New companion reports by the Consumer Federation of America (CFA) and The Pew Charitable Trusts demonstrate that high costs make it hard for small businesses to offer retirement benefits to their employees, and also that high fees can significantly reduce savers’ nest eggs, potentially by hundreds of thousands of dollars. Indeed, smaller firms are much less likely than larger firms to offer retirement plans to their workers.
According to Pew’s research, small employers view retirement savings plans as valuable tools for attracting and retaining talent and enhancing their employees’ financial well-being and say that offering a plan could reduce significant expenses from employee turnover. But many small businesses struggle to offer such plans for various reasons, chief among them the cost concerns.
The costs associated with offering retirement plans include startup costs, administrative services, regulatory and compliance services, investment management, and employer contributions such as matching or nonelective contributions. While some of these costs are borne directly by employers, others—such as investment management fees—are passed on to plan participants. These fees, which are assessed as a percentage of plan assets, can have a significant impact on overall returns to participants’ savings.
The primary reason that small companies often incur higher costs for sponsoring retirement plans than larger firms is the smaller companies’ inability to spread fixed costs, such as fees for administrative and compliance services, over a larger asset base. Smaller employers’ plans also tend to have fewer assets in index funds, which cost less to manage—with fewer or lower fees borne by plan participants and employers—than actively managed funds. In addition, smaller companies have weaker bargaining power than larger firms to negotiate fees for investment management, record-keeping, and other services, and they have fewer resources or less expertise to devote to administering the plan.
However, many small employers overestimate the financial costs and administrative burdens associated with offering retirement plans, suggesting their lack of awareness of cost-effective options in the marketplace.
In fact, survey research shows that many small employers are unaware of various retirement plan options that are designed to reduce administrative and compliance burdens and the associated costs. Pew’s report describes several such options, including traditional 401(k)s, solo 401(k)s, SIMPLE plans, and Simplified Employee Pension (SEP) individual retirement account (IRA) plans—many of which have lower administrative and compliance requirements than other retirement plans. Additionally, innovative solutions such as automated savings programs and multiple employer plans (MEPs) can leverage employers’ collective resources and streamline administrative processes.
The CFA’s report, meanwhile, demonstrates that workers participating in small plans with less than $10 million in assets, which typically have relatively high investment management fees, could retire with hundreds of thousands of dollars less in savings compared with workers in low-fee plans of a similar size—potentially requiring employees to work several additional years to make up for the shortfall. That’s because plan participants don’t just lose the money they pay in higher fees than participants in plans with lower fees pay; they also lose the returns they could have received if they had put their money to work elsewhere instead.
Using information from ICI/BrightScope and Pew’s interactive fee calculator, the CFA calculated that a worker who contributes $500 a month to a small (less than $1 million in assets) retirement plan with average investment management fees for a plan of that size and receives an average 7% real annual rate of return would retire with approximately $289,000 less after a 40-year career than if the same worker had participated in an average-cost plan with more than $1 billion in assets. That’s because administrative and investment management fees decrease, on average, as plan size grows. In this example, the employee would need to work an additional 5.6 years to make up the difference.
| Plan size/costs | Balance at 10 years | Balance at 20 years | Balance at 30 years | Balance at 40 years |
|---|---|---|---|---|
| Less than $1 million (Annual cost 1.26% plan-weighted average) | $81,147 | $224,911 | $479,606 | $930,832 |
| $1 million to $10 million (Annual cost 1.01% plan-weighted average) | $82,277 | $231,736 | $503,231 | $996,407 |
| $1 billion (Annual cost 0.27% plan-weighted average) | $85,739 | $253,455 | $581,528 | $1,220,000 |
Comprehensive data about small firm retirement plans are not generally publicly available, but it’s likely that hundreds of thousands of plans and millions of retirement savers are adversely affected by excessive fees. And while average investment management fees decline as plan size increases, fees also range much more widely among small plans than among large plans. Some small plan participants may be in plans with very high fees; some may be in plans with very low fees.
Survey data indicates that a significant portion of retirement plan participants struggle to understand fee disclosures and their implications. Many small-business owners and managers also lack awareness of the fees associated with their retirement plans, or of the fact that SIMPLE, SEP, and MEP plans have lower fees than other retirement plans.
And high fees in small-company retirement plans can sometimes negate the tax benefits that employees receive from participating in a tax-deferred retirement plan. Once they’ve saved enough in their company’s retirement plan to earn an employer match (if any), some participants may be better off saving any additional money in a low-cost index fund in a taxable brokerage account.
By providing perspectives on fees from employers and employees’ viewpoints, these two reports highlight the importance of education and outreach efforts aimed at individual investors and at small employers. The Department of Labor should require detailed fee reporting and should also ensure that participant fee disclosures provide information that employers and savers can understand, including displaying the impact of fees on portfolios over time.
To maximize retirement savings for their employees, small employers should reduce plan costs as much as possible. And retirement savers need to be vigilant about their plans’ fees—and demand lower-cost options from their employers.
Alison Shelton works on The Pew Charitable Trusts’ retirement savings project.