants are not broken.

Chairman Harkin, Ranking Member Alexander, and Members of the Committee, this completes my prepared statement. I would be pleased to respond to any questions that you may have at this time.

GAO Contact and Staff Acknowledgments

GAO Contact and Staff Acknowledgments

For further information about this testimony, please contact Charles A. Jeszeck at (202) 512-7215 or jeszeckc@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this testimony. Tamara Cross, Assistant Director; James Bennett, Edward Bodine, Sarah Cornetto, Patrick diBattista, Chuck Ford, Gene Kuehneman, David Lehrer, Ted Leslie, Sheila McCoy, Thomas A. Moscovitch, MaryLynn Sergent, Roger Thomas, Frank Todisco, Kathleen van Gelder, Lacy Vong,and Craig Winslow were key contributors to this testimony.

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