Retirement Plan Trends for Small Business
(The News is Better Than You'd Think)

Pension and Retirement Memo
March 2006

            The landscape of qualified retirement plans has been shifting and maturing.  ERISA, the federal pension law, has been in effect for 32 years.  In that time, Congress, the IRS, the Department of Labor, and the private sector have, in combination, created a private sector retirement plan infrastructure that works well, especially for small businesses.

            This did not happen overnight.  Many legal and tax changes in the 70's and 80's were dramatic and painful.  In those years, the IRS's attitude was confrontational.  In the 90's, the legal and tax changes were more subtle and technical.  The changes after 2000 have been fine tuning.  The IRS is now less adversarial with those who are at least trying to play by the rules -- not warm and fuzzy, but at least helpful.

            The World War II generation is fading away, and the 76 million boomers are nearing retirement. Contrary to what the popular press says, the system for small business retirement plans works pretty well.  It's not perfect, but it's better than people realize.

            Serious problems with some retirement plans exist, but they have been sensationalized.  Every day we are bombarded with "end of the world" financial forecasts.  Baby boomers will retire, then starve.  Underfunded private sector pension plans (like those for Delta Airlines and GM) will bankrupt the employer, the PBGC, and  eventually taxpayers.  Underfunded public sector retirement plans will sink every town, city, county, all fifty states, and Guam.  Social security will collapse the very day you sign up for benefits.  Why save for retirement?  It's hopeless! 

            Forget the "gloom and doom."  The news for small business retirement plans is better than ever. 

            Before ERISA was passed in 1974, many pension plans collapsed leaving retirees high and dry.  Plans were "funded" with only promises, because the law did not require employers to put actual money into retirement plans.  Employees had no control over investments.  Vesting schedules stretched 10 years or longer.  Moreover, many employees were excluded from generous plans that covered only the company big shots.  Unless you worked for a large, paternalistic company for thirty years, you got zip.  Retirement plans for small companies?  Forget it.  The laws offered no incentive for them.  In the pre-ERISA years, social security and personal savings were the only income available to retirees from small businesses.    

             The landscape is different today.  I see four major trends in small business retirement plans that you can use to your advantage.

Trend #1 

Small Employers Can Maintain Generous Plans

            Retirement plans for large employers are extraordinarily complex.  Fortunately, plans for small businesses have moved from the complex to the simple.  This is great news and is possible only because Congress gave small business what it wanted:  off-the-shelf plans requiring little or no maintenance that permit large annual contributions, particularly for the owners.

            The three plans that fill this need are (i) the simplified employee pension plan ("SEP"), (ii) the SIMPLE plan, and (iii) stripped-down 401(k) plans for small businesses (I call these "mini-401(k)'s).

            In the first years after ERISA, small employers had to adopt complicated self-designed plans to get a meaningful annual retirement contribution.  Those plans were expensive because the complex rules that applied to retirement plans for corporate giants also applied to plans for mom-and-pop businesses.  The small employer needed a pension lawyer, a CPA, and a plan administrator to make these plans work.   

            Now, small employers can use SEPs, SIMPLE plans, and mini-401(k)'s to sock away lots of money each year.  These plans are readily available from the financial services industry at little or no cost.  I have never had a client regret using one of these plans.   

            The ultimate step toward retirement plan simplicity is having no plan at all.  And, that is beginning to happen.  With increased IRA annual contribution limits (in 2006, $4,000 for those under age 50 and $5,000 for those 50 and older), very small businesses can eliminate a retirement plan entirely.  Why run a 401(k) plan if employees are putting in less than these amounts?

Trend #2 

Plan Administration is Easier

            "Plan administration" is the paper shuffling required to establish a plan and keep it going.

            SEPs and SIMPLE plans require almost no annual administration.  In most cases the employer spends a few hours each year dealing with the plan.

            For larger plans, such as 401(k) plans and pension plans, the documents are complex.  Hence, the IRS has been encouraging prototype documents.  A prototype is an IRS pre-approved plan that can be adopted by an employer.   Prototypes are "sponsored," or offered, by law firms, CPA firms, consulting firms, brokerage firms, and mutual fund companies.  Almost every bell and whistle allowed by law can be included in a prototype.

            The prototype "sponsor" keeps the plan qualified as the tax law changes, so all employers using it are automatically protected. 

            Even better, document updating requirements have been simplified.  The IRS has just implemented a program of "rolling updates," which allows a plan to be updated only once in a five or six year cycle.  Prior to this, plans had to be updated every year or two to keep up with unending tax law changes passed by Congress and the IRS.  The new system levels out the work flow for employers, sponsors, and the IRS.

Trend #3

Compliance is Easier

            Plan "compliance" refers to the annual filing requirements.  Qualified plans have to file an annual report, or tax return, on IRS Form 5500.  The employer must also provide information to participants on an annual or more frequent basis.

            SEPs and SIMPLE plans do not file Forms 5500.  The required information to participants is almost always provided by the brokerage firm or mutual fund.

            Small employers with 401(k) plans have found it easier to deal with annual compliance.  The financial services industry has developed software and web-based products that get the job done smoothly.  Pension consulting firms, or "third party administrators," can do everything at very competitive rates. 

            The IRS "audit risk" has eased because the IRS encourages employers to "self-police" themselves. Under the Employee Plans Compliance Resolution System ("EPCRS"), employers who identify and fix their operational or document problems themselves can do so in most cases without penalty and without even informing the IRS.

            Likewise, the Department of Labor, which regulates the investment and fiduciary requirements for retirement plans, has updated and expanded its Voluntary Fiduciary Compliance Program.  This "self-policing" tool is used when there have been breaches by a plan fiduciary.

Trend #4 

Fiduciary Liability Will Be the Hot Issue

            The hot spot for small business retirement plans will be fiduciary liability, particularly for (i) excessive fees paid by plans, and (ii) underperformance of plan investments.

            Connect these dots.

            First, the amount of money in retirement plans is huge.  We're talking trillions, not mere billions.  The Wall Street Journal reported that at the end of 2004, there was $3.2 trillion in defined contribution plans and another $3.5 trillion in IRAs.  That kind of money attracts attention.

            Second, as boomers retire, and as problem plans like those of GM and the airlines grab headlines, greater interest is being paid to plan investment performance. 

            Third, many boomers will not have nearly enough savings for a worry-free retirement.  We'll get up every morning, check our 401(k) balances on-line, and fret about every hiccup in the markets.  Why can't my employer get a better investment manager? 

            Fourth, a lot of plan information is public, including Form 5500.  Try this:  go to www.freeErisa.com.  That's a website that allows you to see any Form 5500.  You can search by the employer's name.  Just for laughs, check to see how much your competitors put in their 401(k) plans, and how those investments perform.  There's a lot of information packed into a Form 5500, and comparing them from year to year can yield a lot of surprises.

            Fifth, sophisticated software programs can now sift through those Forms 5500 online to ferret out all kinds of data.  That information can be dynamite in the hands of an under-employed plaintiff's lawyer.  Since attorneys' fees are recoverable under ERISA, underperforming and overpriced retirement plans, and the fiduciaries who run them, will become the targets of lawsuits.  Remember asbestos, tobacco, Firestone tires, Vioxx, and lead paint?

            Sixth, many plans of small employers do pay excessive fees and do perform badly without the employer even realizing it.    

            Seventh, the yardstick by which fiduciary liability is measured under ERISA is not the "prudent person" standard.  Rather, it is the "prudent expert" standard.  Plan fiduciaries who fall short of this standard will be liable.

            Eighth, fiduciary liability is always based on hindsight.  How well did your investments do?  They should have done very well, because everybody knew the market would tank in 2000, and everybody knew interest rates would hit historic lows a few years later, and everybody knew that real estate would be hot, and everybody knew that foreign stocks would take off, and everybody knew a hurricane would wipe out oil refineries in New Orleans, and everybody….       

            Conclusion     The infrastructure for small business retirement plans is a jewel.  It has taken thirty years to evolve.  Owners and employees of small businesses have the opportunity to fund meaningful retirement incomes.   However, the risks of fiduciary liability for small business owners have been understated.

© 2008 Eugene Parrs