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Businesses of all sizes offer retirement plans to recruit and retain talented employees. A legislative change from late last year may soon make it easier for small businesses to provide this benefit.
A company that chooses to offer its employees a retirement plan of any sort takes on extra costs and administrative work. This is especially true for qualified plans, including 401(k)s and other types of defined contribution plans, which receive income tax benefits under the Employee Retirement Income Security Act of 1974 (usually shortened to ERISA). Small businesses sometimes forgo qualified plans because of costs, the time commitment involved in administering the plan, and the potential consequences of violating assigned fiduciary duties, even inadvertently. In the face of complex federal – and sometimes state – compliance requirements, some employers decide qualified plans are simply impractical.
Many of these concerns can be eliminated or mitigated if small businesses band together. Employers working jointly can take advantage of economies of scale. A group of employers is better positioned to negotiate lower fees with investment companies, for example. If the businesses work with an external plan provider, that institution can take over some of the administrative burden and due diligence tasks employers don’t have the resources to manage themselves.
Multiple employer plans, or MEPs, have existed for some time. But until recently, most of them were “closed” MEPs. In a closed MEP, participating employers must have common nexus – in other words, some shared characteristic that will let them band together. The employers might all occupy the same industry. They might operate within a narrowly defined geographic area. Or they might be members of some professional organization, such as a trade association.
“Open” MEPs, in which participants lack these common bonds, were not forbidden. But they could not take advantage of many of the reasons closed MEPs appealed to participants. A closed MEP may file a single Form 5500 with the Labor Department, but in open MEPs all participants had to file separately. (If you’re not familiar with Form 5500, my colleague Anthony Criscuolo wrote an overview for our firm’s newsletter.) Any employer in an open MEP with more than 100 participants also remained subject to separate yearly audits. For most businesses, there wasn’t enough benefit.
Both open and closed MEPs were also subject to the “one bad apple rule.” If any single member failed to meet requirements for a qualified plan, the entire MEP’s tax status could be in jeopardy. This meant that participants could face major headaches due to compliance problems beyond their control.
The Setting Every Community Up for Retirement Enhancement Act, which became law in late 2019, set out to address these problems by creating a new way for small businesses to join forces. The SECURE Act created a new class of plan called a “pooled employer plan,” or PEP. By design, participants in a PEP do not need a common nexus. The law also did away with the “one bad apple” rule for both traditional closed MEPs and the newly created PEPs. (This change was not surprising, as both the Internal Revenue Service and the Treasury Department have explored regulatory relief for this rule, though they did not implement it before the SECURE Act passed.)
Both MEPs and PEPs are now protected as long as the plan document sets out a procedure for dealing with an individual member’s failure to follow the rules. Future regulation will shape the particular requirements for these procedures, since plans will likely need to move assets out of the plan if a member fails to meet its compliance obligations. But for now, plans operating in good faith are shielded from the former level of risk that participant failure represented.
PEPs have not arrived just yet; the law specified that they would become available Jan. 1, 2021. But once they are up and running, properly designed PEPs will operate as a single plan, with one annual Form 5500 filing and one annual plan audit. Smaller PEPs may one day be able to file a simplified Form 5500, though these rules are pending. Still, PEPs open the door to simplified operation, as well as potentially lower costs, for many businesses that were reluctant or unable to take on running their own plans.
The financial industry has pushed for some version of this arrangement for a long time. Industry support for PEPs is not mysterious; after all, someone will need to run these new plans. PEPs will have a “pooled plan provider,” or PPP, which serves as the plan’s main fiduciary and administrator. These institutions will register with the Labor Department and the Treasury Department, and will acknowledge their fiduciary responsibility in writing. The law imposes no conditions on what entity can serve as a PPP, though future guidance may narrow it down. In theory, even a participating employer could take on the role, though it is unclear why an employer with that capability wouldn’t simply run its own qualified plan. In most cases, PPPs will likely be investment advisers, insurance companies and other financial service providers.
There is nothing inherently wrong with financial institutions stepping into these roles for PEPs. But business owners should be aware of the trade-offs they will make by handing partial control over to a third party. First, of course, is the danger of fees. While the law forbids “excessive” fees in PEPs, these arrangements are new. It will likely take some time to set industry standards. Employers should also bear in mind they are giving up some flexibility by opting for a PEP. As currently structured, PEPs may only be defined contribution plans, such as 401(k) plans and employer-funded profit sharing plans, not other qualified retirement plan options such as 403(b) plans or defined benefit plans.
This lack of flexibility is one reason why I suspect big firms are likely to stick with their existing plans. Large enough enterprises already have the negotiating leverage and economies of scale a PEP is designed to help small firms secure. They may also want to offer their employees features such as custom investment options or company stock. With the resources to support their own compliance and administrative obligations, big companies are unlikely to find a PEP’s advantages outweigh its restrictions.
But for smaller employers, the calculus may look different. Business owners should bear in mind that they are still responsible for prudently choosing a pooled plan provider, and not all of them will be created equal. The providers ready to go on Jan. 1 of next year are likely to be those that already offer MEPs or other retirement plan administration services. For these entities, running a PEP will be less of a change. Even for these providers, though, building up economies of scale may take a bit of time if participants are hesitant to be the first to jump in with a new plan.
That said, PEPs could offer small business owners real advantages. As with any major retirement plan choice, owners should perform thorough due diligence on any plan they consider. Different plan providers will offer varied investment options, plan structures and pricing. Business owners should take their time and ensure they are comfortable with a provider before committing, not only because of their fiduciary duty to their workers, but because it will help them secure the best possible arrangement.
We will have to wait until next year to see how many businesses decide to put a bit of PEP in their step. But if the new plans work as designed, they could prove a useful way for smaller businesses to offer top-tier retirement benefits without shouldering top-tier costs and administrative work in-house.