Despite the acknowledged importance of retirement savings, the cost of offering a defined contribution plan keeps many small business owners from offering them.

The Employee Benefit Research Institute s (EBRI) most recent Small Employer Retirement Survey reveals that at companies with fewer than 100 workers, only one-third of employees are covered by an employment-based retirement plan, compared to 64% of those at bigger companies. Moreover, only 29% of non-sponsors claim to be at least somewhat likely to start programs in the next two years, down from 32% the year before.

The reason, say employers, is cost. According to the EBRI survey, it is going to take significant financial changes to make retirement plans appealing to small employers. Respondents cited an increase in business profits, a plan that requires no employer contributions and increased tax credits for start-up expenses as prime motivators for sponsorship.

Prospective sponsors' concerns are not unfounded. Retirement plan experts explain that small plan sponsors face a number of difficulties in providing programs to their employees. However, most of these can be overcome with proper education, preparation and plan design.

Defined benefit pension plans, of course, are difficult for most companies to afford, large or small. Few small businesses still have them. According to the Bureau of Labor Statistics, 9% of those with fewer than 100 workers and 38% of companies with 100 or more, including large corporations, operate pension programs.

Bill Slater, vice president of MetLife Retirement Plans, notes that the expense is the major obstacle to establishing and maintaining a program, despite what appears to be a minor resurgence in DB plans.

Federal legislators are trying to revitalize the DB system by replacing the Treasury bond rate and simplifying the administration requirements. A cash balance structure might help mitigate the cost, but Slater admits that it would not necessarily help older workers. Therefore, employers probably are better off opting for a 401(k). But despite the relatively low price, sponsors, even those with as many as 500 employees, find that even 401(k) plan expenses can be daunting, especially the employer matches that are a standard component.

"Small employers face tension from various competing concerns, but if you can boil them down to one concern, it would be covering the cost and still providing employees with adequate benefits," said Don Mazursky, a partner at the Atlanta law firm of Mazursky & Dunaway.

Assistance at Hand

Some assistance is available for cash-strapped sponsors and would-be sponsors. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) offers 50% tax credits for qualified plan start-up costs to employers with fewer than 100 workers, plus a $500 tax credit during each of the first three years the plan is in effect. Employers also can save money through plan structure, said Catherine Collinson, senior vice president of Transamerica Retirement Services.

"Most providers are very flexible in terms of structure and cost," said Collinson, who also suggested that sponsors don't necessarily have to offer the employer match. "Everybody places a very high value on the match, but the labor market's been soft. Chances are the employer won't lose employees or have a hard time hiring them because of the lack of a match. The match is important, but having a plan is even more important."

Plan sponsors also need to educate themselves about their legal responsibility. Studies have shown that small business owners are shockingly unaware of their fiduciary duties. Most do not regularly evaluate their investment selections, and many have no idea that they are the primary fiduciaries of the plan. Furthermore, they do not know about the tax credits available to them or even about the most common types of retirement plans.

"In the post-Enron environment, with the mutual fund issue and Department of Labor guidance about what you have to do to stay on top of a crisis, [the amount of regulation] makes it harder for a small businessperson to allocate the time to do all those things," said EBRI President Dallas Salisbury. "For example, very fast vesting requirements and non-discrimination requirements add time and expense to administering [a 401(k)] and uncertainty about what employers can contribute."

Mazursky recommends that employers appoint a committee whose members make it their business to keep up with the regulations needed to operate a plan and who "actually understand they're responsible for looking after the participants' best interest."

The non-discrimination requirements and attendant testing of retirement plans have proven particularly nettlesome for small employers, especially those whose tiny businesses have a few highly compensated people (usually the owners) and a few low-paid employees. The result of such an arrangement usually is a lower-paid population that cannot afford to contribute as much as they might like and a higher-paid workforce that is not allowed to contribute as much as they might like for fear of violating anti-discrimination rules.

The decrease in retirement plan participation does not help, either. Small businesses of 500 or fewer have seen a drastic drop-off, from 80% in 2000 to 61% last year. If an employer's focus is on keeping key, highly compensated employees happy, barring them from saving for retirement is not the way to go. Fortunately, there are other options.

Mazursky suggests several financial structures that allow sponsors to meet the anti-discrimination requirements. One arrangement, which involves a safe harbor and matching contribution, allows employers to contribute a 100% match for a small percentage of a 401(k) and then a 50% match for another small percentage. This adds more money to the funds provided by the lower-paid employees and gives the highly compensated a chance to save more.

Those results can be accomplished by paying non-qualified elective contributions on behalf of lower-paid workers, thereby boosting the percentages for the purposes of the anti-discrimination test. However, Mazursky points out that the IRS is considering restricting this practice because employers could contribute on behalf of employees who already have left the company.

A third option for a small plan sponsor would be to set up a non-qualified retirement plan especially for the highly compensated employees, what Mazursky calls an "excess 401(k) plan," that does not have the same tax advantages but does allow sponsors to bypass the testing.

Salisbury remarks that many employers bypass 401(k)s altogether and opt for savings incentive match plans, or SIMPLE plans, to cut down on the number of rules and reporting requirements.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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