The Internet has propelled 401(k) plans out of the "dark ages," opening the door to a largely untapped $1.2 trillion in assets in the small business market, according to a study by Celent Communications.

The Boston-based firm, which provides e-commerce and Internet consulting services to the financial services industry, said Internet technology allows online providers to serve the small plan market more efficiently and profitably, in addition to making it more cost effective for plan sponsors to establish 401(k) plans. The small-plan market is defined as companies having no more than 100 employees.

Pointing out that traditional plan administration is usually a "laborious, inefficient and error-prone process," the report said new online platforms "are automating many of these processes."

The e-401(k) providers can seamlessly transport information between front-end applications, such as voice-response systems or Web sites, and back-end systems handling payroll deductions and transaction processing. "As a result, plan information is available on demand, processing errors can be identified and flagged, and payroll deductions for contributions can be automated, among other benefits," according to the report. "Given that one of the top reasons a plan sponsor leaves a provider is due to processing errors, automation should minimize this consequence."

It also said 401(k) automation has reduced administrative and record keeping costs between 20% and 30%.

`Underserved'

Small businesses have been "underserved" by 401(k) providers in the past, according to the report. Heavy administrative burdens, cost and poor investment selections are among the factors keeping small employers from adopting 401(k) plans.

The new online 401(k) providers "are breaking down those barriers," said the report. "These plans are easy to administer, cost effective and provide investment options that make them attractive to small business owners. In turn, Internet technology allows the e-401(k) platforms to service this market segment more profitably."

While the small-plan market may look attractive and is likely to be profitable to the online providers for some time, the study also points out that competition for a piece of the estimated $1.2 trillion in "untapped" small-plan assets is likely to intensify.

Some drawbacks

Celent generally gives the online 401(k) platforms high marks for ease of use, cost effectiveness and the choices in investment options they offer participants, but there are some drawbacks.

Pricing is one of the primary reasons online providers are attractive to small businesses. Online 401(k) costs "are between 30% and 50% lower than large-plan costs, particularly in the areas of set-up, conversion, administration and compliance," the report said. "In some cases, providers give away these services as a competitive device."

The Internet also is having a significant effect on 401(k) providers in the area of building lifetime customer relationships, which translates into opportunities to sell other investment products, the report indicated.

Retention of 401(k) rollover assets is another area in which providers may reap major benefits from the Internet, the report said. "Currently, the average rollover retention rate is 20% among plan providers. Given that $1.5 trillion in 401(k) assets will be rolled over during the period 2001 to 2005, we estimate an opportunity cost of lost revenues amounting to $196 billion on a net present value basis, assuming the retention rate remains at 20%."

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.