With the SECURE Act passed in December 2019, there is increased opportunity for small- and medium-sized employers to pool assets in a collective retirement plan. This allows for multiple efficiencies through economies of scale and lower administrative burdens.
Multiple employer plans (MEPs) are not a new thing; they have existed, but generally have not been practical. The problem with the long-standing MEPs has been onerous restrictions by the Department of Labor (DOL) and the Internal Revenue Service (IRS).
The New Rules for Pooled Employer Plans
The SECURE Act allows for the creation of Pooled Employer Plans (PEPs). The major problems of prior MEPs are addressed with the new plan rules.
The DOL historically held that MEPs, to qualify for the benefits of being treated as a single plan, had to consist of employers with a “common nexus.” This could be, for example, industry or geography.
This rule precluded truly open MEPs, which the DOL has historically considered multiple plans, eliminating most of the benefits of creating one.
The SECURE Act specifically removes this limitation for PEPs.
There is no requirement for a common nexus or any other relationship for companies to pool together to create a common retirement plan.
Another major problem with the existing MEPs was a rule commonly referred to as the “bad apple rule.” The IRS has held that if one employer in an MEP failed to meet its requirements then the entire MEP was invalid.
That was a very harsh position, requiring employers to be extremely careful about approaching a potential MEP. PEPs do not become invalid if a member’s employer fails to meet its obligations, if there is a specific provision in the plan document for the transfer of that member’s assets.
These two provisions address the major problems of the traditional MEP structure and put PEPs on a level playing field with other retirement plans. PEPs bring several advantages to potential members.
Hurdles for Defined Contribution Plans
Many small- and medium-sized employers want to offer a quality retirement plan to their employees. Since the switch to employees being primarily responsible for their own retirement accumulation through defined contribution plans, these plans are seen as important to attracting and retaining good employees.
There have been two major obstacles to small employers having their own stand-alone defined contribution plan, such as a 401(k). They have had a variety of other options, but the 401(k) has often seemed just out of reach.
One problem has been cost. There is considerable cost associated with a 401(k), even a small one.
If the plan is sufficiently large, these costs are dispersed and reasonable — for a dozen or couple dozen employees, the costs have traditionally been hard to justify.
There is also a large administrative burden with having a defined contribution plan. There is a requirement for an annual filing of a form 5500 and potentially an audit of that data. This adds to the already high-cost burden of additional administrative costs, excessive for many small businesses.
Benefits of Pooled Employer Plans
These problems are addressed by the PEP. To form a PEP, there needs to be a Pooled Plan Provider (PPP).
The PPP can be one of the employers in the plan, or it can be a third party, such as a bank or investment firm. The PPP files form 5500 for the plan; there is no need for each employer to file one individually.
Additionally, if the plan has no single employer with 100 or more employees and fewer than 1,000 employees in total, there is the opportunity for simplified reporting, with no requirement for annual audit of the 5500 numbers.
These two advantages translate into significantly reduced cost and administrative burden for the employer.
This in turn makes adopting of one of these plans far more attractive than trying to do it alone.
An additional advantage is that the PPP is the plan fiduciary, taking another burden from the employer. The employer retains a fiduciary responsibility for selection of the PPP and needs to monitor their performance. There may also be an investment fiduciary, depending on the plan setup.
PPPs can offer several forms of retirement plan; the 401(k) will be the most common, but others are available if the situation warrants.
As an inducement for these plans, the IRS is offering tax credits to qualifying employers of up to $5,000 for each of its first three years of participation in the plan.
An additional $500 per year is available for the first three years if automatic enrollment is used. Interested employers should consult their tax advisor to make sure they take the necessary steps to qualify.
Economies of Scale
PEPs bring an additional economy of scale to defined contribution plans for small businesses. Larger 401(k) and other defined contribution plans have traditionally held an advantage in that they have lower cost investment options available, as compared to smaller plans.
Investment firms make low-cost options available only when offered in larger plans; pooled plans may achieve economies of scale previously enjoyed only be large individual plans.
The Bottom Line on Pooled Employer Plans
Small- and mid-sized employers now have an opportunity to offer a defined contribution plan to compete with plans offered by even the largest of employers.
This reduces a competitive disadvantage smaller firms had as employers, but also eliminates the reduced opportunity employees of smaller firms had due to less competitive retirement plans.
Firms are incentivized to look at these closely, with tax credits potentially offsetting the startup costs of getting into a new plan.
The onerous regulatory burden of the old MEPs is addressed by the new PEPs, providing opportunity for employers to participate in a plan and achieve economies of scale and reduced administrative burden.
These plans are just being rolled out now; it is too early to tell how quickly they will catch on, but the future looks bright for small businesses to offer quality retirement plans.