A Common Sense 401(k) Plan for Small Businesses
The Thrift Savings Plan (TSP) is a 401(k)-like plan for Federal employees. By combining index funds and low cost administration services, the TSP offers participants professionally-managed market returns with very low drag from expenses. In an Aspen Institute article last month, I wrote 401(k) plans modeled after the TSP are the key to incentivizing retirement plan sponsorship by small businesses – which today sits at a low 52 percent. This rate is a big problem because American workers are 15 times less likely to save for retirement when their employer fails to offer a savings plan.
I think TSP-like 401(k) plans offer indisputable value to participants. They make it dead simple for participants in even the smallest 401(k) plans to achieve professionally-managed, market-correlated returns for a very low all-in fee. Their value makes it easy for 401(k) plan sponsors to demonstrate their plan pays reasonable fees – an important fiduciary responsibility.
In short, I think TSP-like 401(k) plans are a common sense retirement plan - a safe harbor of sorts from the confusing array of services, fee structures and investments offered by 401(k) providers today. That said, these simple and effective plans are not for everybody. Sometimes, 401(k) investments and investment-related services with higher fees are a better fit for a small business and its employees. Not sure if you’re one of these businesses? Compare these services against a TSP baseline to decide if they are worth the extra money.
Selecting a 401(k) fund lineup
TSP baseline – an all index fund lineup. The investment objective of this lineup is simple – earn highly-correlated market returns.This objective is different than most 401(k) plans, who try to “beat the market” with costlier actively-managed funds. The problem? Studies show most actively-managed funds fail to outperform comparable index funds, net of fees, over long periods of time.
Alternative – Use actively-managed funds for the chance to outperform market benchmarks (i.e., S&P 500 index). I HIGHLY RECOMMEND using a professional financial advisor with this alternative. Picking actively-managed funds that outperform comparable index funds takes a lot of skill. These funds also require complex monitoring to ensure they don’t underperform comparable index funds over time.
How to choose – Do you reasonably expect the returns of actively-managed fund(s) to offset any additional fees and expenses? If not, you probably want to stick to index funds.
Delivering 401(k) investment advice
TSP baseline – Target Date Index Funds (TDIFs). By investing 100% (not a lower %) of their account in the TDIF that best matches their estimated retirement date, 401(k) plan participants can have their account professionally managed.
Alternative – Hire a professional financial advisor. Employees are often intimidated by 401(k) saving and investing decisions – which can lead them to not save at all. An advisor can help these employees make informed 401(k) decisions they can feel good about. An advisor is also recommended when employees want customized investment advice.
How to choose – Do your employees need 401(k) plan coaching to keep retirement savings on track or want customized investment advice? If yes, a fiduciary-grade financial advisor is likely the best choice for your 401(k) plan. If not, use TDIFs for investment advice.
Choosing the right 401(k) plan services is important!
Small businesses have a fiduciary responsibility to pay only reasonable and necessary 401(k) fees. While most 401(k) plan fiduciaries are clear they can only pay reasonable 401(k) fees, few understand these fees must relate necessary services – basically, investments and services that add value to participants. Paying reasonable fees for underperforming investments or unused services can still cause excessive 401(k) fees that unnecessarily reduce participant returns and increase fiduciary liability.
The good news? It’s not hard to pay reasonable fees for necessary 401(k) plan services. The key is modeling your 401(k) plan after the Federal TSP. Think you want different investments or more robust investment-related services? Use the TSP as a baseline to decide if these features are worth their higher cost. Not sure where to find a financial advisor in your area? Check out directory of fiduciary-grade advisors.
About Eric Droblyen
Eric Droblyen began his career as an ERISA compliance specialist with Charles Schwab in the mid-1990s. His keen grasp on 401k plan administration and compliance matters has made Eric a sought after speaker. He has delivered presentations at a number of events, including the American Society of Pension Professionals and Actuaries (ASPPA) Annual Conference. As President and CEO of Employee Fiduciary, Eric is responsible for all aspects of the company’s operations and service delivery.