A) What are 401(k) Plans?
401(k) plans are arguably the best government-sanctioned, tax-deferred retirement savings opportunities in the United States; their numbers have grown commensurably
since their institution by Congress in 1978. One estimate, by CHALK 401(k) Advisory Board, Inc., places the number of qualified 401(k) plans in 1997 (the last year
surveyed) at 225,000, and the number of participants in those plans at approximately 28 million; the Investment Company Institute (ICI) estimates 36.7 million participants
in 1998. New plans continue to grow in number at an annual rate of more than 14% (U.S. Department of Labor).
However, 401(k) plans must be sponsored by an employer. Millions of American workers can't take advantage of the 401(k)'s many attractive attributes because, for one
reason or another - typically high plan costs, plan inflexibility, and/or prohibitive minimum participation standards - their employers do not sponsor a plan. In particular, very
small, small, and medium-sized companies have found sponsorship difficult if not impossible. Some 89% of very small companies (10-50 employees), 72% of small
companies (50 - 100 employees), and 66% of medium-sized companies (100 - 250 employees) do not have 401(k) plans (Census Bureau figures). These figures do not
include the companies that have fewer than 10 employees, what might be called "micro" companies.
B) Characteristics of Today's 401(k) Plans
Employees rank 401(k) plans second only to health benefits when it comes to employer-offered benefits they desire. 401(k) s offer employees an unmatched long-term savings potential, primarily because neither 401(k) contributions nor their earnings are subject to income tax during all the years plan participants contribute before retirement.
This tax deferral has a huge compounding effect: $150 per month put into a typical taxable savings account paying 8% annual interest will grow to $42,034 by the end of 20 years (assuming a combined federal and state personal income tax rate of 34%). In a 401(k), however, the same deposits earning the same rate of return during the same 20 years will yield $88,353. Even if that amount is taxed at the 34% rate when the money is withdrawn from the plan, which is unlikely if the participant is retired, the 401(k) participant will walk away with more than $16,000 compared to the equivalent non-401(k) investment return.
401(k) plans also have the highest annual contribution ceiling of any of the tax-deferred defined contribution savings programs (IRAs, SEPs, etc.). More money contributed equals more money earning money, equals more money in the account 20 years later. Add to this earning potential the convenience of contributions made through automatic payroll deductions and it's easy to see why 401(k) s are so popular.
The Investment Company Institute (ICI), the trade association of the mutual fund industry, estimates that at the end of 1998 assets in 401(k) plans stood at $1.41 trillion. These plan assets grew at an average rate of 18% per year during the 1990s. Plansponsor.com reports that they rose nearly 22% in the final year of the decade, from $1.7 trillion in 1999 to $2.1 trillion in 2000.
Average salary deferral rates of plan participants have also been on an exponential rise. The Profit Sharing 401(k) Council of America (PSCA) reports that the average salary deferral rate grew from 4.2% in 1991 to 5.4% by 1999, an increase of more than 28%.
The average account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000.
Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will.
A constraint on 401(k) growth is the fact that 401(k) plans must be sponsored by an employer and contributions must be subtracted from the employee's pay within the payroll process, before income tax withholding is calculated. Due largely to misinformation about the complexity of running a 401(k), coupled with a general fear of the IRS and the Department of Labor (both of which have regulatory power over the plans), many employers have excluded this popular benefit from their employee benefits package. This is especially true of very small (including micro), small, and medium-sized companies.
C) The Challenges Facing Small Business 401(k) Plans
For many small and medium-sized companies that do have 401(k)s, the plans' futures are bleak: many are being canceled because they are not profitable enough a service for vendors to maintain; in other cases, service is not being canceled but the level of service is so disproportionate to the high fees being charged that employers themselves must pull out or endure the aggravation of continually feeling they are being overcharged. The company estimates there are more than 400,000 very small, small, and medium-sized companies that (a) have no plan, (b) have had their plan canceled or have canceled their plan, or (c) have a plan they are unsatisfied with.
D) The Untapped Small 401(k) Market
Traditional 401(k) plan vendors did not think much about approaching smaller companies until recently, and did so then only because they recognized that the larger-company market was pretty well saturated. When they did turn their attention to the smaller and mid-sized plan market, they were well prepared with a library of useful educational materials for potential and actual plan participants. Participation is participation, after all, whether it is in a plan with 50 participants or 50,000.
Unfortunately, however, these vendors were not equally well prepared to service the needs of the smaller companies: the plans they designed and the packages they offer are not always appropriate in price, substance, or style, and their pamphlets and publications are often too dry, legalistic, and expensive. Perhaps it is because most of these vendors are large companies themselves that they have difficulty designing
401(k) plans that embody the entrepreneurial, "do-it-yourself" spirit so prevalent in many small and medium-sized companies.