Should Small Plans Mimic Big Ones?

Mitchem, an executive vice president at State Street Global Advisors (SSgA), made that argument recently before the U.S. Senate Subcommittee on Economic Policy, which falls under the wider Senate Committee on Banking, Housing and Urban Affairs. During her testimony, Mitchem highlighted the success that the largest corporate employers have had in helping their workers achieve retirement income adequacy, as well as ways in which regulators and industry leaders can make success more universal.

Mitchem pushed lawmakers and regulators to remove barriers that may prevent smaller companies from offering the well-structured, well-funded retirement savings programs prevalent among large U.S. corporations. She said the defined contribution (DC) plans of the largest corporate employers have done a much better job than smaller employers to help fill the gap left by closed and frozen defined benefit (DB) plans, upon which many Americans historically relied to fund their retirement.  

The upshot of Mitchem’s presentation was that “the great divide” in retirement readiness is involved more with employer size than employee income level. That’s because large employers are much more likely to provide a retirement plan, and when they do, the plan produces better results for those employees that participate in it. During her presentation, Mitchem compared government data from large and small plans across a number of dimensions to illustrate the impact of employer size on retirement readiness: 

• Access: Nearly nine in 10 (89%) large companies offer DC plans, according to the Bureau of Labor Statistics, while just 14% of small businesses sponsor some type of plan for their employees to save for retirement in a tax-advantaged environment.
• Participant Rate: the average employee participation rate in the largest plan segments is close to 80%. For the smallest companies that offer a plan, participant rates dip to an average of about 74%.
• Savings Rates: In the largest plans, the average employee savings rate is 7.3% of salary, while for the smallest plans it is 5.6%.
• Account Balances: The average account balance in the largest plans is about two times the average across all plan sizes—at $140,000 compared to about $64,000.

Mitchem explained that the advantage large plans have over small plans usually boils down to the inclusion of automatic enrollment and contribution escalation features, as well as the benefit of economies of scale on investment fees and administration costs. She pointed to a recent analysis from the Employee Benefits Research Institute (EBRI), which shows that 85% to 90% of younger middle-class workers who consistently participate in retirement plans with automatic features during their working lifetime can expect to replace at least 80% of income in retirement. Many experts point to between a 70% and 80% income-replacement level as a “successful retirement.”

Mitchem admitted that the analysis includes some potentially problematic assumptions about Social Security eligibility and payments staying the same despite major funding challenges facing the federal safety-net program, but she said the point still holds about auto-features dramatically improving outcomes. And, she says, there’s no denying larger plans have been better at including these features.

Additionally, larger plans are more likely to offer more aggressive and diversified investments as the default investment option, Mitchem said, which contributes significantly to employees’ retirement success. Large plans also tend to offer participants a more streamlined and simplified menu of investment choices to help participants make better decisions, she said, as well as robust access to online planning tools and engagement features like mobile applications and income-need calculators.

Mitchem frequently cited the PLANSPONSOR 2013 Defined Contribution Survey during her presentation. The research shows the occurrence of auto-enrollment is more than twice as prevalent in the mega plans category (61.4% for plans $1B+ in assets) when compared with micro plans (23.4% for plans with less than $5M in assets), increasing quickly as one looks across larger and larger subsets of plans. One of the biggest divides between large and small plans comes in comparing the occurrence of automatic escalation features, which hovers at about 12% for micro plans and 54% for mega plans (see “What That 1% Increase Can Do for Participants”).

Mitchem pointed out that the micro plans are also eating more of the average participants’ investment returns in the form of fees and administrative expenses. So while 45.3% of mega plans are able to achieve an average expense ratio between 0.25% and 0.50% (25-50 bps), only about 10.6% of micro plans can deliver this low expense target. Large plans (at $200M to $1B in AUM) can do this about 32% of the time. The small plan category ($5M to $50M) hits the low-expense benchmark 14.9% of the time and mid-market plans ($50M to $200M) do so 19.6% of the time.

Mitchem said these results beg the question, “How do we translate the successful evolution of DC plans sponsored by large employers into success in the small employer market?” 

Her first piece of advice is for federal lawmakers and regulators to help remove the obstacles that can make plan sponsorship more challenging for small employers. Unlike large employers, small businesses often don’t have the time, resources or expertise to efficiently administer a retirement plan, she said, so they benefit from being able to merge their plans when circumstances permit. 

One potential solution Mitchem floated would be to expand the multiple-employer plan (MEP) system through a new, federally supported industry group or other association. That could make small employers more likely to adopt some sort of retirement savings plan option, and could have the added benefit of merging many small plans into a single, larger plan that can be run more efficiently and secure the best share classes and lowest investment fees for participants.

Mitchem recommended that the current Department of Labor (DOL) nexus requirement be eliminated for participant-funded retirement programs, and that a safe harbor be offered to sponsors of multiple-employer DC plans, provided that certain best-in-class plan design features are incorporated. Such “well-structured MEPs” should also mimic the largest plans in the U.S. by being required to leverage automation and simplification to drive better participant outcomes, she said.

Mitchem said that in SSgA’s view, the features required for safe harbor coverage of MEPs should include the following:

• Auto-enrollment starting at a minimum of 6% with default into an indexed target-date fund (TDF);
• Automatic contribution rate escalation at a minimum of 1% annually, up to a cap of 15%;
• A simplified investment menu including an index TDF, a limited number of core options and a lifetime income option to help manage longevity risk;  
• A loan program available only for hardship to prevent plan leakage;  
• A total plan expense ratio under a certain limit based on the size of the MEP; and
• An optional employer match or discretionary profit-sharing type contribution.

Mitchem urged the removal of testing and reporting requirements for employers under a certain size, either inside or outside MEPs. Also important, she argued, is acceptance of aggregated 5500-type reporting with a breakdown of contribution amounts by participating employers, as well as alterations to the tax code to prevent disqualification of an entire MEP in the case of a violation by one (or more) participating members.

“We believe granting small businesses the ability to participate in simplified MEPs would send an important signal to the retirement market,” Mitchem said. “This change would inspire DC plan service providers and investment managers to create more products tailored to small businesses, providing a broader range of choices and greater economies of scale to an underserved market segment.”