Maybe your business already offers employees a basic retirement plan such as a SEP or a SIMPLE IRA. At what point, if any, should you trade up to a 401(k)?
Start considering these more comprehensive programs when your own plan’s funds accumulate to a level where your increased buying power more than offsets the high administrative fees characteristic of the 401(k) plan.
“Once you accumulate $500,000 or more in your plan you may want to test the market and get some competitive bids on qualified 401(k) plans,” says Yannis P. Koumantaros, principal and director of Spectrum Pension Consultants, Tacoma, Wash. (spectrumpension.com).
Getting to a “yes” decision relies on a favorable cost benefit analysis. On the one hand, qualified retirement plans have administrative expenses while many SEP or SIMPLE IRAs do not. However, the 401(k)’s administrative expense may be more than outweighed by the cost savings you can obtain as a result of lower annual expense fees charged for purchase and ownership of mutual finds in the plan.
Here’s an example. “Suppose you have a ‘free’ SEP plan in which you are paying a 2.5 percent mutual fund expense ratio,” posits Koumantaros. “If you can change to a 401(k) plan in which you are only paying one percent expense ratio because of the plan’s greater buying power, you can save $1,500 in annual expenses for every $100,000 invested.” That $1,500 in savings may more than offset any administrative fees you pay the firm providing the 401(k) plan.
Lower expense ratios result from the highly competitive 401(k) marketplace. Firms offering 401(k) plans are highly regulated and have to disclose all of their fees. These firms (sometimes called “platform providers” because of the array of mutual finds they maintain) are often able to negotiate institutional buying power with Wall Street mutual funds rather than accepting shares priced at retail.
A 401(k) plan requires more set-up savvy than other plans discussed in this article. “To set up a 401(k) Plan you really need to hire a third party administration firm,” says Tracy Davidson, president of Davidson Pension Consulting, Corte Madera, CA (www.davidsonpension.com). “These firms do the basic work such as maintaining the employee census, keeping track of hire dates, birth dates and other required data.”
The administration firm will also prepare reports for participating employees. “These statements are often done on a daily basis by way of the administration firm’s web site,” says Davidson. “The market fluctuates and employees are interested in following their balances.”