About 40 percent of working households with members aged between 25 and 64 having no retirement savings.[1] So how did we get in to this predicament and what can we do to fix it? A very brief examination of the history of retirement saving in this country is a helpful start.
A 401(k) plan is a cash or deferred arrangement under which a covered employee can elect to have a portion of his or her compensation (otherwise payable in cash) contributed to a qualified retirement plan as a pre-tax reduction in salary (however, some plans also accept after-tax contributions from employees). The safe harbor 401(k) was designed to avoid discrimination between higher-paid and lower-paid employees and came in response to a history of higher-paid employees' receiving higher-percentage contributions.
The safe harbor 401(k) plan rules enacted by Congress in 1998 have helped simplify some rules covering 401(k) plans, but it has clearly not gone far enough in making a 401(k) plan more appealing for small business employers. Congress has taken some positive steps recently in reducing the fees imposes on 401(k) plan investments on employees, but that doesn’t solve the main problem that establishing and administering a 401(k) plan for a small business is just too expensive to justify its intended benefits.
Here is one some simple solution that can help bridge the gap and get many more small business with employers interested in establishing a 401(k) plan:
- For employers with less than 25 full-time employees, simply require the employer to notify the employee of the availability of a 401(k) plan, but do not impose any matching contributions or related plan testing requirements (i.e. top heavy calculations, ADP, or ACP testing). Essentially suspend the safe harbor and all ERISA related plan-testing requirements. This will make it easier and more cost effective for employers to offer 401(k) plan benefits as well as reduce annual record-keeping costs and still give employees the ability to participate in the plan if they so elect to do so.
This solution would reduce the cost for small business owners involved offering 401(k) plan benefits and would still allow all eligible employees to participate. The employer would still be able to make matching contributions if it so wished to do so, but would not be required. Most of the small business owners I have spoken with really want to offer their employees 401(k) plan benefits, but when they sit down and do the math, the costs involved just do not justify its benefits and that is really the core of the problem.
According to the most recent statistics provided by the U.S. Department of Labor, there are 638,390 defined contribution retirement plans in the U.S. (513,000 of which are 401(k) plans), covering more than 88 million total participants (more than 73 million active), but only 50.6 percent of Americans work for an employer that sponsors a retirement savings plan.
According to a February 2015 SBA Office of Advocacy Report, in 2015, there were approximately 5,707,941 small businesses with employees (22,735,915 small businesses without employees) that employ close to 56,062,893 Americans. With only about 638,390 401(k) plans in existence, there are over 5 million small businesses with employees that are not offering any retirement benefits to their employees. That essentially means that these employees are relegated to making traditional or Roth IRA contributions if they want to save for retirement, which is capped at just $5,500, or $6,500, if over the age of 50, for 2016.
Why are more small businesses not offering 401(k) plans to their employees? It all comes down to cost and complexity. The average employer will pay a third-party administrator anywhere from $750 to $1500 a year to provide administration, recordkeeping, and 401(k) plan filing services. In addition, the employer adopting a safe harbor 401(k) plan is generally required to make a minimum 3 percent safe harbor matching contribution of each eligible employee’s salary. For example, if a small business has six full-time employees who each make $50,000 annually, the employer would have to make 401(k) safe harbor matching contributions of at least $9,000 annually, plus the cost of recordkeeping and administering the plan. The employer contribution is tax deductible to the employer, but it is still cash that the employer needs to come up with, and depending on the size of the company and level of income the employees earn, could become a major financial burden for the employer.
These are the calculations that business owners are making every day before deciding to establish a 401(k) plan for their business. Accordingly, the numbers show, in significantly more instances, the employer is electing against establishing a 401(k) plan, thus, leaving the employees with the traditional or Roth IRA as their sole retirement saving option.
With so many Americans not saving for retirement, it is crucial that Congress and all government agencies look for creative ways to help encourage more Americans to participate in retirement plans and to save for retirement. Plus, a more financially secure elderly population will likely help Treasury better deal with a very serious social security predicament facing our country over the next twenty-five years. That and the quality of retirement life for millions of Americans is what are at stake.
[1] N. Rhee, 2013 ( Jul.), "The Retirement Savings Crisis: Is It Worse Than We Think?," National Institute on Retirement Security, Washington, DC.
