There's no doubt that a strong retirement benefit is a powerful tool for luring and retaining talented and dedicated employees. In fact, it confers a significant edge on small outfits, since only 15 percent of companies with five to 99 employees offer "defined contribution plans," as the IRS calls 401(k)s and IRAs.
Of course, given the costs associated with administering such a benefit and the matching contributions to your employees' accounts, it's also a fairly expensive way to keep your people happy. Yes, the government helps defray a significant portion of those expenses. All participants, company owners included, defer taxes on the wages they direct into a defined contribution plan. And your company can deduct its matching contributions and plan expenses. Still, it's well worth your time to be sure that any retirement plan you set up makes the most of your investment.
The pages that follow will help. They contain a step-by-step guide to picking a plan, a primer on the fees you can expect to pay, questions to ask a prospective investment adviser, and resources for further inquiry. Please read on.
Picking a Plan
1. Evaluate Your Needs
If you want to encourage your employees to contribute to their retirement, there are two options: a so-called SIMPLE (savings incentive match plan for employees) or a full-blown 401(k). Which you choose depends on how much your company can afford to match, how much you intend to save for yourself, and how likely your employees are to participate. The last of these, in fact, might dictate the choice -- and, according to St. Louis-based retirement-plan consultant Patrick Shelton, "If someone is 30 years old or younger or makes $30,000 or less per year, they typically don't participate in retirement plans."
The SIMPLE Option For businesses with up to 100 employees, SIMPLE IRAs and the similar SIMPLE 401(k)s are, indeed, fairly simple. You fill out a two-page IRS form, pay a small fee (at Fidelity Investments, for example, the largest administrator of SIMPLE and 401(k) plans, it's $350 plus $25 per participant), and that's about it. In most cases, participants (including employers) can put away up to $10,500 in a SIMPLE IRA and $10,500 in a SIMPLE 401(k) in 2008. (In both instances these are pretax dollars.) The company must match at least either 3 percent of the salaries of employees who participate in the plan or 2 percent of the wages of all eligible employees, including those who do not participate -- and this employer match is immediately fully vested. Brokerages and investment companies offer SIMPLEs -- judge them on fees, breadth of potential investments, and customer service.
The 401(k) Option A 401(k), by contrast, generates a lot of paperwork, costs several thousand dollars per year, and requires more thought. But participants can put away up to $15,500 per year (again, these are pretax dollars), provided the company makes a slightly more generous match than the SIMPLE requires. (If you don't make these so-called safe-harbor matches, the amount owners can defer is limited by how much employees elect to defer.) On the other hand, 401(k)s without safe-harbor matches require no employer match at all, a potential plus for early-stage companies. (And you can always revisit the matter later.)
The Rule of Thumb: Generally, a full 401(k) makes sense once a company reaches a payroll of about $500,000 -- or, alternatively, when you and your participating employees combined contribute at least $20,000 in salary deferrals and company matching.
2. Get Professional Advice
A 401(k) is not something you want to tackle on your own. Two kinds of guidance are in order: investment advice and plan design and management. Some professionals and investment companies perform both of these services. Others specialize, in which case you're opting for an unbundled, or open architecture, plan.
The Package Deal Mutual fund companies, banks, and insurers offer bundled plans that allow harried entrepreneurs to quickly put the whole issue out of mind. You might not even need to cut a check, because the fees often come out of the plan's assets. That doesn't necessarily mean bundled plans are cheaper -- though it can be hard to tell, because the fees are often buried (see "Figuring Out the Fees"). One thing you generally won't get in a bundled package: specific recommendations about which funds to offer. Also note that, for better or worse, bundled plans typically give you fewer investment choices.
À La Carte Services Unbundled plans, which often let you deal locally with other small businesses, tend to emphasize service -- in particular, custom- designed plans and investment advice. But it takes a little more work to go this route. First, you will need a third-party administrator, who creates the plan and manages it. These consultants can design a plan that will not only save a company money but also ensure that the owner gets the maximum allowable benefit from the plan. You will also need an independent registered investment adviser, who can negotiate the thicket of fund companies and individual funds. Some advisers are reluctant to take on small plans, but with patience you will find one (see "Resources" in How to Launch Your Company's 401(k) Plan).
What to Expect: Whichever option you go with, you should get a letter that specifies what the adviser is expected to deliver -- a projection of how many employees will begin contributing to their retirement and how much money they will contribute, as well as goals for investment returns and fees -- and how much it's all going to cost. At year's end, expect a letter that explains what the adviser did to meet these goals.
3. Pick a Fund Platform
Virtually every fund company, bank, or brokerage in the 401(k) business can offer the basic mutual funds any defined contribution plan should have. An independent investment adviser will compare fund performance, of course, but he or she will also give weight to other ways in which the fund will serve your business. One key factor should be fees, which vary widely and can be quite large. Among the other considerations: Can the vendor conduct educational seminars in multiple locations or provide materials in Spanish?
There are many types of investment vehicles for a 401(k), but mutual funds are by far the most popular. Insurance brokers often sell funds packaged within what's called a group variable annuity contract. As the market consolidates, the menu of offerings is looking ever more similar from company to company. A basic 401(k) plan ought to begin with a basket of funds, including:
- A large-cap value fund
- A large-cap blend fund
- A large-cap growth fund
- A mid-cap blend fund
- A small-cap blend fund
- At least one bond fund
- A fixed income fund, such as a money market
- An international fund
- Three to five asset-allocation funds targeted to employee retirement dates
What about individual stocks and bonds? Not a good idea. A plan must offer prudent investment choices, and educating participants about all those options is all but impossible given the complexities of the market. If you or your employees want to bet on individual companies, do it outside your retirement plan.
3 Questions to Ask An Investment Advisor
Will you take fiduciary responsibility for the plan?
A 401(k) plan is set up for the exclusive benefit of participants, who may seek redress if the plan isn't suited to their investment needs, doesn't provide the proper guidance, or performs poorly relative to the market. If your adviser doesn't assume responsibility, then the plan's sponsor -- namely your company and its officers -- is at greater risk of being held liable. In which case, find another adviser.
Do you take compensation from an investment company?
A sales commission from a plan provider may cloud your investment adviser's judgment; he or she might steer you toward a provider that may or may not be the best match for your company.
Are you certified by a professional organization?
It's no guarantee, but hiring an adviser who has been vetted by a standard-setting organization (see "Resources" in How to Launch Your Company's 401(k) Plan) increases the odds that he or she will follow best practices in maintaining your plan's integrity.
Figuring Out the Fees
Fees for 401(k)s are a hot issue right now -- participants are suing, regulators are tinkering with the rules, and Congress is considering a rewrite. It's a complex topic, but suffice it to say: Don't believe it if an adviser says his services cost nothing -- you're paying for it, one way or another. Here's a breakdown of the fees to watch for.
MUTUAL FUND FEES Hidden fees are especially common among fund companies competing in the small-business market. They embed administrative fees in the fund expense, for instance. When insurers wrap funds in annuities, they add features -- including a guaranteed income option and an easy annuity rollover -- but often layer extra fees on top of the usual expenses. And brokers collect commissions, which fund companies recover by selling a share class with higher expense ratios.
UP-FRONT VS. EMBEDDED FEES Retirement-plan consultant Shelton urges clients to avoid embedded costs and arrange up-front fees when possible. Company owners ultimately pay that expense, either as the plan's sponsors or as its leading participants; better to take it as a tax deduction than to have it eat away at investment returns.
ADVISER AND ADMINISTRATOR FEES Investment advisers generally charge fees as a percentage of plan assets; figure a quarter of a percent to 1 percent of assets, depending on the services offered, and more if they're taking on an administrative role. Third-party administrators typically charge a base fee of about $1,000 plus $25 to $35 per participant. Sometimes those fees are partially offset by commissions paid by the fund companies to the plan administrators.
- For information from 401(k) basics to small-biz-specific issues, check out 401khelpcenter.com or benefitslink.com.
- For a searchable database of financial advisers accredited by the Center for Fiduciary Studies, go to fi360.com.
- The National Association of Personal Financial Advisors certifies fee-only financial professionals. Search for members at napfa.org.
- Financial Service Standards certifies advisers with the Professional Plan Consultant designation. Search for PPCs at 401kservicesolution.com.