In today’s competitive labor market, across industries ranging from construction to retail, offering a 401k plan as part of a benefits package can be a critical employee recruiting, retention and engagement strategy for small businesses. Many owners are concerned about the expense of setting up a program, but by carefully evaluating the options, it is possible to find a cost-effective retirement plan that meets your business’ needs.
There are three main fees that you should pay attention to when evaluating traditional 401k plans: plan administration, fund management and variable asset charges. Plan administration responsibilities include compliance and discrimination tests that are required by the Employee Retirement Income Security Act of 1974 (ERISA), as well as basic tasks like making sure money is being transferred into the correct funds.
All mutual funds charge an expense ratio that is used to cover annual operational costs. That fee is deducted from the mutual fund’s returns. The expense ratio is calculated annually and can be found in the fund’s annual report or shareholder prospectus.
The variable asset charge is found in variable annuity contracts sold by insurance companies and in older mutual fund plans. A surrender fee is charged for early withdrawal or termination of an annuity contract or agreement. Annuity products are complex and require professional consultation.
All traditional 401k plans require federal tax and compliance reporting requirements employers must meet under ERISA. As a result, most small-business owners hire a third-party administrator like Vanguard or Fidelity to oversee the retirement plan. Here are some important factors to take into consideration when searching for a cost-effective employee retirement plan:
Finding Hidden Fees
Be wary of a plan with administrative costs that seem too good to be true. “Some plans will say they cost employers next to nothing – $500 a year – but you may get very little help with record-keeping and administration,” says Michael Dempsey, president of Ann Arbor, MI-based Dempsey Incorporated, an employee benefits consultancy and brokerage service company.
Other plans that appear to be low-cost require employees to pay a higher fund-management fee. “Some plans bury the administration cost in the management fee,” says Dempsey. “That is a fee that your employees will bear indirectly.”
To calculate the management fee, Dempsey suggests a basic formula: Take the total amount of assets you will have by the end of the year and multiply that against the mutual fund expense fee. The assets are the total projected annual amount of contributions made by both your employees and you, the employer.
Time Is Money
“With any of these fees, the biggest factor to consider is dollars per employee over time,” says Dempsey. Dempsey advises employers to do a three-year forecast. “The first (plan) year, there is cheaper administration, but if you have high fund costs, then it is less desirable for employees to join the plan,” he says. “Don’t take the lowest-cost plan or the highest-cost plan. Usually there is a middle ground.” The cost structure becomes more favorable the more assets you have and the more assets you have per employee.
Business Size Matters
Depending on the size of your business and what your growth plans are, there are a few plan options you may not have considered that could fit your needs. :
Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA)
“If you have fewer than 100 employees, a Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA) plan is probably the best,” says Zachary Armstrong, an advisor for Grand Ledge, MI-based Siena Wealth Advisors, an asset management firm. Much like a traditional IRA, the SIMPLE plan is easy to set up and, as there is no third-party administration, the costs are lower. Each employee selects his or her own self-directed brokerage account and defers a portion of their earnings pre-tax.
Simplified Employee Pension Individual Retirement Account (SEP)
Don’t want to make annual employer contributions? The Simplified Employee Pension (SEP) IRA does not require any startup or administrative costs like more conventional retirement plans, however, employees are not able to make salary deferrals. In addition, employers must contribute to all participants plans and pension contributions generally have to be the same for all employees, which can become more difficult as your small business grows.
Although the process of setting up a retirement plan can feel overwhelming, the benefits can be significant for your small business in the long run. With a good dose of planning and analysis of the three main fees that are associated with purchasing a traditional 401k plan – administrative, fund management and variable asset charges – you should be well on your way to finding a cost-effective program for you and your employees.
SooJi Min is a freelance writer and nonprofit executive based in Ann Arbor, MI. She has written on small business topics for Crain’s, Imagination Publishing and The University of Chicago Booth School of Business.