Small firms' new retirement choices

Nation's Business, Feb, 1997 by Stephen Blakely

Since the beginning of the new year, small business owners have been able to begin a new and supposedly simple kind of retirement plan: the Savings Incentive Match Plan for Employees. But evaluating SIMPLE's pros and cons isn't necessarily easy.

SIMPLE was approved by Congress in August as part of a political trade-off designed to include something positive for small firms in legislation that raised the minimum wage. The law, which took effect Jan. 1, permits companies with 100 or fewer employees to offer their workers two new types of tax-deferred retirement plans: a SIMPLE 401(k) plan and a SIMPLE individual retirement account (IRA).

The plans were designed to give small businesses a way to offer employees retirement plans that would cost less and have simpler federal reporting requirements than traditional 401(k) and IRA retirement plans. Compliance with Internal Revenue Service regulations is widely regarded as the chief factor boosting pension administrative costs.

The new SIMPLE IRA plan replaces a plan previously available to small-business owners--the Salary Reduction Simplified Employee Pension, or SARSEP. Existing SAR-SEPs can remain in force; no new ones can be created.

The SIMPLE 401(k) plan is another option for small companies. If a small firm establishes a SIMPLE plan, however, it cannot have other tax-deferred retirement plans.

The Cost Factor

While the two SIMPLE plans clearly require lees paperwork, financial experts caution that either arrangement could increase overall retirement-plan costs for any employer shifting from a traditional 401(k) or IRA. The reason is that the law also requires small companies to match their employees' contributions to SIMPLE accounts, which can cost the companies up to $6,000 a year for each participating employee, and to make employees fully vested immediately--that is, entitled to keep all of the funds put into their accounts.

In conventional 401(k) plans, matches paid by employers are voluntary, and employees typically have to stay with a company five to seven years to become fully vested. For companies with seasonal workers or high turnover, granting all employees full and immediate vesting under the SIMPLE plans could prove costly.

Similarly, companies that have had SAR-SEP programs and now turn to SIMPLE IRAs are likely to find their costs rising because they will have to make contributions--a requirement the employers didn't face under SAR-SEP rules.

"SIMPLE isn't all that simple," says Robert Eastwood, vice president for technical services at Actuarial Consultants, Inc., a Torrance, Calif., firm that designs and administers pension plans, including many for small businesses. "You do avoid all the reporting problems" of traditional 401(k) plans, he says, "but you also pay a high price" in both the required employer match and the immediate vesting.

For T. Rowe Price Associates, Inc., an investment-services company based in Baltimore, the price was too high. The $93 billion family of no-load mutual funds won't even offer a SIMPLE 401(k) plan "due to the additional costs and limitations of the plan," says Jeanette LeBlanc, the firm's retirement-plan manager.

For a typical 75-employee firm, LeBlanc says, a SIMPLE 401(k) plan cost cost $7,200 a year more than T. Rowe Price's existing 401(k) Century Plan for small companies because of the mandated employer-paid match. "The overall cost to the employer would be lower in an existing 401(k) plan even though administrative costs may be higher,"LeBlanc says.

IRAs Are Popular

T. Rowe Price and other financial-services companies, however, are bullish on the SIMPLE IRAs and are actively marketing a new IRA product under the program. "Our analysis shows that when you get above 50 employees, the existing small-company 401(k)plans make sense," says LeBlanc. "For less than that, the SIMPLE IPA is best."

At Fidelity Investments, the nation's largest mutual-fund company, only an IRA is currently available as a SIMPLE option. The Boston-based financial-services company would not say if it would market a SIMPLE 401(k).

Fidelity has three conventional 401(k) plans targeted at small companies, including one offered exclusively to members of the U.S. Chamber of Commerce. "We currently offer a 401(k) product for small businesses that's very similar to the SIMPLE 401(k)," says Camille Lepre, a Fidelity spokeswoman. "It's very effective and thousands of small companies are using it."

John Hancock Funds, a Boston-based financial-services company, overcame initial misgivings and is now offering both IRA products as SIMPLE options. Ted Lavelle, first vice president, says Hancock was concerned that participants would be able to shift their SIMPLE IRA funds at will among any of the 6,000-plus mutual funds currently available, potentially increasing the company's administrative costs.

But Hancock was reassured by recent clarifications issued by the Labor Department and the IRS, which said employers will be able to designate--and keep--just one financial institution to manage its SIMPLE IRA accounts. "The employer will control the institution he will use" for SIMPLE accounts, Lavelle says, which will help keep SIMPLE IRAs within the designated family of mutual funds.