Which Retirement Plan Is Best For My Small Business?

One of the most common questions I come across with clients is “what is the best type of retirement plan for my small business?” Getting the answer right on this question is EXTREMELY important because it impacts so many areas regarding the long term success of not only your business but also your retirement. Yet with such an important decision I feel that many individuals don’t always get independent and objective advice on all their options. Instead, many of the small business owners I’ve met with in the past have been sold a product rather than provided a total solution. A recurring issue I see is that business owners are sold on plans that are way more complex, expensive, and wrought with additional fiduciary liability than what they really need to accomplish their business goals.

Let’s start this discussion with a little bit of background regarding employer sponsored plans. As a financial advisor, there are so many areas one has to be familiar with. Yet the area of employer sponsored retirement plans is one of the biggest challenges I’ve tackled in my career. Understanding ERISA’s (Employer Retirement Income Security Act) rules and regulations is, to say the least, a doozy. At over 500 pages long, ERISA Law is extremely convoluted and nearly impossible for a small business owner or HR professional to find the time to understand - not just because of complexity but also because of its sheer scope. One analogy I often use regarding employer sponsored plans and the financial advisors who recommend them is that it’s similar to comparing dentists to orthodontists - both are dentists yet the orthodontist has additional training and skills in a particular skill set. Could a dentist put braces on you and help you straighten your teeth? Yes, probably. However would they be as effective and knowledgeable as a specialist who has spent years working in that specific area of dentistry? No, probably not. In the same way, any financial advisor can set up an employer sponsored plan. But does that mean that working with any advisor will provide you with an expert who has a detailed understanding regarding the intricacies of how these plans work? Again - no it does not.

When I decided to really get serious about understanding ERISA Law as well as how the DOL (Department of Labor) enforces it, I initially dedicated a year to research and self study. Many of you know that I spent my military career in the special operations community as an Army Ranger and one of the key things I took away from that experience was the importance of planning and reconnaissance. I learned that gathering and organizing as much data as possible before conducting a mission could be the difference between success and failure; the difference between life and death. While the stakes with setting up the right retirement plan are nowhere near as high as conducting raids in Afghanistan, there is still a tremendous amount of fiduciary liability one may end up taking on as the sponsor of an employer sponsored plan such as a 401(k). Knowing this, I wanted to make sure I fully understood the ins and outs of these plans. I wanted to make sure that I understood what separated the good plans from the bad, the successful plans from the failures, and the easy to administer from the administrative nightmares. I wanted to give my clients all the facts so they could make the best decisions and achieve their desired outcomes.

As a result I got to work gathering data. To do this, I would wake up around 5 in the morning 5-6 days per week and spend around 90 minutes reading everything I could get my hands on regarding employer sponsored plans. My goal was to learn everything possible about the employer sponsored landscape. In that time, I read the top 20 books on 401(k)s that I could find, dozens of articles, countless white papers, and so many internet posts that I can’t even begin to guess how many it comes to. I signed up for newsletters, bookmarked every valuable resource I could find and took additional courses to get my CPFA (Certified Plan Fiduciary Advisor) certification to demonstrate that I was knowledgeable in the employer sponsored plan field.

After doing all this research I took what I learned and spent another 6 months to build a step-by-step benchmarking  process that would allow companies to gauge the effectiveness of their current 401(k), score it on an easy to understand 1-100 point system, and then provide easy to implement solutions and best practices to improve the success of their plan (to get access to that benchmarking tool, click HERE). After building this benchmarking report, I took it a step further and completely outlined everything a client would need to effectively run a 401(k) -  from their fiduciary audit files, to structured annual trainings, to meeting minute templates, investment policy statements and an array of other important documents.

The amount of work I spent perfecting the system was one of the biggest projects of my financial advisory career. And here’s the funny part - as a result of doing all this work I realized, without a shadow of a doubt, that most small businesses DON'T NEED A 401(k) plan to accomplish their organization’s retirement planning goals. I know some advisors will find that statement sacrilegious - but it’s true. In my opinion, the majority of small businesses would be better served by a different type of employer sponsored plan rather than simply setting up a 401(k). I believe that most advisors simply sell 401(k) plans because they are popular and because it’s what they’re trained to sell, not because they are the best fit for their clients.

Now that I’ve made what some would consider a ludicrous statement, let me justify my position. First off, there are situations where a 401(k) is 100% the best option for the company. For example, if a company has over 100 employees or the owners are looking for the maximum deductions, or the ability to control vesting schedules - then yes, a 401(k) makes the most sense. But for many small businesses, these criteria are not the case. Let’s consider the 3 reasons businesses typically set up an employer sponsored plan before we go further into my justification.

The Three Reasons Businesses Set Up Retirement Plans Are:

1. To Recruit and Retain Key Employees
2. To Reduce the Company’s Tax Liability
3. To Save For The Business Owner’s Retirement
   

Now, will a 401(k) do all these things for a small business? Yes, it undoubtedly will. And it will do so in a way where the business owner has the most options on how they want to set up the plan, the matching formula, the investment lineup, the vesting schedule, and a host of other features. Yet a 401(k) will also be one of the most (if not the most) expensive options as well as expose the small business owner to the greatest level of fiduciary liability. In fact, courts have called ERISA Fiduciary standards “The Highest Standards Known to Law.” According to the IRS and ERISA Law, plan sponsors have a fiduciary duty to:

1. Act solely in the interest of the participants and their beneficiaries
2. Make decisions for the exclusive purpose of providing benefits to participants and beneficiaries
3. Only pay reasonable expenses of the plan
4. Carry out duties with the care, skill, prudence and diligence of a prudent person familiar with the matters

These 4 guidelines may not seem like much until you review the 538 page pdf of ERISA Law (If you’re having trouble sleeping at night, you can find that HERE). Suddenly, “carrying out duties with the care, skill, prudence and diligence of a prudent person” seems a little more daunting. Let’s consider some other data points on the issue:

1. According to Census.gov The Average Small Business in The United States Has 5 Or Fewer Employees
2. The Average Small Business Owner in the United States Earns $105,012
3. Polls consistently show that small businesses owners work longer hours than employees and have considerably more responsibilities
   

So, when one considers the additional fiduciary obligations of 401(k) plans as well as the size and scope of most small businesses, my questions are these:

1. Do small business owners who are not planning to max out their 401(k) ($66,000 for individuals under 50 with employee and employer profit share) need the additional fiduciary liability that comes with sponsoring a 401(k) to accomplish their business goals?
2. Do small business owners need the additional complexity associated with 401(k) rules when they’re already stretched thin on time due to their busy schedules?
3. Do small business owners need the additional costs associated with operating a 401(k) when they’re typically already concerned about keeping operating costs low?
   

My experience is that most financial advisors do a poor job of educating clients on what they’re signing up for when they choose to sponsor a 401(k) and an even worse job of presenting other viable (and often better) options. Because all 401(k) assets must be held in a trust account, there are additional administrative and recordkeeping costs that are not found with other plan types. There are also additional liabilities associated with maintaining the trust that make the plan sponsor and all fiduciaries of the plan personally liable if something goes wrong and they are found at fault for the mistake.

And things do go wrong - in 2020, 67% of DOL Audits resulted in monetary results and/or corrective actions totaling $3.4 billion paid out to employee benefit plans, participants, and beneficiaries. Furthermore, it’s not just small plans that get things wrong. Some of the largest, most notable settlements have come from Fortune 500 companies or even financial institutions. My question is this - If Fortune 500 companies and financial institutions have DOL issues, how confident can the average small business owner be in their 401(k) process?

These facts aren’t presented to scare clients away from sponsoring a 401(k). With the right advisor and process in place, nearly all of the major pitfalls can easily be avoided. However, clients should be provided with all relevant information so they can understand their responsibilities going into setting up their plan. Financial advisors and institutions should view it as their duty to help clients understand that if they choose to implement a 401(k) then they need to have a detailed and documented process to help them navigate the rules and regulations.

When I meet with clients and discuss employer sponsored plans I always say something similar to this:

“ERISA Law is complex for a reason. It’s written with huge plans in mind. For example, on a Fortune 500 company’s 401(k) with hundreds of millions or even billions of dollars in its trust account, we want to know that there are detailed rules in place to provide guidelines and regulations to help ensure the safekeeping and proper management of that pool of money. We want very clear rules in place to protect plan participants and ensure that the corporation isn’t using the 401(k) for the company’s benefit but instead for the employee’s benefit. Even if a company is not a mega company, but maybe instead has a couple hundred employees with plan assets of $50-$100 million dollars, we still want to know there is a set standard and set laws in place to oversee the trust which houses that large sum of money. However, if a company is a small business with low plan assets, and they choose to use a 401(k) for their retirement plan then they are subjecting themselves to those exact same standards and regulations that those larger companies must follow. One can easily imagine that larger corporations have more resources at their disposal. They have dedicated HR teams, dedicated legal teams, and more resources to help them navigate ERISA regulations. A smaller, “mom-and-pop” style business just doesn’t have those types of resources at their disposal. As such, it often is not in their best interest to take on the additional liability that comes with these ERISA style plans.”

There’s a reason that plans like SIMPLE IRAs and SEP IRAs exist. And yes, while they still are technically ERISA plans, they are not subject to the majority of the regulations associated with ERISA Law. When you look at the requirements for smaller style employer sponsored plans it becomes clear that they are, for most small businesses, the best overall option. Why do I say this? Well, SIMPLE IRAs when set up right can look and feel very similar to their 401(k) counterparts without the high administrative fees or same level of fiduciary liability. They can still offer relatively high contribution limits (for individuals under age 50 $15,500 plus a 3% company match in 2023) and an easy to administer process. For many small business owners, the employee plus employer contribution puts their overall contribution limit around $18,000. For small business owners who want to save more than that amount, they can choose to set up a Traditional or Roth IRA - oftentimes one that can be deducted straight through a payroll deduction. When combined with the SIMPLE IRA, Roth or Traditional contributions can put their total contribution limits before company match at $22,000 - only $500 less than what they’d get with a 401(k) and without any of the high costs associated with the plan. Depending on their income, many small business owners can still deduct the contributions of both plans if they choose to set up a Traditional IRA.

For solo or very tightly held companies, SEP IRAs can offer contribution limits as high as 401(k) plans without the high administrative and recordkeeping fees. These plans are extremely easy to set up and maintain and typically only cost around $25 per year in admin costs compared to thousands of dollars one would spend on a 401(k).

We offer business owners a quick and easy guide to help them figure out which plan is most likely the best fit for them - all in about 3 minutes. A simplified version of that tool can be seen below.

All in all, choosing the right retirement plan can seem daunting for a small business owner. This process is only exasperated by the fact that many advisors and institutions simply push clients towards 401(k) plans. I can’t tell you how many times I’ve heard a business owner tell me they have a 401(k) simply because they called their current advisor or financial institution and told them that they wanted to set up a “401(k) plan for their employees.” What most small business owners really mean with this statement is “I want to set up a retirement plan that best meets my business and employee needs.” Instead of asking a few simple questions to determine what exactly the goals of the client are, many institutions just set them up a 401(k) plan because the client “asked for it” - despite the fact that 401(k) plans are often the most expensive, most risky type of plan the business owner could choose to set up. Because most business owners are already busy and are not experts in the retirement plan landscape, they simply don’t know what they don’t know and end up just signing up for what they’re sold versus getting the coaching and advice they need to make the most informed decision.

Again, my intention with this post is not to scare people away from 401(k) plans - they are an incredible option for the right situation. When set up properly and monitored consistently, there is very little risk of something going wrong. My hope instead is that business owners will be provided with all available options so they can carefully consider which option is best for them. On numerous occasions, my team and I talk with business owners who currently have a 401(k) and are frustrated with the high costs of administering the plan. When they find out that oftentimes they can cut that cost by 90-95% by restructuring the plan type - it is a bittersweet discovery. It’s sweet in the fact that moving forward they can save thousands each year. It’s bitter in knowing they could have accomplished their organization’s goals at a fraction of the cost and with less liability for all the years they've had the plan in place.

If you are currently considering which retirement plan type would best fit your needs, feel free to send me an email at Robert@LinkFinancialAdvisory.com with the subject line of “What Retirement Plan Is Best For My Business?” I’ll be happy to provide you with additional resources and answer any questions you may have.

If you currently have a 401(k) and you’d like to review it to verify it’s the best option for your company, send me an email with the subject line “I’d Like To Review/Benchmark My 401(k).” As always, if you have any other questions I can answer for you, please feel free to email me or call me directly at 406-369-3396.