Scaling for the Future
It is no secret that the U.S. faces a significant retirement coverage gap. Anyone without a retirement plan, either through his employer or self-directed, is considered in the gap. The lack of coverage is just one issue, as many Americans either have yet to start saving or started saving late and must catch up. The difference between what individuals have accumulated and what they need in order to maintain a minimum standard of living in retirement is called the savings gap, and, says T. Rowe Price’s “2022 Retirement Market Outlook,” the disparity is approaching $4 trillion.
The problem is especially acute for self-employed individuals and small businesses. According to data from the Aspen Institute Financial Security Program, these groups are often the last to think about creating a retirement plan, because they tend to be short on resources and time. Those that do take the time, though, will find a few options: The savings incentive match plan for employees (SIMPLE) and simplified employee pension (SEP) plan are the most common. Both types allow individuals and/or small employers to contribute a portion of their income to retirement savings in a tax-advantaged manner.
Either option can be a great starting point, but it will also come with drawbacks. According to plan rules for SIMPLEs, if a business grows past 100 workers, it will no longer qualify. That can be tricky for a small business working on actively increasing its headcount. Contributions for either plan type are also capped at a lower rate than are those for a 401(k) plan. For a SEP plan, for example, IRS rules say contributions may not exceed 25% of the employee’s income, and the employee herself may not contribute.
As with 401(k) plans, the IRS updates SIMPLE contribution limits annually. For 2022, the limit for SIMPLEs is $14,000 vs. $20,000 for a 401(k). Employees making catch-up contributions after age 50 may contribute an additional $3,000 this year to a SIMPLE, vs. $6,000 to a 401(k) plan.
As businesses grow and mature, they may also encounter user and investment limits with their SEP plan or SIMPLE, and experts agree that some companies may benefit by switching to a traditional 401(k). Yet, there are both real and perceived barriers to transitioning plans, and that can keep employers on the fence about acting until they must.
Sources say the industry has new solutions that can make the transition relatively easy but admit that advisers and providers could do more to get the word to employers.
Costs and Confusion
Financial advisers may want to focus outreach and engagement efforts on employers that offer SEPs or SIMPLEs, to get them thinking now about their retirement offering’s future.
“There are some misconceptions out there about what transitioning to a 401(k)-style retirement plan means in terms of cost, time and effort,” explains Christa Iacono, Los Angeles-based institutional retirement senior product manager at Capital Group. “Often, employers assume that their costs will go up significantly or that it will take a lot of time and resources to make the move. If you’re a small business, you may not have [either]. But this is where working with financial professionals on plan design can help. The costs have come down, and there are more solutions available for small plans than ever before.”
“There are some misconceptions out there about what transitioning to a 401(k)-style retirement plan means in terms of cost, time and effort.”
Jason Crane, head of retirement distribution at Ascensus in Chicago agrees. “I think there’s been a growing recognition within the adviser space that working with smaller plans is possible and can lead to a broader relationship,” he says. “Many of the needs of small plans are the same as larger ones’, and you may see employers want to do something later on with insurance or cash balance plans, for example. Advisers who take the time to build the relationship early are going to see more of those opportunities.”
Recent innovations in financial technology have lessened the administrative burden for advisers, Crane says. Automation makes it easier to bring on new plan participants, and technology can help manage basic portfolios. Taken together, these factors have changed the economics of plan management, so that advisers do not necessarily need high plan minimums to make the costs work out. “What we see today is that there are advisers who can work with almost any size plan,” he says. “That’s a shift that has happened in the past few years that people may not be readily aware of and can help employers bring a new layer of financial advice and capability to their plans.”
New Solutions
Other things are changing, too. New product offerings are giving employers more options for how they structure their plan or plans. This enables greater plan customization and a bigger push into 401(k) plans by small-business owners, according to sources. The availability of these offerings also provides a new impetus for companies to work with a financial adviser who can help explain the various options and their trade-offs.
Capital Group recently launched its SIMPLE IRA [Individual Retirement Account] Plus plan, which has the basic structure of a SIMPLE but with a level of financial advice and menu customization baked in. Iacono says the Plus plan can provide solutions for employers that want a bit more out of their retirement offerings but hesitate to transition to a full 401(k) just yet. “We think this is a way for small employers to set their employees up for success,” she says. “We’re also continuing to add features. We think this is a really viable option for small businesses because they can still offer a simplified plan but also begin building a relationship with an adviser.”
Iacono adds that, with something such as the Plus plan, employers can designate a target-date fund as the default option but also provide a customized menu for participants who are more proactive about investing. The result is a user experience that hues more closely to what participants get in a 401(k) plan, which can be helpful from a change management perspective if an employer moves to a 401(k) offering later, once the business grows.
The new state-run IRA programs, too, are prompting some small employers to consider their options. The state-run programs typically offer a very basic IRA to workers who have no access to a plan. Generally, in states with these programs, employers not offering a retirement benefit must register their employees with the state option.
Ascensus currently provides the basic account individuals get if they are enrolled in CalSavers, California’s state-backed plan. Crane says, when employers look at the basic plan, some decide they want to engage with a financial adviser to get more customization and sponsor their own offering for employees.
“From our view, we want to see people get enrolled in a plan so we can solve the coverage gap issue. That’s why we’ve been very involved with the state plans; we think there has to be more than one solution,” Crane notes. “But, that said, we’ve seen where some smaller employers look at the basic state IRA and decide they want more. So the existence of the state plans is really moving the conversation about retirement forward, and more employers are getting engaged on this issue, which is positive.”
Art by Irene Servillo