More than half of the 55 million Americans who are not offered a retirement plan through their employer work for small businesses. While some see this longstanding coverage gap among small firms as an unsolvable problem, others see a market opportunity. This is the first in a series of blogs that will feature perspectives from entre- and intra-preneurs in both the for- and non-profit sectors who are using technology and other innovations to reach this hard-to-serve population. We hope that the resulting insights will help other market players and federal and state policymakers better understand what it will take to achieve a truly universal retirement savings system in the US.
Small businesses have a large impact on the economy and employ the majority of the American workforce. It can be both surprising and alarming to realize that only 14% of businesses with fewer than 100 employees offer a retirement plan, exacerbating the already looming retirement crisis facing our country.
Small businesses have traditionally not offered employer-sponsored retirement benefits because of high fees as well as time-consuming compliance and administration. In speaking with thousands of business owners across the country, I frequently hear how difficult it has become to run a small business: costs are mounting, large corporations leverage economies of scale and superior resources to undercut prices, and competition for talent is fierce.
While employers would theoretically like to offer retirement benefits to their employees, these plans are prohibitively costly to set up and administer, and the problem is only getting worse.
The Retirement Plan Supply-Side Shortage and Its Impact on Consumers
There is a chicken-and-egg problem: business owners cannot afford the high fees of retirement plans, but on the other side of the market, many retirement plan providers are finding it difficult to afford servicing this type of client, and will therefore charge higher fees.
On top of a shortage of demand from smaller employers, 401(k) providers, brokers, and financial advisors in the retirement space also complain that it is both unprofitable and inefficient to serve clients in the “microplan” market segment, or plans with less than $5 million assets under management (AUM).
The fixed costs in human labor to set up and service plans and the accompanying liability exposure often means that, in order to cover the costs of managing a 401(k), service providers and brokers charge high fees on the assets of the plan. Employees are often totally oblivious, because these fees are taken out of their funds automatically. As a matter of fact, 58% of 401(k) participants are unaware that they are paying anything at all on their workplace retirement savings.
The Department of Labor’s (DOL) proposed fiduciary rule would be positive for consumers, but would also require retirement plan investment advisors to take on more fiduciary responsibility, which often translates into even higher costs for companies and their employees.
These fees are disproportionately expensive for smaller companies. According to A study by Brightscope, large plans (defined as those with more than$100 million AUM) almost all have fees below 1%, whereas most small plans pay in excess of 2% of total plan assets in fees. Given that data is largely unavailable for plans with less than $1 million AUM, it is highly likely that those costs are even higher still. I have even talked with some small companies that had been paying nearly 5% in total fees.
While a one or two percentage point difference in AUM fees might seem immaterial, this could actually add up to a decade of retirement money, given that fees, just like investment gains, compound over time. A study by Nerdwallet showed that a millennial can retire over half a million dollars richer by reducing fund fees by one percentage point, assuming the investor started with an initial investment of $25,000 and added $10,000 annually over 40 years. The difference in total after-fee retirement savings is a staggering 30%.
Compliance Burdens for Small Companies
In addition to the financial burden on small companies, there is added complexity in the compliance and documentation required by the IRS (given the tax-deferred status of a 401(k) plan) and DOL under the Employee Retirement Income Security Act (ERISA)–a federal law that sets standards for employer-provided pension benefits.
These compliance regulations are well-intentioned: they’re meant to protect employees and they apply equally to all companies. However, in practice, because the requirements are largely agnostic to company size and budget, they place a disproportionate burden on smaller companies who don’t have a full HR department to handle the administrative workload, which scares off many small businesses from offering a retirement benefit to their employees.
The space is badly in need of disruption, both because existing plan providers are unable to serve the needs of the small business market, and also because these small businesses genuinely want to take care of their employees by offering an attractive employer benefit. However, when searching for such a benefit, they cannot find a viable option that is both affordable for the business and does not hit employees with high fees.
The Future: Technology
In order to effectively serve the small business segment while still adhering to all the compliance and regulations necessary to offer 401(k) and 403(b) plans, it is necessary to fundamentally shift the current servicing model. In today’s age of automation and paperless transactions, the logistics of retirement plan benefits are long due for an overhaul.
Human Interest and other newer options seek to do this by leveraging technology. This includes automating the manual work that a business owner or provider would have to do when offering a retirement benefit — recordkeeping, payroll contribution processing, employee onboarding, rollovers, and more.
Financial technology, like robo-advising, democratizes access to quality financial services so that all employees have access to an automated SEC Registered Investment Advisor (RIA) embedded into their retirement accounts. That way, everyone, regardless of prior knowledge or wealth, can seamlessly follow the best practices of investing. Finally, it is important to streamline payroll contributions, reporting, and other paperwork so that data is transferred efficiently and the plan stays in compliance.
Innovations in fintech and HR tech will continue to make it easier and more affordable for small businesses to offer retirement benefits. I’m looking forward to a day when any employee, at any company, will have greater opportunities to achieve financial security.
Author: Joyce Yan Zhang is the head of business development at Human Interest, a Silicon Valley-based startup that helps small businesses offer automated retirement plans and investment advising to their employees. She previously worked at the Federal Reserve Bank of New York and the U.S. Department of Labor, and has a B.A. from Harvard University, an M.P.A. from Princeton University, and an M.B.A from the Stanford Graduate School of Business.
The views and opinions of the author are their own and do not necessarily reflect the view of the Aspen Financial Security Program or our funders.
