Now for the Good News
Ignore the D.C. struggle over how to reform 401(k) rules. The real issue is why more CEOs don't take advantage of an existing program that both they and their employees can profit from
Last spring Marshall Rafal, the chief executive and owner of OLI Systems Inc., a Morris Plains, N.J., environmental-software manufacturer, investigated setting up a 401(k) plan for himself and his 12 employees. But although the idea seemed enticing at first, Rafal nixed it after doing a bit of research. "I learned that I had to worry about all kinds of expenses OLI would face if only the highest-compensated employees signed up," he says. "Then I found out there was the potential for being sued by my employees if the investments we chose for the plan turned out to be unprofitable. I wanted no part of this."
Unfortunately, Rafal is far from alone.
According to the Small Business Administration, 76% of companies with fewer than 100 employees have thumbed their noses at 401(k) plans and other pension-plan options. The company owners complain about excessive administration costs and complex regulations. That has left most small-business owners and their employees without any significant form of retirement savings -- in disturbing contrast with companies with more than 100 staffers, of which nearly 70% provide pension coverage.
That crisis has caught the attention of Washington, where several pension-reform measures are winding their way through Congress. But here's the irony. Despite years of strong bipartisan support for pension reform, similar measures were squashed twice before, when President Bush vetoed the larger pieces of Congressional legislation they belonged to. The latest push for pension reform may well meet a similar fate at President Clinton's hands.
So perhaps it's time for small-business owners to reexamine their 401(k) dilemma. Flawed as they are, current pension options are nowhere near as problematic as many small-business owners believe. And they do offer some real advantages for entrepreneurs and employees alike. Meanwhile, the diehards who hold out for true pension reform could find themselves waiting a very long time, given Congress's other, more pressing financial priorities.
Let's take a look at the various pension-reform proposals that have floated around Washington in the past year. Last summer President Clinton captured some headlines with his proposal for a plan called NEST (National Employee Savings Trust). It had one advantage going for it: simplicity. It allowed companies with fewer than 100 staffers to make retirement contributions directly to employees' individual retirement accounts, rather than to pension trusts that companies would have to administer. Employees could contribute up to $5,000 annually on a tax-favored basis; their employers could then choose between two options for required contributions.
NEST won some fans quickly. "The beautiful thing about it was that the small-business owner only had to make his or her financial contribution. There weren't any hassles about paperwork or plan testing or other government requirements," notes Jere Glover, the chief counsel for advocacy at the SBA. But there were problems too, chief among them that NEST's employer-contribution requirements were actually less flexible than the rules currently governing 401(k) plans. All this became academic when NEST failed to win a place in any of the pension-simplification measures floating around Congress, perhaps because of its White House baggage.
Then a Republican counterproposal picked up steam. Nicknamed SIMPLE (for Savings Incentive Match Plan for Employees), it was backed by Senate majority leader Bob Dole and was quickly added into the pension-simplification package, part of the budget-reconciliation bill that was marked up by the Senate Committee on Finance. SIMPLE offered many of the same advantages as the Clinton plan: especially, exemption from the federal nondiscrimination rules that make compliance with 401(k) plans such a costly proposition. But SIMPLE had its own fair share of problems, including the fact that congressional economists believed it would cost $500 million in revenues over seven years -- a drop in the bucket to some, but nonetheless an additional cost in a time of budget cutting. However, it was included in the House's pension-simplification legislation.
So despite much work and attention, SIMPLE seems not much likelier than NEST to find its way into law, at least not in the immediate future. Should small-business owners really care? Probably not. Although it is certainly true that the owners of start-ups and growing businesses need something to motivate them to start pension plans for themselves and their employees, I'm not sure that a new alternative is necessary. That is, certainly not something along the lines of NEST and SIMPLE, both of which fell short of their promised relief for small-business owners.
Take flexibility, for example. It's one of the biggest gripes entrepreneurs have about 401(k) plans. In the past five years I've probably listened to hundreds of business owners tell me they wouldn't set up a 401(k) because they refused to box themselves into a corner where they would be forced to match their employees' retirement contributions. But here's a reality check: NEST and SIMPLE -- the two plans that promised to solve everybody's 401(k) problems -- required mandatory contributions, while a 401(k) does not.
Now, 401(k) plans are not perfect, and the rules about them could use some simplification. Safe-harbor guidelines would be a welcome start. For companies that qualified for safe harbors, such guidelines would offer some relatively simple 401(k) design models that would exempt small companies from federal nondiscrimination regulations, thus lowering administrative and other costs. Such a measure was part of the pension-simplification packages that were approved twice by Congress and were included in the legislation pending there last fall. In a rational universe, they would have been signed into law by the time you read this article. But if they have succumbed to a veto, small-business owners should wise up and stop waiting for pension miracles from Washington.
Small-business owners need to take advantage of the current system. Too often they have so many misconceptions about 401(k) plans that they can't begin to consider the plans with an open mind. They've lost sense of the all-important value of retirement savings, for themselves as well as for their employees. Or they convince themselves that their own retirement will be taken care of as their companies keep getting bigger and better (a risky proposition to bank on). Meanwhile, they reject 401(k) plans because of all the problems they've heard about. "The funds aren't portable," is a complaint I've often heard -- "401(k)s just don't fit the new U.S. economy, where people change jobs more often."
That's plain wrong. U.S. business owners don't need NEST or SIMPLE to make pension funds portable. They already are. When corporate employees switch jobs, they can bring any 401(k) funds they are vested in right along with them, simply by transferring the funds to their new company's 401(k) or by setting up an IRA to receive them.
What about Marshall Rafal's fear of being sued if his plan's investments fare poorly? Even that's not a significant risk these days, so long as companies choose among the growing number of bank, insurer, or mutual-fund 401(k) plans that are designed and administered to comply with federal investment guidelines. While it's also true that 401(k) plans are costlier to administer than anyone would like (the latest estimate is about $230 a participant for small companies), tax advantages can help offset some of those costs. Employer contributions, for example, actually reduce a company's payroll and other taxes.
The fact is, Washington should spend its time trying to fix things that are truly broken -- not things that need tinkering with. Even the National Federation of Independent Business's Kent Knutson, a strong proponent of 401(k) reform, argues that other legislative initiatives should take priority. "The first thing we should be doing is fixing the health-insurance situation. No small company should set up a pension plan before they've got medical coverage," he says.
"The bottom line is, there are flaws, but 401(k) plans as they stand now are certainly better than nothing," says pragmatist David W. Kemps, manager of employee-benefits policy for the U.S. Chamber of Commerce. Every year that entrepreneurs waste waiting for lawmakers to create the perfect 401(k) plan represents a lost year of retirement savings that they and their employees will never be able to recover.* * *
Jill Andresky Fraser is the finance editor of Inc.