Workforce & Economics

Removing barriers to small business retirement plans

May 3, 2016

The “retirement crisis” in the United States takes many forms, but the crucial common thread is that people aren’t saving enough, and that lack of savings is in part driven by a lack of access to workplace retirement savings plans. This problem is particularly acute for the one-third of private sector workers—more than 40 million in all—who work for firms that employ fewer than 100 people. A surprising 86% of these small businesses don’t offer an employer-sponsored retirement savings plan. 1

And despite the disadvantage this poses to their workers, it’s not so easy to blame the leaders of these companies. They’re busy serving their customers, meeting payroll, managing expenses, and facing all the day-to-day and long-term challenges of running and growing their businesses. They view the costs, paperwork and administrative duties of sponsorship as distractions at best and burdensome at worst. Most lack investing expertise and find the vast array of plans and choices too complex to navigate. On top of all that, certain laws and regulations impose fiduciary responsibilities that small business owners find daunting and even worrisome. Business owners fear being held responsible for bad outcomes from investment advice that, they would be the first to admit, they’re not qualified to give.

Of course, individual workers are free to save on their own through an IRA or other, similarly-purposed vehicle. But not incentivized enough to actually do so. And the problem is most acute at lower income levels—the very people most in danger of not being able to retire, or facing retirement relying only on Social Security, with too little savings to cover needs that Social Security can’t. For instance, only 5% of those earning between $30,000 and $50,000, and who lack access to a workplace plan, regularly contribute to an IRA. On the other hand, participation rates in employer-sponsored plans—especially those that provide clear guidance on how to invest—are much higher.2

What can be done to encourage small businesses to offer retirement savings plans? Broad-based reform at the federal level is, for a number of reasons, unlikely, though preferable. Still, improvements are possible short of sweeping reform.

Federal solutions

So what can be done to encourage small businesses to offer such plans? Broad-based reform at the federal level is, for a number of reasons, unlikely, though preferable. Still, improvements are possible short of sweeping reform. Here are three:

  1. Simplify ERISA reporting and disclosure: The Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code)—while doing much to protect generally less sophisticated investors—also impose significant administrative costs on plan sponsors and deter small employers from establishing and maintaining plans. Let’s simplify ERISA reporting and disclosures, including eliminating extremely complex Form 5500 filings for defined contribution plans that offer only certain, safer investments.
  2. Eliminate “Top Heavy” testing for small employer plans: The Internal Revenue Code is designed to ensure that plans don’t unduly benefit highly-paid employees. While the goal is laudable, the mechanism is costly and burdensome, and disproportionately affects small employers. In particular, top-heavy annual testing requirements should be eliminated for small employer plans.
  3. Allow open MEPs: A multi-employer plan (MEP) allows businesses to share administrative and other responsibilities associated with establishing and maintaining a retirement plan. The MEP sponsor assumes overall fiduciary responsibility, files required reports, and handles many other administrative and recordkeeping tasks. Participating employers would be responsible for contributions and distributions, but would be relieved of fiduciary responsibilities assumed by the sponsor and would therefore shoulder a significantly lower administrative burden. Current judicial and regulatory rulings require that there be a “nexus” among the employers who participate in the MEP (e.g., multiple franchises of the same restaurant chain). The Obama Administration recently proposed eliminating this “nexus” requirement, which would pave the way for many more small employers to join a MEP. Eliminating the nexus requirement—whether through legislation or regulation—would be a positive step.

What about the states?

All of this will help. A more complicated question is: what can—or should—the states do?

The question is complicated for many reasons. First, ERISA supersedes all state laws that “relate to” any employee benefit plan subject to the federal law. That means that any state-based program subject to ERISA would face additional costs and complexities. This is something that state legislators looking into establishing state-based plans are trying to avoid.

Late last year, the Department of Labor (DoL) stepped in to propose a rule under which state-based IRA plans that comply with certain provisions (e.g., automatic enrollment that has an opt-out feature) would not be preempted by ERISA. This rule could be a promising step, but without broader reforms to ERISA (and the Code), it risks creating regulatory arbitrage that may lead to inferior outcomes.

Once an ERISA-exempt plan is available at the state level, we fear that small employers that have not adopted an ERISA plan will be discouraged from doing so, and that over time those that currently offer such plans will stop in favor of simpler and less expensive state alternatives. In many cases, this could lead to reduced retirement savings—IRA annual limits are approximately one-third of 401(k) limits and IRAs cannot enjoy a company match—thus harming the purpose of these state programs. This risk provides yet another compelling reason why Congress, plus the Labor and Treasury Departments, should intensify their efforts to achieve reform at the federal level—focusing particularly on streamlining and simplifying requirements for employers with under 100 employees.

State-by-state solutions?

It’s tempting to look to “the laboratory of the states” (to paraphrase Justice Louis Brandeis) for solutions. This approach could create several benefits, but would also pose some potential disadvantages.

But first, let’s look at what a good state-level program would look like. We think a promising plan would need to incorporate three elements:

  1. The programs would be structured as IRAs;
  2. Employers would be mandated to participate and automatically contribute a specific percentage of an employee’s pay, but the employee would be allowed to opt out; and
  3. Assets would be automatically contributed to a qualified default investment alternative (QDIA)—a multi-asset class investment solution that provides a diversified portfolio.

To further enhance their programs, states could (and, we believe, should) provide easy-to-understand educational tools to help beneficiaries understand the basics of retirement investing. As electronic investment advisory services (e.g., digital wealth management providers) become more established, states can consider ways to incorporate these services to help participants with additional investment advice. Finally, to facilitate rollovers from the state program to a personal IRA, states could follow the example of the state of Washington and work with IRA providers to establish a portal or marketplace that makes the process simple and inexpensive.

Benefits

State-based mandatory payroll deduction IRA programs offer a number of benefits that could improve retirement outcomes for individuals who work for small employers that do not currently offer a plan. Such plans are relatively simple and—if exempted from ERISA—should carry lower administrative burdens and costs than single employer plans. Most importantly, automatic or mandatory payroll deduction represents an effective way to improve savings. Studies show that if savings are “automatic,” more people will save more.

Potential disadvantages

State-based automatic payroll deduction programs raise a number of concerns. It is expensive for states to establish a program and then maintain an operational and compliance infrastructure. It will also be costly for states to provide ongoing, needed investment education and/or advice. Most of the current state mandatory payroll deduction IRA proposals require that the programs be self-sustaining, which could be a difficult hurdle to overcome. Over time, one would reasonably expect that the ongoing costs should be less than those associated with establishing a single employer plan. However, startup costs, in particular, could be significant, and public funding may be needed.

A major concern with state programs is a potential lack of standardization. A patchwork of different systems that vary from state to state could make it more difficult for employers with operations in more than one state, or with employees who live across a state line, to offer plans that comply with competing state laws.

The issue of portability could also become problematic. If employees relocate from one state to another, what happens to their retirement savings? Would it need to be rolled into an IRA? Could employees stay invested in a state program without making additional deposits? What would happen to a guarantee or insurance benefit, such as those included in the California and Illinois programs? These questions would need to be resolved before launching any state program.

As discussed above, the potential for regulatory arbitrage raises important concerns. State-based IRA programs structured so they are not subject to ERISA, as provided under the DoL’s proposed rule, could discourage small employers from establishing an ERISA qualified plan. Considering the complexities of ERISA and the Code, small employers may opt for a simpler and less costly state alternative. IRA contribution limits are significantly lower than those applicable to 401(k) and other ERISA plans, and this could result in individuals saving less through state programs, and also missing out on a potential employer matching contribution. In the absence of simplification of ERISA and Code requirements, employers weighing the benefits of the alternatives are likely to move toward the state program, potentially resulting in lower savings for many workers.

Conclusion

Americans are living longer and increasingly must rely on their own savings to fund their retirement. In the current political climate there is a low likelihood of comprehensive reform at the federal level. Given this landscape, we urge Congress, the DoL, Treasury and the states to coordinate on workable solutions—for both the private and public sectors—that move retirement savings in the right direction.

At the federal level, a review of the burdens of ERISA and Code rules on small employers could lead to a streamlining of reporting and testing requirements. We believe additional employers would offer plans if the costs, administrative burdens, and risks were addressed. The federal government should also take further steps to facilitate private sponsors of open MEPs. Eliminating the “nexus” requirement is an excellent start. We believe this can be done through DoL guidance and should be included in any federal rule addressing state programs to temper the impact of regulatory arbitrage.

In addition, we welcome innovation at the state level to create potential retirement savings solutions. As noted, there are significant hurdles that need to be overcome, and it is important to avoid an outcome in which these public solutions crowd out the private sector or create a regulatory arbitrage that inadvertently results in lower savings. We are also concerned about the potential downside from a lack of state-to-state standardization.

In conclusion, as the federal and state governments move forward in addressing the challenges of securing retirement, it is critical that they ensure that their initiatives offer solutions that:

  1. Make it easier for employers—in particular small employers and individuals—to establish a DC plan or IRA platform;
  2. Encourage and facilitate continuing and increasing levels of retirement savings, starting at an early age; and
  3. Support well-designed investment programs for individuals planning to retire and for those in retirement.

 

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About the author

Barbara Novick
Vice Chairman, BlackRock
Barbara G. Novick, Vice Chairman, is a member of BlackRock's Global Executive Committee, Corporate Risk Committee and Global Operating Committee. From the ...