Small-business owners with relatively few employees often tell us that they would like to start a 401(k) plan but believe the costs would outweigh the benefits. Instead of looking more closely at a 401(k), the owners gravitate toward a SIMPLE IRA or, more likely, offer no retirement plan at all.
There are several government policy proposals seeking to address the small-business retirement plan gap, including Association Retirement Plans (ARPs) and Secure Choice payroll-deduction Individual Retirement Accounts. We don’t think small-business owners need to wait for new policies though.
We believe 401(k)s can be less expensive than feared, relatively simple to manage and provide significant long-term benefits to both the owner and employees. For high-earning small business owners, the ability to defer taxes on a significant chunk of income each year—more than is possible with a SIMPLE IRA—and avoid the pro rata rule on “backdoor” Roth IRA contributions make 401(k) plans attractive, especially over the long run.
Entrepreneurs or contractors without employees can find great solo 401(k) offerings at Vanguard, Fidelity, Schwab, E-Trade or TD Ameritrade. Small-business owners with dozens of participating employees and meaningful plan assets can design great plans with recordkeeper/third-party administrators like Vanguard Small Business (Ascensus) or Fidelity. But until the past few years, owners of smaller businesses with, let’s say, 5 employees—like a dental or medical practice—haven’t had great options. Often the administrative costs of the plan would have offset the owner’s tax benefit of deferring compensation into the plan. We think that’s changing, with several choices for high-quality plans at reasonable costs.
The caveat, though, is that very small 401(k) plans typically require a DIY approach. The owner needs to do a little homework and assume some fiduciary responsibility. It’s not that complicated though. Find a good recordkeeper/third-party administrator (TPA) to help with plan design and compliance. Consider hiring an advisor to help with investment options and employee education. While you can hire outside providers to assume some legal responsibility for aspects of the plan—the TPA may or may not act as a 3(16) fiduciary and the advisor may or may not act as a 3(21) or 3(38) fiduciary—the plan sponsor always retains ultimate fiduciary responsibility. If you offer a great plan, though, you should be able to sleep well at night knowing your fiduciary risk is low.
There are 7 primary steps in starting up a 401(k) at your small business:
1) Pick a recordkeeper and TPA. Recordkeepers and TPAs are outside providers of plan administration services. These duties are often bundled together and performed by one company. You can think of recordkeeping as plan accounting, making sure money gets from point A to point B and providing online information portals for both plan sponsors and participants. Third-party administration is in some ways even more critical, as TPAs help with plan design, administration, and—importantly—compliance. There are several good small-business recordkeeper/TPAs, and we’ve heard especially positive comments recently regarding Ubiquity and Employee Fiduciary.
2) Have the TPA do a plan design study. One of the key functions of the TPA is helping you with plan design. Your TPA should be able to help you understand the pluses and minuses of major design features like safe harbor nonelective contributions, safe harbor matches and different profit-sharing allocation methods (e.g., social security integrated, age-weighted and new comparability). Ultimately, the TPA can help you design a plan that maximizes your deferrals and tax benefits while still acting in the best interest of all participants. Employee Fiduciary offers a plan design study for $150, which is credited towards the plan establishment fee if you move forward. We believe this would be money well spent.
3) Work with the TPA to draft plan documents. The TPA will ask you a relatively detailed series of questions to help create your plan documents, a written record of the terms and features of the plan required for compliance purposes. In general, the more the plan design and plan documents are relatively “off-the-shelf,” or standard, the easier and cheaper it is to manage and administer.
4) Choose an investment line-up. In investing, we believe simple beats complex almost every darn time. We would recommend a simple line-up of low-fee index funds, like those from Vanguard, including a full slate of target retirement date funds, which buy an age-appropriate mix of stocks and bonds and automatically adjust over time. The fund line-up below is good starting point.
5) Provide census and payroll data to the recordkeeper. The recordkeeper will need information about your employees and payroll process to facilitate enrollment, contributions and other transactions.
6) Schedule enrollment and educate employees. Your recordkeeper/TPA will let you know when your enrollment window opens and closes. Set dates and times to meet with your employees, as a group or individually, to explain the investment options and the benefits of saving into the plan.
7) Consider hiring an hourly-rate advisor. While optional, a reasonably-priced plan advisor can provide help choosing and continuously validating the fund line-up and educating and supporting your employees. A good advisor should help employees think about how much to save, how to save more and how to invest. A non-conflicted hourly-rate advisor can also provide financial planning to your employees, further promoting financial wellness. If you work with a traditional asset-under-management fee advisor, create a written agreement that the advisor will not take employee IRA rollovers out of the plan to manage at a higher fee.
While you don’t really need Aptus to start a 401(k), our standard rate card pricing is $1,000 plus $65 per participant to help with investment selection and employee education, all of which is typically conducted via videoconference.
For a hypothetical small business with 1 owner and 4 employees, using Employee Fiduciary as the recordkeeper/TPA and Aptus as the advisor, we estimate plans costs of $3,125 and safe harbor matching contributions to non-owner employees of $8,000. In our view, the match money should not be considered a plan cost, but rather part of overall compensation with relatively high bang for the buck.
We believe highly-compensated small business owners should seriously consider starting a 401(k) plan. Assuming the owner pays all the costs except fund fees, our back-of-the-envelope calculations suggest that the net costs of a 401(k) are, at worst, relatively modest. More likely, though, the 401(k) will more than pay for itself in employee satisfaction, productivity and retention. And over time, as the 401(k) matures and assets grow, more of the costs can be shared by non-owners by applying some of the fees pro rata to participants based on their account balances.
Small businesses can have great 401(k)s by taking a DIY approach. Do your homework. Hire a great recordkeeper/TPA. Consider Aptus for help on investments and education. You can do it yourself, but you don’t have to do it alone.