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Pooled Employer 401(k) Plans (PEPs): Myth vs. Reality

Eric Droblyen

on February 16th, 2022


In 2019, the SECURE Act created Pooled Employer Plans (PEPs) – a form of “open” Multiple-Employer Plan that pools the 401(k) assets of multiple unrelated employers. Supporters claim PEPs can offer lower fees for plan participants and greater liability protection for plan fiduciaries than a traditional single-employer 401(k) plan (SEP). In truth, a SEP with an investment menu of leading index funds and flat administration fees can usually beat a PEP on both fronts.

The 401(k) industry has aggressively marketed PEPs since the SECURE Act made them possible. This support can seem odd when you understand that PEPs are more difficult for 401(k) providers to administer correctly than SEPs due to their multiple employer nature. It makes perfect sense, however, when you understand how PEPs can be more profitable.

If you’re in the market for a new 401(k) plan, you should be skeptical of PEPs. Their purported benefits are usually more myth than reality. Here’s what you need to know.

High 401(k) Fees

Myth #1 – PEPs Cost Less Than SEPs

PEP supporters claim that 401(k) plans need “economies of scale” – basically, lots of assets - to pay low fees for quality administration services and investments. In truth, the rise of passively-managed index funds has made this claim obsolete.

The reason? While 401(k) plans generally need a lot of assets to pay low fees for actively-managed funds from leading providers, all plans - regardless of their assets – can pay low fees for index funds from leaders such as Vanguard, Fidelity or Schwab. The kicker? Leading index funds tend to outperform comparable active funds over time, net-of-fees.

Another benefit of leading index funds? Few – if any – pay hidden fees. That forces a 401(k) provider to charge direct fees – which are much more transparent – instead. In my experience, 401(k) plans with no hidden fees cost less.

How much does a SEP with leading index funds cost? Assuming our fees, a 30-participant SEP with $1 million in assets would cost about $2,300 in annual administration fees and less than 0.15% in average index fund expenses. I’ve never seen a PEP cost less.

Don’t take my word for it? Shop around.

Myth #2 – PEPs Lower 401(k) Fiduciary Liability

All 401(k) plans – regardless of their PEP or SEP status - have the same basic fiduciary hierarchy. This hierarchy includes both fiduciary and non-fiduciary (“ministerial”) roles. In general, the fiduciary roles have discretionary power, while the ministerial roles do not. The named fiduciary sits atop the hierarchy with the power to delegate the other roles.

In most SEPs, the named fiduciary is the employer– which includes controlled groups and affiliated service groups. When an employer joins a PEP, they delegate the named fiduciary role to the PEP provider – called a pooled plan provider (PPP).

PEP supporters claim this delegation lowers the 401(k) fiduciary liability of employers. I think it does the opposite by giving a PPP the power to boost their profit by delegating the subordinate PEP roles to affiliated companies or by choosing investments that pay hidden fees.

Reality #1 – PEPs are Harder to “Monitor”

Employers have a fiduciary responsibility to “monitor” their 401(k) provider – to ensure the provider is doing a competent job for “reasonable” fees. To make this responsibility easy to meet, I recommend business owners avoid 401(k) providers with opaque services, investments, and fees - not to mention, conflicts of interest. There is no way around this fiduciary responsibility – even when employers delegate the entire fiduciary hierarchy to their 401(k) provider.

PEPs can be much more opaque and conflicted than SEPs due to powerful administration-related fiduciary roles that employers delegate to a PPP – making the PPP harder to monitor than a SEP provider with no discretionary power.

Reality #2 – PEPs are Harder to Leave

Terminating a SEP is usually a straightforward process because the IRS considers a plan termination a distributable event. Upon the termination date, plan participants can roll their 401(k) account to a new retirement plan or take a cash distribution.

However, this simple termination process is not available for PEPs. Why? Employers lack the authority to terminate their portion of a PEP. With no distributable event triggered by a plan termination, participants can be trapped in a PEP until they terminate employment or become eligible for an in-service distribution.

To create a distributable event for active PEP participants, an employer must establish a brand new SEP, transfer the PEP accounts to that plan, and then terminate the SEP. That can be a lot of work – not to mention, costly – for employers.

Reality #3 – PEPs Offer Less Design Flexibility

Each SEP is governed by its own written plan document. These documents can be highly tailored by a consultative 401(k) provider to meet an employer’s unique goals and budget. 

In contrast, employers share the same plan document in a PEP. In my experience, PPPs often limit an employer’s plan design options to basic ones that are inexpensive for the PPP to administer.

Reality #4 – PEPs May Not Offer a Tax Credit

The SECURE Act increased the 3-year tax credit that small businesses (under 100 employees) can claim for starting a new retirement plan. A qualifying small business will always be eligible for all three years of the tax credit with a SEP.

This credit only applies for the first three years that a retirement plan is in existence. That means a qualifying small business that joins a PEP won’t be eligible for all three years of the credit if the PEP was established in a preceding year.

Pooled Employer Plans are Good for the 401(k) Industry, Bad for Plan Participants!

For about a decade, the 401(k) industry lobbied Congress to authorize “open” MEPs. They got their wish in 2019 when the SECURE Act created PEPs. Was this push a selfless act by the 401(k) industry to lower the cost of retirement for workers and make plan sponsorship less risky for employers? Of course not. Put simply, PEPs can be more profitable and harder to leave than SEPs.

The purported benefits of PEPs can sound attractive at first blush. Business owners should understand how they can, in fact, harm plan participants.

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