According to AARP, Americans are 15 times more likely to save for retirement when they are covered by a workplace retirement plan. However, while most large businesses – companies with more than 100 employees – sponsor a retirement plan, 51 to 71 percent of small businesses don’t. Causing many small business owners to steer clear of 401(k) plans, in my view, is a perception that plan sponsorship is too expensive, time-consuming, and/or fraught with liability – in short, not worth the trouble. To help overcome this perception – and close the small business coverage gap – I think we need more straightforward and transparent 401(k) plans.
A straightforward and transparent 401(k) plan has three features - flat administration fees, passively-managed index funds, and basic administrative tasks for the employer to complete. Such plans offer diversified and cost-efficient market returns for participants and low liability and time commitment for business owners.
The problem with straightforward and transparent 401(k) plans? There’s little profit in them. For this reason, they’re not a popular solution within the broader 401(k) industry for closing the small business coverage gap. More popular are Multiple Employer Plans (MEPs). These plans can sound attractive at first blush, but in fact, make it easier for 401(k) providers to obfuscate fees and conflicts of interest. I think the push for MEPs signals a broken 401(k) industry that prioritizes profit ahead of the interests of retirement savers.
The case for MEPs
For those that don’t know, a MEP is a 401(k) plan that’s co-sponsored by two or more unrelated employers. The MEP provider is considered the lead plan sponsor, with each employer co-sponsor delegating many (if not all) of the roles within the 401(k) fiduciary hierarchy – including their incumbent responsibilities - to them.
Supporters claim that MEPs offer two key advantages over traditional single-employer plans - lower fees due to “economies of scale” and lower fiduciary liability due to the delegation of fiduciary responsibilities. In truth, MEPs deliver neither.
Debunking “economies of scale”
MEP supporters claim that 401(k) plans need “economies of scale” – basically, lots of assets - to access top-quality administration services and investments for low fees. The rise of passively-managed index funds and flat administration fees has made this claim obsolete.
401(k) plans no longer need lots of assets to pay low fees for top investments thanks to passively-managed index funds. While 401(k) plans generally need a lot of assets to pay low fees for top actively-managed funds, nearly all plans - regardless of their assets - pay the same fees for top index funds, The kicker? Index funds tend to outperform comparable actively-managed funds on a net-of-fees basis.
401(k) administration services include asset custody, participant record-keeping, and Third-Party Administration (TPA). Many 401(k) providers charge asset-based fees for these services. The problem? Assets have little to do with the level of plan administrative services delivered by 401(k) providers. In truth, except for asset custody, 401(k) administration services scale with employee headcount, not assets. That means it’s more reasonable to pay flat (i.e., headcount-based) administration fees to the extent possible.
Single-employer 401(k) plans with index funds and flat administration fees can be extremely low cost – no economies of scale required. Want proof? Given our fees, a participant in a 50-participant 401(k) plan with $100,000 in assets could pay $43.60 in annual administration fees and less than 0.10% in index fund expenses. I’ve never seen a MEP come close to these prices.
Debunking lower liability
Employers must meet certain fiduciary responsibilities to protect the interests of their 401(k) plan participants. They have two basic options for meeting each responsibility – do it themselves or delegate it to a 401(k) provider. Delegating 401(k) fiduciary responsibilities can sound like an easy to reduce fiduciary liability until you understand that employers have a fiduciary responsibility to “monitor” their 401(k) provider – basically ensure the provider is doing a competent job for reasonable fees. Due to this monitoring responsibility, I strongly recommend employers avoid 401(k) providers with administration services, investments, and fees they don’t understand.
In general, MEP providers are more difficult to monitor than single-employer 401(k) providers. This is true due to the administration-related fiduciary responsibilities delegated to the MEP provider. This discretionary control makes MEPs more prone to conflicts of interest or downright abuse. A recent GAO study noted DOL concerns about “the potential for inadequate employer oversight of the MEP is greater because employers have passed along so much responsibility to the entity controlling the MEP. Labor officials noted that potential abuses might include layering of fees, misuse of the assets, or falsification of benefit statements.”
In my view, it’s a lot less risky for employers to meet administration-related 401(k) fiduciary responsibilities themselves. A qualified 401(k) provider will do most of the heavy-lifting and guide employers in doing their part. A simple checklist can be used to manage these responsibilities.
Other MEP disadvantages
I consider MEPs are more of a marketing gimmick than a way to cut 401(k) fees or fiduciary liability. For this reason, I think sophisticated business owners will avoid them. Especially once the inherent disadvantages of MEPs are understood:
- Employers lack the authority to terminate their portion of a MEP. That means their employees can be trapped in a MEP until they terminate employment or become eligible for an in-service distribution.
- MEPs must satisfy certain ERISA requirements at the plan - not employer - level. For example, participating employers must count the service accrued by their employees at other participating employers when determining plan eligibility and vesting.
- MEPs often limit an employer’s plan design options to ones that simplify plan administration and increase provider margins.
- MEPs require much more complicated record-keeping than single-employer 401(k) plans due to the fact they commingle the assets of multiple employers – which also makes them more prone to trading and/or reconciliation problems. Consider payroll processing. While a single-employer 401(k) plan might process 24-30 payrolls per year, a 500-employer MEP might process 12,000-15,000! That’s a lot of trades to process without issue.
So why the push for MEPs?
The 401(k) industry at large has been lobbying Congress hard for years to expand small business access to MEPs. Perhaps unsurprisingly, their reasons are self-interested. Actively-managed investments and asset-based administration fees have been on the decline for a while now. MEPs are a way for the 401(k) industry to reduce their cost while maintaining margins. Worse, MEPs can be a delivery mechanism for high-margin investments and ancillary services that single-employer 401(k) plan sponsors have historically rejected.
Simple solutions are often best, and it shouldn’t surprise anyone that commingling the assets of potentially hundreds of unrelated employers in a single trust account doesn’t result in a better retirement plan. Straightforward and transparent single-employer 401(k) plans are an objectively better alternative.