Small Business Employee Retirement Plans

Small Business Employee Retirement Plans Today's tight labor market on the Treasure Coast has small business owners looking for an edge in the competition for top talent. A 401(k) plan can provide that lure, but many companies have shied away from this popular retirement savings vehicle because of high costs and liability concerns.

If you are one of these small business leaders, you now can construct a unique low-cost 401(k) plan that also provides professional investment advice options for employees.

Employers looking to start a plan, and those with existing plans, often have a misperception that a 401(k) is expensive and burdensome. In reality, if constructed properly, the plan can be less expensive than a company-sponsored Savings Incentive Match Plan for Employees IRA.

There are a number of advantages to 401(k) plans:
Owners and employees can put away 50 percent more retirement money each year in a 401(k) than in a SIMPLE IRA.

The federal government allows small businesses with fewer than 100 employees to take a tax credit in the first three years of the plan to defray startup cost.

By designing an "open" plan, independent of an insurance or mutual-fund company, your employees will not be locked into a proprietary set of funds or investment options dictated by those companies. These "closed" plans often are loaded with conflicts of interest and fees from 2 to 4 percent. This excessive cost eats into plan assets and often is the reason for the majority of funds under-performing the leading stock indexes.

Your open plan should have an independent record keeper, allowing you and your advisor to choose the best and lowest cost investment options. You can avoid being captive in a plan with one or two poorly performing mutual fund families.

To hold down costs in your plan, consider a customized low-cost 401(k) plan, which can include a diversified stable of both low-cost index funds and exchange traded funds, which have exploded in popularity because of their simple structure.

Index funds mirror a stock or bond index, like the Standard & Poor's 500. They are attractive investments because fees and expenses are very low. In contrast, 80 percent of active fund managers historically under-perform the S&P 500.

Exchange Traded Funds, or ETFs, are similar to index funds in several ways. They consist of a portfolio of securities designed to track an index or sector, are diversified and have very low costs. In contrast to index funds, priced at close of trading, ETFs trade all day like a stock.

Employers also can get help in limiting the fiduciary liability of having a 401(k). Many business owners fear that employees will sue if their accounts fare poorly and fail to produce sufficient funds for retirement.

The solution: prudent monitoring of plan assets by an independent advisor who can construct a cost-effective plan and help employees with investment decisions. This creates a shared liability between the business and a trusted third-party advisor. It pays to use an independent registered investment advisor to prevent any conflicts of interest, such as those between advisors affiliated with brokerage firms and 401(k) plan administrators.

Employees usually are very receptive to having a professional manager oversee their investment options. Most employees are not financial experts and often are intimidated by the prospect of handling retirement assets. This can create either paralysis, causing employees to stay with losing investments much too long, or market-timing attempts, often way off the mark.

An advisor can bring needed discipline and risk-management skills to employees, lessening their anxiety. This arrangement combines the best of the pension and 401(k) plans. The advisor can be paid directly by the company (outside of plan assets), leaving index fund or ETF expenses as the only cost to employees.

The advisor should work on a fee-only basis. That person must disclose, in writing, the fee for managing risk and portfolio costs. This straightforward approach prevents conflicts of interest that have become so prevalent in the current 401(k) environment and on Wall Street in general.

Retirement Plan Pre-Tax Contribution Limits
Year SIMPLE IRA Traditional 401(k)
2004 $9,000 $13,000
2005 $10,000 $14,000
2006 $10,000 $15,000
Source: Investopedia.com

Estimated total annual cost (with % of assets) of small business retirement options
(assumes retirement plan with $1.5 million in assets and 20 employees)
Professionally Managed
Low Cost 401k
(with average mutual fund expense ratio)
Insurance/Annuity 401k Mutual Fund Sponsored 401k
$14,075 (0.94%) $23,000 (1.53%) $33,894 (2.25%) $34,500 (2.3%)
Sources: Employee Fiduciary (employeefiduciary.com) and Hewitt Associates