Private Pensions: Better Agency Coordination Could Help Small Employers Address Challenges to Plan Sponsorship
Released: 2012-03-07T00:00:00

Letter

Background

To encourage employers to establish and maintain retirement plans for their employees, the federal government provides preferential tax treatment under the Internal Revenue Code (IRC) for plans that meet certain requirements. In addition, the Employee Retirement Income Security Act of 1974 (ERISA), as amended, sets forth certain protections for participants in private-sector retirement plans and establishes standards of conduct for those that manage the plans and their assets, generally called fiduciaries. To the extent they qualify as fiduciaries under the law, plan sponsors assume certain responsibilities and potential liability under ERISA. For example, a fiduciary must act prudently and solely in the interest of plan participants and their beneficiaries, which may require documenting decisions relating to the plan, including hiring outside professionals or service providers that advise and help administer plans. Small employers may choose a plan for their employees from one of three categories: employer-sponsored IRA plans; defined contribution (DC) plans; and defined benefit (DB) plans Appendix II presents (often referred to as traditional pension plans).information provided by Labor and IRS about some of the various types of retirement savings plans available to small employers.

Employer-sponsored IRA plans: Employer-sponsored IRA plans allow employers and, in some cases, employees to make contributions for deposit in separate IRA accounts for each participating employee. These plans generally have fewer administration and reporting requirements than other types of plans. Participating employees bear the full investment risk of their account assets. There are two types of employer- sponsored IRA plans. Savings Incentive Match Plans for Employees (SIMPLE) IRA plans require employers to either match their eligible employees’ voluntary salary reductions (typically up to 3 percent of compensation) or to contribute 2 percent of compensation for each eligible employee. The second type is the Simplified Employee Pension (SEP) IRA plan, which can be sponsored by an employer of any size, and has higher employer contribution limits than the SIMPLE IRA plan. In a SEP IRA plan, employer contributions are voluntary and employee salary reductions are not permitted.

Defined contribution plans: DC plans allow employers, employees, or both to contribute to individual employee accounts that are grouped under a single plan. Employee salary reductions, if provided under the plan, may be pretax or after-tax, in some cases. As with employer-sponsored IRA plans, employees participating in DC plans bear the full risk of investment and will realize any returns (gains or losses) on those investments. DC plans tend to have higher limits for employee contributions but also more rules and reporting requirements than employer-sponsored IRA plans. For example, some DC plans may be required to conduct annual testing in order to ensure that the contributions or benefits provided under the plan do not discriminate against rank-and-file workers in favor of highly compensated employees,. In addition to nondiscrimination testing, some DC plans may also be subject to top-heavy requirements and be required to conduct further testing to ensure a minimum level of benefits are provided to rank-and-file workers in plans that are sponsored by owner-dominated firms, where the majority of benefits accrue to “key” employees, such as owners and top executives. As we have previously reported, top-heavy requirements are intended to address a greater potential for tax-shelter abuses in such plans. Top-heavy requirements are most likely to affect smaller plans (fewer than 100 participants), according to the IRS. The most common type of DC plan is a 401(k) plan. In 401(k) plans, employees can defer a portion of their salary—pretax or after tax, if permitted by the plan—for deposit into a separate retirement account. Employers may also choose to make additional contributions (such as contributing a percentage of each eligible employee’s salary), match the amount contributed by the employee, or both. One type of 401(k) plan, the safe harbor 401(k) plan, is not subject to some of the requirements associated with traditional 401(k)s that generally require annual plan testing. However, under safe harbor 401(k) plans, employers are required Another type to make certain contributions to each participant’s account.of tax-qualified DC plan, the profit sharing plan, gives the employer the discretion to determine annually whether and how much to pay into the plan, within certain maximum limits. Employer contributions, if any, are allocated to each employee according to the terms of the plan.

The assets held in DC plans and employer-sponsored IRA plans are not insured by the Pension Benefit Guaranty Corporation. requirements, nondiscrimination testing, and top-heavy requirements. Operating DB plans typically requires the expertise of an actuary.

Over the years, Congress has responded to concerns about lack of access to workplace retirement plans for employees of small businesses with legislation to lower costs, simplify requirements, and ease administrative burden. For example, The Revenue Act of 1978 and the Small Business Job Protection Act of 1996 established the SEP IRA plan and the SIMPLE IRA plan respectively, featuring fewer compliance requirements than other plan types. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) also included a number of provisions that affected small businesses. For example, EGTRRA eliminated top-heavy testing requirements for safe harbor 401(k)s, increased contribution limits for employer-sponsored IRA plans and 401(k) plans, and created a tax credit for small employers to offset startup costs, including the cost of educating employees about a new plan. EGTRRA also created a tax credit for individuals within certain income limits who make eligible contributions to retirement plans. The Pension Protection Act of 2006, among other changes, made these EGTRRA provisions permanent and established additional provisions that support retirement plan participation by rank-and-file employees, such as automatic enrollment.

To help encourage plan sponsorship, federal agencies conduct education and outreach activities and provide information about retirement plans for small employers. Labor, IRS, and the Small Business Administration (SBA)—which maintains an extensive network of field offices—have collaborated with each other and with national and local organizations to develop information on small employer retirement plans and conduct outreach with small employers. For example, Labor, IRS, SBA and the U.S. Chamber of Commerce partnered to create the Choosing a Retirement Solution Campaign, which targets small employers and their employees.retirement plan guidance for small employers, highlight key aspects of and differences between various plans and features, including tax benefits for employers and employees. Labor also worked with the Society for Human Resource Management and the American Institute of Certified Public Accountants (AICPA) on the Fiduciary Education Campaign to provide retirement plan fiduciaries with information about their fiduciary responsibilities under ERISA.

The campaign’s educational materials, including web-based In addition, various private-sector service providers, from individual accountants, investment advisers, recordkeepers, and actuaries to insurance companies and banks, assist sponsors with their retirement plans. Some sponsors hire a single provider that offers a range of plan services for one fee—sometimes referred to as a “bundled” services arrangement. Other sponsors hire different providers for individual services under an “unbundled” arrangement, paying a separate fee for each service. Plan services include legal, accounting, trustee/custodial, recordkeeping, investment management, and investment education or advice. Service providers can also assist with plan administration functions, including nondiscrimination testing, top-heavy testing, and filing of government reports. Some providers also include payroll services, which further centralize an employer’s administrative services through a single company. Labor provides some guidance for plan sponsors in selecting and monitoring plan service providers. Further, the American Society of Pension Professionals & Actuaries (ASPPA) publishes a list of certified firms that adhere to ASPPA’s standards and best practices concerning recordkeeping and administration services for retirement plans.

Number of Employees and Average Pay Level Greatly Influence Plan Sponsorship

More Employees and Higher Average Wages Increase the Likelihood of Plan Sponsorship

GAO found that the number of employees and average wages greatly influence the likelihood that a small employer will sponsor a retirement plan. Further, the regression analysis using Labor and IRS data found that small employers with larger numbers of employees were the most likely of all small employers to sponsor a retirement plan, as were those paying average annual wages of $50,000 to $99,999. Conversely, employers with the fewest employees and the lowest average annual wages were very unlikely to sponsor a retirement plan.

A separate GAO analysis using Labor and IRS data found an overall small employer sponsorship rate of 14 percent in 2009.sponsorship rate does not include small employers that sponsor SEP IRA plans because IRS currently does not have a means to collect these data, which limits what is known about small employers that sponsor SEP However, the plans. According to IRS, its Form 5498, “IRA Contribution Information,” includes some SEP information; however, the agency is unable to link this information to an employer’s employer identification number (EIN). As a result, IRS can identify participants in SEP plans but not sponsoring employers.proposed a change to the form to allow IRS to identify SEP IRA plan sponsors, officials said the proposal was not adopted.

While the IRS Tax Forms and Publication Committee Further examination of sponsorship rates looking at small employer characteristics found that those with 26 to 100 employees had the highest sponsorship rate—31 percent—while small employers with 1 to 4 employees had the lowest rate—5 percent (see fig. 1). Additionally, even though small employers with 26 to 100 employees made up only 10 percent of the overall small employer population, they sponsored more retirement plans than employers with 1 to 4 employees.

Looking at the average annual wage characteristics, small employers with average annual wages of $50,000 to $99,999 had the highest rate of retirement plan sponsorship at 34 percent while small employers with average wages of under $10,000 had the lowest sponsorship rate—3 percent (see fig. 2). Further, despite having a smaller overall population, small employers with average annual wages of $50,000 to $99,999 sponsor almost three times as many retirement plans compared to small employers paying average wages of under $10,000. As a point of comparison, the overall annual average wages for employees working for small employers was about $38,000.

Analysis of the Labor and IRS data examining the interaction between both characteristics—number of employees and average annual wages— illustrates how sponsorship rates increase as numbers of employees and average annual wages increase. For example, the plan sponsorship rate for employers with 26 to 100 employees and average wages of $30,000 to $49,999 was more than nine times higher than employers with the same number of employees and wages below $10,000. Further, the sponsorship rate for small employers with 26 to 100 employees exceeded 75 percent when average wages were $50,000 or higher. In contrast, small employers with 1 to 4 employees reached their highest sponsorship rate of 13 percent when average annual wages were $50,000 or more; however, sponsorship rates were still about one-sixth the rate for small employers with 26 to 100 employees in the same wage category. Our analysis showed the sponsorship rate for employers with one to four employees lowered the overall sponsorship rate in the average annual wage categories. For example, the figure shows that small employers with average annual wages of $100,000 or more have an overall sponsorship rate of 26 percent, but this is much lower than the sponsorship rates for small employers with five or more employees. Figure 3 shows small employer sponsorship rates by size of employer and average annual wage paid.

In examining the geographic distribution of sponsorship rates, small employers in the Midwest and Northeast were more likely to sponsor plans, while employers in the West and South were less likely.in examining data on individual states, Connecticut, Wisconsin, and Washington, D.C., had the highest rate—with Washington, D.C., showing the top rate of 23 percent. Florida and Mississippi had the lowest Further, sponsorship rates at fewer than 10 percent. Figure 4 shows the percentage of small employers that sponsor plans by state.

According to GAO analysis of Labor and IRS data, 401(k) and SIMPLE IRA plans were overwhelmingly the most common types of plans sponsored by small employers. Out of slightly more than 712,000 small employers that sponsored a single type of plan, about 86 percent sponsored either a 401(k) or a SIMPLE IRA plan. Additionally, non- 401(k) DC plans, which include non-401(k) profit sharing plans, make up 11 percent of the plan type population; SARSEP IRAs are 3 percent, while DB plans make up only about 1 percent of the small employer sponsor population.sponsored by small employers.

Plan Complexity and Resource Constraints Were Most Frequently Cited Barriers to Retirement Plan Sponsorship

Many Small Employers Find Retirement Plans Complex and Burdensome to Start and Administer

Small employers and other stakeholdersadministration requirements, fiduciary responsibilities, and top-heavy testing requirements as complex and burdensome, often citing these factors as barriers to sponsoring retirement plans or as reasons for terminating them. identified various plan options, Plan options and administration requirements: Small employers and other stakeholders said that plan options and administration requirements are frequently complex and burdensome and discourage some small employers from sponsoring a plan. For example, some small employers and retirement experts said that the number of plan types and features make it difficult for small employers to compare and choose plans. Representatives of a plan service provider said that too many plan options overwhelmed small employers, making it more difficult for them to choose a plan and, ultimately, less likely that they will sponsor one. Some stakeholders also described the administrative burden of plan paperwork, such as reviewing complicated quarterly investment reports or complying with federal reporting requirements—like those associated with required annual statements—as particularly burdensome. For example, one small employer with a DB plan described a dense and highly technical quarterly investment report for his plan that ran 50 pages, making it difficult to glean summary financial information about the plan. Another small employer who previously sponsored a 401(k) with a company match said the amount of required plan paperwork, including generating annual reports, was a key reason he terminated it. Stakeholders also identified interim amendment requirements as burdensome for plan administration. Plan sponsors generally submit plan documentation to IRS periodically to ensure that plans are up to date and compliant with relevant federal statutes and regulations. However, when statutes and regulations change, some sponsors may be required to modify plan documentation and resubmit their plan documents to IRS. Some stakeholders, including small employers, a small business advocacy organization, and plan service provider, said that complying with interim amendment requirements can be costly and time consuming for small employers. IRS has recognized that interim amendment requirements pose a burden to plan sponsors. However, an IRS official noted that most small employer plans are likely based on plan designs that are preapproved by IRS, and interim amendment requirements are likely to entail little administrative burden for most small employer sponsors.

Fiduciary responsibilities: A number of stakeholders indicated that understanding and carrying out a sponsor’s fiduciary responsibilities with respect to their qualified retirement plans presents significant challenges to some small employers. Plan sponsors may qualify as fiduciaries under ERISA, for example, if they have discretionary authority or control over the management of the plan or control the plan assets. Fiduciaries have a number of responsibilities, such as the duty to act prudently, in the sole interest of the participants and beneficiaries, and to diversify the investments of the plan. Some small employer sponsors found the selection of investment fund options for their plans particularly challenging. A small employer with a 401(k) plan described the difficulties of selecting appropriate investment options, with an appropriate balance of risk, for a workforce that includes younger and older workers. A number of small business advocates and retirement experts said that not all small employers have an adequate understanding of their fiduciary duties and are not always aware of all their responsibilities under the law. For example, a retirement expert said that small employers that do not consult with plan professionals often lack the time and expertise to understand complicated fiduciary rules under ERISA. 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 liabilities that being a fiduciary carries, and may avoid sponsoring a plan out of fear of being sued by their employees.

Top-heavy requirements: Top-heavy requirements are most likely to affect smaller plans (fewer than 100 participants), according to IRS. A number of stakeholders said compliance with the requirements is often burdensome and poses a major barrier to plan sponsorship for small employers. Small employers with high employee turnover may face an even greater likelihood of becoming top-heavy. According to some experts, employee turnover alone can force some small employers out of compliance with top-heavy requirements as they replace departing employees. Over time, rank-and-file employees separate and take their plan assets with them, while long-term employees, such as business owners or executives, continue to contribute to the plan, eventually leading to a top-heavy imbalance of plan assets. For example, one small employer with a 401(k) plan stated that, because two of the four owners had worked for the company for about 25 years and their retirement accounts made up the majority of the total plan assets in the 401(k) plan, the plan had become top-heavy.

To comply with the top-heavy requirements, sponsors of certain plansare required to test their plans annually. An employer’s failure to make certain adjustments to a plan deemed top-heavy can result in it losing its tax-qualified status and the associated tax advantages for the employer and employees. A number of stakeholders stated that top-heavy compliance is confusing and can pose significant burdens on some small employers. For example, some retirement experts said that small employers whose plans are found to be top-heavy may encounter a number of additional costs in the effort to make their plans compliant, such as hiring a plan professional to make corrections to the plan document and instituting a minimum top-heavy employer contribution for all participating rank-and-file employees. According to one expert, in some cases, the costs of mandatory contributions to employees’ accounts may prevent owners from making contributions to their own retirement accounts, and may make some small employers reluctant to sponsor a plan, or may drive those that sponsor a plan to terminate it. Sponsors can avoid top-heavy testing by adopting a safe harbor 401(k) plan with no additional contributions, which is not subject to top-heavy requirements. However, safe harbor 401(k) plans require the employer to make either specified matching contributions or a minimum 3 percent contribution to each participant’s account. According to representatives of the accounting professional, the additional cost to the employer of required contributions under a 401(k) safe harbor plan may offset the advantages of sponsoring such a plan.

Federal Guidance Is Available to Address the Complexities Associated with Plan Sponsorship but May Lack Visibility among Small Employers

Federal agencies provide guidance that can assist small employers in addressing some of the challenges of starting and maintaining retirement plans. Labor and IRS, often in collaboration with SBA, have produced publications, conducted workshops, and developed online resources, among other efforts, to assist small employers in understanding options, requirements, and responsibilities of running a plan. For example, Labor and IRS jointly published a guide that compares various features of different plan types, including IRA, DC, and DB plans. Both agencies have also developed websites and online tools to help small employers navigate plan information and make informed decisions about plan options. For example, IRS’s Retirement Plans Navigator is a key component of its education efforts for small employers and is designed for employers that are less likely to hire a service provider. According to IRS, the navigator is intended to lead a novice through basic information on retirement plans and compliance. Similarly, Labor, in collaboration with the American Institute of Certified Public Accountants (AICPA), developed an interactive website highlighting small employer retirement options. The website introduces employers to a number of plan options from simpler IRA plans to more complex automatic enrollment 401(k) plans, and describes the advantages and features of various plan types. According to Labor, employers with as few as two employees can find options using the tool.

However, a number of stakeholders suggested that many small employers are unaware of federal resources on retirement plans. For example, the Advisory Committee on Tax Exempt and Government Entities (ACT) recognized that, despite the numerous IRS retirement plan resources available, many small employers and other stakeholders in the small business community are unaware of these resources. ACT indicated these resources could go a long way in addressing the needs of the small employers were it not for their lack of visibility. The lack of visibility of federal guidance on small employer plan options may be due, in part, to difficulties in finding useful, relevant information across federal websites. For example, while Labor’s webpage on small employer retirement plan options contains links to relevant topics, such as compliance assistance, participants’ rights and fiduciary responsibilities, it is easy to navigate away from but difficult to return to the content developed for small employers because there is no consistent page navigation menu for small employer information. Furthermore, while the Labor website includes guidance on selecting and monitoring plan service providers, there is no link to the guidance on the small employer plan options page. IRS’s Retirement Plans Navigator is located on a separate website from the rest of the agency’s online plan resources for small employers. When navigating from the page on small employer retirement plan resources on IRS’s main portal to the agency’s Retirement Plans Navigator, a message alerts users that they are leaving the IRS website and entering another government website. IRS officials noted that small employers who participated in focus groups on IRS plan resources reported challenges to understanding plan-based information when navigating these resources. Furthermore, Labor and IRS present their online content separately, which makes it necessary for an employer to navigate both agencies’ websites to gather complete information about starting and maintaining a retirement plan. For example, to review information on fiduciary responsibilities, users must visit Labor’s website, and to review information on nondiscrimination and top-heavy testing, users must visit IRS’s site. Neither agency maintains a central web portal for all information relevant to small employer plan sponsorship, though such portals exist for federal information resources in other areas such as healthcare. Consolidating Internet-based services and information is also consistent with one of the purposes of the E-Government Act of 2002 to promote interagency collaboration in providing electronic government services.

Small Employers Identified Lack of Financial Resources, Time, and Personnel as Deterrents to Sponsoring Retirement Plans

Small employers that lack sufficient financial resources, time, and personnel may be unwilling or unable to sponsor retirement plans. In particular, stakeholders stated that plan sponsorship may be impractical for smaller or newer firms that are unable to undertake the commitment to sponsor a plan. For example, one expert noted that the first priority of a small employer is remaining in business, and this focus may preclude sponsoring a retirement plan as a benefit to employees until the firm becomes more established.

Financial resources: Small employers, especially those with lower profit margins or an unstable cash flow, could be less willing or less able to sponsor a retirement plan because of the one-time costs to start a plan and the ongoing costs involved with maintaining the plan. These costs can result from start-up activities, complying with reporting and testing requirements, and fees paid to an outside party for administration tasks. Stakeholders stated that these expenses can make sponsoring a plan unappealing. For example, one small employer stated that as a new business owner, she thinks it is better for her business to proceed cautiously and avoid adding to her fixed cost structure. Additionally, any requirement for small employers to match employee contributions or to make mandatory contributions to an employee’s account can also increase costs. Further, small employers stated that general economic uncertainty makes them reluctant to commit to such long-term expenses and explained that they needed to reach a certain level of profitability before they would consider sponsoring a plan. For example, one small employer stated that he wanted to be able to expect consistent profits over several years before he would consider investing in a plan. Another small employer stated that she wanted to triple her business revenue to a little less than $1 million before she would consider sponsoring a retirement plan.

Time and personnel: Some small employers stated they may not have sufficient time to administer a retirement plan themselves or lacked the personnel to take on those responsibilities. For example, one small employer said that he was not prepared to assume the burden of managing a plan as he thought it would require almost daily attention and did not have the staff to devote to it. Further, a plan service provider described how the focus of the small employer would not be on absorbing the additional time that starting and maintaining a plan would require. Additionally, a plan sponsor employer stated that, since her business did not have a dedicated human resources person or accountant, she performed these duties herself, as she would ultimately be responsible for any mistakes. Further, small employers may not have time to develop the expertise to investigate or choose financial products, select the best investment options, or track their performance. For example, one small employer described how business owners without the financial expertise to compare and select from among different plan options would likely find the experience intimidating.

Small Employers Report That Insufficient Incentives and Lack of Employee Demand Discourage Plan Sponsorship

Some small employers stated that they may be less likely to sponsor a retirement plan if they do not perceive sufficient benefits to the business or themselves. For example, several small employers stated that their firms sponsored retirement plans in order to provide the business owners with a tax-deferred savings vehicle. One small employer stated that his firm evaluated the plan annually in order to determine whether it continues to benefit the owners. A service provider observed that the cost of mandatory contributions—such as those associated with safe harbor 401(k) plans—can discourage small employers, since the cost of the contributions can outweigh the benefit to the owners.

Low employee demand for an employer-sponsored retirement 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. Further, one small employer stated that his employees perceived a more immediate need for health care benefits, while perceiving retirement benefits as a future concern. Additionally, some small employers, such as those who described having younger workforces, 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.

Plan Service Providers Help Small Employers Meet Some but Not All Retirement Plan Needs

A number of small employers indicated that they use plan service providers to address various aspects of plan administration, which enabled them to overcome some challenges of starting and maintaining a plan. For example, one small employer said his service provider addresses his plan testing requirements and educates employees about the plan. Another employer noted that her business would not have the time or the expertise to administer their plan without a service provider. A third employer stated that he would not be able to administer a plan without the assistance of a service provider to help navigate the complexity of plan administration.

Some stakeholders said that service providers offer small employers plan administration solutions by providing basic, affordable plan options. For example, one service provider said a small employer could sponsor a plan for an administrative fee as low as $1,200 annually. They and other retirement industry representatives said they are able to provide plan options at affordable rates because they market and administer IRS pre- approved standard plans in high volume, thereby reducing the costs of administration. Even so, while some small employers said the fees service providers charge were affordable, others said they were too high. Further, some stakeholders pointed to other limitations of using service providers, such as the difficulties of choosing a provider, setting up a new plan through a provider, and switching to a new provider, as well as the significant plan responsibilities that remain with the sponsor. For example, a small employer described the process of finding a service provider and setting up a plan as particularly difficult, especially for an employer with little knowledge of retirement plans or experience in working with a service provider. Another small employer said she was not satisfied with the services of her current service provider but would not consider switching to a new one because of the administrative hardships that would entail. Finally, as representatives of the accounting profession noted, even with the assistance of a service provider, small employer sponsors often continue to have significant plan responsibilities, such as managing plan enrollments and separations, and carrying out their fiduciary duties.

Proposed Options to Spur Plan Sponsorship Target Simplification, Incentives, and Education

Stakeholders Proposed Simplifying Requirements and Increasing Tax Credits to Encourage Plan Sponsorship

Stakeholders provided several suggestions targeted at addressing some of the administrative and financial challenges they believed inhibited plan These proposals, which they said could reduce complexity sponsorship.and ease administrative and financial burdens for small employer plan sponsors, included simplifying plan administration rules, revising or eliminating top-heavy testing, and increasing tax credits.

Simplify plan administration requirements: Several stakeholders suggested proposals that could simplify plan administration requirements and ease administrative burdens for small employers. For example, representatives of a large service provider stated that there is a need for simplification of existing rules and processes for retirement plans and proposed easing nondiscrimination and top-heavy testing requirements as an example. Similarly, several small employers said that federal regulators should strive for simplicity in requirements governing plan administration. A small employer who sponsored a 401(k) plan suggested reducing the amount of paperwork as an example. Another small employer who sponsored a 401(k) plan said federal regulators should “just keep it simple.” One proposal from a national small business association would simplify plan requirements by reducing the frequency of statements sent to certain plan participants, from quarterly to once per year, and allowing some required disclosures to be made available solely online. Another proposal, advocated by IRS, would simplify plan requirements by streamlining interim amendment requirements—an aspect of plan administration that stakeholders identified as particularly burdensome for some small employers. Each year since 2004, IRS has published a cumulative list of changes in plan qualification requirements that must be incorporated by plan sponsors. An IRS official stated that IRS is proposing to replace a requirement for some interim amendments with a requirement for notices to be sent directly to employees. These notices would explain how a plan intends to comply with changes to relevant laws and regulations and could reduce the burden for plan sponsors by reducing the number of times plan documents must be amended. The amendments that would be subject to the less-stringent requirement would be those triggered by changes to laws and regulations but that do not affect plan benefits.

Revise or eliminate top-heavy testing: A number of stakeholders proposed revising or eliminating top-heavy testing to ease administrative and financial burdens. For example, representatives of the accounting profession told us that top-heavy testing is duplicative because there are other plan testing requirements intended to detect and prevent plan The representatives and discrimination against rank-and-file employees. officials of a large service provider told us lack of plan participation or high turnover among a business’s rank-and file employees frequently cause plans sponsored by small employers to become top-heavy. As a result, the representatives said top-heavy testing should be revised or eliminated.

Increase tax credits: Some stakeholders believed that tax credits, in general, are effective in encouraging plan sponsorship and that larger tax credits could encourage more small employers to sponsor plans. However, a stakeholder cautioned that the credits must be sufficient to offset the costs of plan sponsorship, which a service provider said can amount to $2,000 or more per year. Currently, small employers may claim an annual tax credit of up to $500 based on plan startup costs for each of the first 3 years of starting a qualified plan. A national organization representing small employers cited tax credits as a top factor in an employer’s decision to sponsor a plan; however, an organization official said the likelihood of an employer doing so often depends on whether the tax credit offsets a significant portion of administrative and startup costs of sponsoring plans. Some small employers stated that larger tax credits could ease the financial burden of starting a plan by offsetting plan- related costs, thus creating greater incentives for an employer to sponsor a plan. Other stakeholders said that existing plan startup tax credits are insufficient to encourage plan sponsorship. Officials at another national small business association cautioned that short term tax credits do not provide sufficient incentives for a small employer to make the long-term commitment of sponsoring a plan. Similarly, one small employer who sponsored both 401(k) and DB plans said there needs to be a larger incentive for the small employer to sponsor a plan because starting and maintaining plans can be expensive.

Stakeholders Said More Education and Outreach Are Needed to Increase Awareness of Plan Options and Requirements

Numerous stakeholders agreed that the federal government could conduct more education and outreach to inform small employers about plan options and requirements; however, opinions varied on the appropriate role for the federal government in this area.

A retirement expert said that the federal government can do more to educate consumers about retirement plans and improve general financial literacy. Officials of a service provider to small businesses stated that, because clients are generally not aware of the retirement plan options available to them, the federal government should provide more education and outreach to improve awareness of the plan types available and rules that apply to each. Another large service provider mentioned the federal government should provide educational materials that help small employers find quality service providers. In addition, in its 2011 report, ACT made numerous recommendations calling for better publicity of IRS resources. According to the report, the committee recommended, among other things, that IRS explore potential partnerships with community organizations and plan service providers to enhance the visibility of IRS resources for small employers.

Although several small employers agreed on the need for more education and outreach about plan options and requirements, opinions varied on the extent to which the federal government should provide these services. For example, a representative of a small employer believed the federal government could provide more educational materials that are easy to understand. Another small employer said the federal government should focus education and outreach on service providers instead of on small employers. Conversely, some small employers said the federal government should have a limited role or no role in providing education and outreach efforts.

Other Options to Encourage Plan Sponsorship Would Require Broader Reforms

There are a number of domestic pension reform proposals from public policy organizations, as well as practices in other countries, that include features, such as asset pooling, that potentially reduce administrative and financial burdens and could boost retirement plan sponsorship among small employers. By pooling funds, small employers realize economies of scale because plan administration is simplified and administrative costs and asset management fees are reduced. Pooling also creates larger plans, which are more likely to attract service providers that previously may have found it uneconomical to service smaller individual plans. One proposal by the Economic Policy Institute, which incorporates the concept of asset pooling, would create a federally managed and federally guaranteed national savings plan. Generally, participation in the program would be mandatory for workers, and employers and employees would be required to make equal contributions totaling 5 percent of employees’ earnings. Funds would be pooled and professionally managed, and benefits would be paid out in the form of annuities to ensure that workers do not outlive their savings. In addition, Automatic IRAs—which are individual IRAs instead of employer- sponsored plans—are another proposal that draws from several elements of the current retirement system: payroll-deposit saving, automatic enrollment, and IRAs. The automatic IRA approach would provide employers that do not sponsor any retirement plans with a mechanism that allows their employees to save a portion of their pay in an IRA. For most employees, payroll deductions would be made by direct deposit, and enrollment would be automatic unless employees choose to opt out of participation.

However, as we reported in 2009, some of these proposals that call for broader systemic reforms pose other trade-offs. For example, proposals that mandate participation would increase plan sponsorship and coverage for workers. However, mandatory participation may create burdens for some employers, and employers might compensate for the costs of contributing to workers’ retirement plans by reducing workers’ wages and other benefits. Proposals that guarantee investment returns can protect workers from market fluctuations and can ensure a minimum level of benefits; however, significant costs to the government might result if the guarantee were unsustainable. In addition, proposals that simplify and centralize 401(k) plans may require new regulatory and oversight efforts, and compliance-related costs could be passed on to employers, workers, and taxpayers in general.

Retirement systems in other countries also use asset pooling and other features that reduce administrative and financial burdens for small employers and could spur plan sponsorship. For example, the United Kingdom’s National Employment Savings Trust (NEST), launched in 2011, features low fees for participating employers and employees and default investment strategies for plan participants. NEST also permits plan participants to take their retirement accounts with them throughout their working life, which eliminates ongoing administration of those accounts by former employers when a worker leaves a company. As we previously reported, the predominant pension systems in the Netherlands and Switzerland pool plan assets into pension funds for economies of Denmark’s pension system also pools scale and for lower plan fees.plan assetsfurther lowering administrative costs for small employers.

Conclusions

Despite efforts by the federal government to develop new plan designs and to increase tax incentives to spur plan formation and retirement saving generally, sponsorship remains low among small employers. To some extent, it would be expected that sponsorship rates for small employers would be somewhat lower than for larger employers partly because of the heavy “churn” of small business formation and dissolution. However, small employers’ sponsorship rates remain far below those of larger firms. If a complete picture of sponsorship by small employers were available—including information on small employers that sponsor SEP IRA plans, which is lacking because IRS currently does not have a means to collect these data—IRS and Labor would be better able to target their research and outreach efforts.

Small employers continue to face a variety of challenges to starting and maintaining retirement plans, including obtaining useful information about the large menu of available plan options, managing administrative requirements that small employers reported as burdensome and overly complex, and drawing upon small employers’ often limited resources to administer and finance a plan. While increased competition among plan service providers may result in more affordable options and plans that are easier to start and maintain, options for many small employers may remain out of reach.

Federal agencies have a key role to play in understanding and addressing the barriers to plan sponsorship and to spur sponsorship among small employers by conducting research and conducting education and outreach to small employers. Labor and IRS already provide small employers with a great deal of online information. However, much of the information is scattered among a variety of websites and portals in a largely uncoordinated fashion. A small employer with little knowledge of retirement plan options is forced to navigate multiple sources to retrieve relevant information and may be discouraged from doing so. Increased collaboration and more comprehensive strategic planning between these agencies could enhance outreach and education efforts to more small employers. For example, Labor and IRS could reach out to small employers by utilizing SBA’s extensive network of field offices and by entering into partnerships with public and private organizations. More fundamentally, a coordinated review by the relevant agencies of existing plan designs and their effectiveness in spurring plan sponsorship and participation could help agencies evaluate and develop options that mitigate the barriers to small employer plan sponsorship.

Recommendations for Executive Action

Department of Labor

To address the need to strengthen the retirement security of employees at small businesses and to build on interagency data-sharing agreements already in place, we recommend that the Secretary of Labor convene an interagency task force with representatives from Treasury, IRS, and SBA, and other agencies deemed appropriate, to review, analyze, and address the challenges facing small business retirement security in the United States. The aim of this taskforce would be to develop strategies and arrangements for the agencies to routinely and systematically coordinate their existing research, education, and outreach efforts to foster small employer plan sponsorship. Specifically, this body should focus on, but not be limited to, the following goals:

Conduct plan research on the characteristics associated with small businesses that are more or less likely to sponsor a retirement plan (including employer-sponsored IRA plans) to support agencies’ education and outreach efforts to small employers and provide Congress and the public with information about plan coverage among them.

Evaluate and develop proposals for mitigating barriers to small employer retirement plan sponsorship, including an assessment of the cost effectiveness of existing plan designs—with regard to the expansion of coverage, and the potential to provide an adequate retirement income, as necessary--and the appropriateness of alternative plan designs.

Create a single web portal to centralize federal agencies’ retirement plan information to enhance the visibility and usefulness of federal guidance on plans for small employers.

Department of the Treasury

Considering the lack of information on the number and characteristics of sponsors of SEP IRA plans, as well as their performance in improving retirement security, the Secretary of the Treasury should direct the Commissioner of the Internal Revenue Service to consider modifications to tax forms, such as Forms W-2 or 5498, that would allow IRS to gather complete and reliable information about these plans.

Agency Comments and Our Evaluation

We provided a draft of the report to Labor, Treasury, IRS, Commerce, and SBA for review and comment. Agencies generally agreed with our recommendations. Only Labor provided a written response (see app. VII). Labor, Treasury, IRS, and SBA also provided technical comments, which we incorporated as appropriate. Commerce did not provide comments.

In its written response, Labor generally agreed with the findings and conclusions of the report. Labor also noted that, since 1995, the agency has developed various initiatives to provide education and outreach to the small business community—particularly in the context of retirement saving and financial literacy—by partnering with SBA, the U.S. Chamber of Commerce, and other entities to target small employers. Labor cited these and other efforts as progress in response to of our recommendation for a taskforce that would analyze and address the challenges facing small business retirement security, stating that Labor remains committed to continuing its existing coordination efforts with respect to plan research and developing proposals for mitigating barriers to small business plan sponsorship.

However, Labor disagreed with our recommendation to create a unified web portal to centralize retirement plan information for small employers, expressing concerns about its necessity. Specifically, Labor noted that an SBA website, http://www.business.gov, currently serves as the central portal for information—including information about retirement plans— relevant to small employers. However, none of the stakeholders we interviewed during this report—including Labor and SBA officials— identified http://www.business.gov as a resource of retirement plan information for small employers. Further, in reviewing http://www.business.gov, we found the retirement plan information consisted primarily of links that send users to websites maintained by Labor. We did not find links to or information regarding any IRS retirement plan guidance, including the Retirement Plans Navigator—the agency’s key online retirement plan tool for small employers—or http://www.choosingretirementsolution.org, Labor’s online retirement plan tool for small employers. However, even if http://www.business.gov contained links to all available federal guidance on retirement plans for small employers, it is not clear how it would increase the visibility of the guidance among small employers because so few small employers and other stakeholders we spoke with appeared to be aware of its existence. Thus, while we commend Labor for its existing coordination efforts, we continue to believe that there are additional benefits to be gained by consolidating information on retirement plans for small employers into a single, easy-to-use source—an initiative that would also appear to be consistent with the administration’s interest in information technology consolidation and in encouraging agencies to conduct their missions more effectively.

Finally, in its written response, Labor cited BLS’s 2010 National Compensation Survey, which found that an estimated 45 percent of establishments employing fewer than 100 workers offered a retirement plan to their workers. This is not necessarily inconsistent with our estimate of 14 percent of small employers sponsoring some form of retirement plan, given the different units of analysis used. While the National Compensation Survey used “establishment” as its unit of analysis, we chose to use “firms” for the purposes of this study. There are important differences between an establishment and a firm. For example, according to BLS’s definition, an establishment is a single economic unit at a single physical location. Thus, an establishment can be a business at a single physical location or a branch of a larger company operating multiple branches and the characteristics of each branch is measured as a separate business instead of in the aggregate. On the other hand, for this study, we defined a firm as a complete, for-profit, independent business with 1 to 100 employees. As a result, Labor’s estimate comprises a broader population of employers beyond the small employers we examined. Further discussion of our methodology can be found in appendix I.

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If you or your staff have any questions regarding this report, please contact Charles Jeszeck at (202) 512-7215 or jeszeckc@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs can be found on the last page of this report. Key contributors are listed in appendix VIII.

Appendix I: Objectives, Scope, and Methodology

Information Regarding the Rates of Small Business Employees Who Do Not Have Access to a Retirement Plan, Based on BLS and Census Data

In the body of this report, we present a range for the rate of employee access to retirement plans. According to the Congressional Research Service (CRS), the differences in the estimates regarding employee access to retirement plans between information obtained from Bureau of Labor Statistics (BLS) and the Census Bureau may stem from the different populations used in the surveys. BLS’s National Compensation Survey (NCS) is conducted among a nationally representative sample of private-sector business establishments. The term establishment usually refers to a single place of business at a particular location. An establishment might be a branch or a small operating unit of a larger firm. The Census Bureau’s Current Population Survey (CPS) is conducted among a nationally representative sample of households. Employer characteristics are reported at the level of the firm, which may include more than one establishment. CRS has reported that, in any given year, the NCS can reasonably be expected to show a higher rate of retirement plan participation than the CPS because the business owners and benefits specialists who are interviewed for the NCS might have greater knowledge about the retirement benefits they sponsor than the household members who are interviewed for the CPS. However, CRS has noted that the gap in Census and BLS estimates has grown over time, further complicating the process of estimating both the proportion of workers without employer-sponsored retirement plans and the trend in retirement plan participation rates.

Data Sources and Development of the Analytic Data Set

To perform this work, we combined and analyzed 2009 data from the Department of Labor’s (Labor) Form 5500 database, the Internal Revenue Service’s (IRS) Information Returns Processing (IRP) database, and the IRS Compliance Data Warehouse database (CDW) to obtain information on what would make a small employer more or less likely to sponsor a retirement plan, descriptive statistics on small employer retirement plan sponsors and nonsponsors, and descriptive statistics on the types of retirement plans sponsored by small employers. The Form 5500 database provided information on defined benefit (DB) and defined contribution (DC) plans, and the publicly available data was downloaded directly from Labor’s website: http://www.dol.gov/ebsa/foia/foia-5500.html. The IRP database provided information on employer-sponsored SIMPLE IRA and SARSEP IRA plans and was provided by the IRS officials in the Tax-Exempt Governmental Entity Employment Plans division. The CDW database provided the characteristics regarding the universe of small employers with 100 or fewer employees and was provided by IRS officials with the Statistics of Income (SOI) division. We assessed the reliability of the Form 5500, the IRP, and the CDW data generally and of data elements that were critical to our analyses and determined that they were sufficiently reliable for our analyses.

Our unit of analysis was the small employer, as identified by its employer identification number (EIN). For the purposes of this study, we defined a small employer as an independently owned and operated for-profit firm with at least 1 employee and no more than 100 employees. This definition excluded agricultural businesses, such as farms, as well as tax-exempt organizations, such as nonprofits and government entities. This definition also excluded subsidiary for-profit firms.

To prepare the Form 5500 data in advance of combining the data with the other datasets, we screened out any plans that were not entered in the Form 5500 or Form 5500-SF as “single employer plans,” those that did not have a plan year beginning date in 2009, as well as screened out any plans that had entries in the Welfare Benefit Codes. Our analysis did not consider small employers that only participated in multiple employer plans, in which two or more employers maintain a single plan, or multiemployer plans, in which a joint plan is maintained under a collective bargaining agreement between at least one employee organization and more than one employer. As individual employers are not considered sponsors of multiple employer plans and multiemployer plans, including these plans was considered beyond the scope of this report. We then matched the Form 5500 data and the IRP data with the CDW data using the EIN in common. Any matches between a small employer in the CDW database and a plan in either the Form 5500 or IRP database classified the small employer as one that sponsored the plan while any small employers that did not match with a plan were classified as nonsponsors.

Data Analysis of Small Employer Plan Sponsorship

We developed bivariate and multivariate regression models to estimate the likelihood that a small employer would sponsor a retirement plan using the following small employer characteristics: the number of employees, the annual average wage of the employees, the industry using the 2007 North American Industry Classification System (NAICS) with a depth of two digits, and the region in which the small employer resided as defined by the Census Bureau. For results of the regression model, see appendix VI. The regression model did not include the age of the business as a variable in the model. It is difficult to measure this variable because, over time, a small employer may change its EIN. For example, some small employers change their business structure, which may also require the business to obtain a new EIN. It would be challenging to track businesses over time with changes to the EIN.

In addition to the regression model, we produced a descriptive statistical analysis of small employer characteristics using cross-tabulations of the following characteristics: the number of employees, the annual average salary of the employees, the industry using the NAICS with a depth of two digits, and the state in which the small employer is located. The ranges used for the characteristics identifying the number of employees and average annual wages were established using the statistical spreads identified by the regression model.

Data Analysis of Plan Type

Appendix II: Some Retirement Plans Available to Small Employers

Table 2 is based on guidance produced by Labor and the IRS to educate small employers about their retirement plan options. This guidance, titled “Choosing a Retirement Solution for Your Small Business,” can be found at http://www.dol.gov/ebsa/pdf/choosing.pdf. The content of this table is reproduced from the Labor/IRS publication without alteration, with the following exceptions: GAO updated some dollar amounts to reflect changes made for 2012, where applicable (specifically, the maximum annual contributions to the defined contribution plans and SEP IRA plans, and the maximum compensation upon which contributions to non-DB plans may be based), reordered the columns, and omitted information about payroll deduction IRA plans, which are beyond the scope of this review. GAO did not independently verify the legal accuracy of the information contained in the table.

Appendix III: IRS Form 5498 IRA Contribution Information

Appendix IV: Small Employer Plan Sponsorship Rate by Industry

In analyzing small employer retirement plan sponsorship by industry, we found that small employers in heath care and manufacturing were most likely to sponsor a retirement plan, while small employers in the food and hospitality industry were least likely to sponsor a plan. See figure 8 for the sponsorship rate by industry and table 3 for a sample list of businesses contained within each industry type.

Appendix V: Small Employer Plan Sponsorship Rate by State in 2009

Appendix VI: Regression Results

Appendix VI: Regression Results ** denotes p-value < 0.01. * denotes p-value < 0.05.

Category Employee count 1 to 4

Odds ratio from multivariate model 95 percent Wald Confidence Limits (lower)

95 percent Wald Confidence Limits (upper)

Ref.

Average wage per employee Less than $10,000

Ref.

Ref.

Ref.

Industry classification (NAICS)

Appendix VII: Comments from the Department of Labor

Appendix VIII: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, individuals making key contributions to this report include David Lehrer, Assistant Director; Edward Bodine, Analyst-in-Charge; Curtis Agor; Kun-Fang Lee; and David Reed. Susan Aschoff, Susan Baker, James Bennett, Michael Brostek, Sarah Cornetto, Cynthia Grant, Catherine Hurley, Anna Kelley, Gene Kuehneman, Karen O’Conor, Dae Park, MaryLynn Sergent, Aron Szapiro, Frank Todisco, James Ungvarsky, and Walter Vance also provided valuable assistance. SOI (IRS) provided valuable assistance in extracting small employer data from the CDW.