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Americans at small companies deserve better retirement plans

Americans at small companies deserve better retirement plans
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In the last 40 years, section 401(k) of the tax code ballooned from an obscure provision to the foundation of the U.S. retirement system. However, the program has not expanded equally across all segments of American workers, creating a predicament in which many people do not have access to retirement plans at work.

Here’s why we face a crisis. As the defined contribution system evolved, it split into two distinct segments: the large company plans, which are mostly established and robust, and the small company plans, which even when they exist are frequently much worse than the ones offered by large employers.

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Let’s start with the state of affairs at large companies, where things look pretty good. Coverage levels are strong, as more than 90 percent of large company employees have access to a 401(k). The costs to workers for investing in such plans is low, as workers can expect to pay around 0.37 percent of assets to invest in the largest plans, according to a Morningstar analysis of company filings.

Furthermore, through enhancements such as automated enrollment programs, which place new employees into a plan, and auto-escalation features, which gradually increase a participant’s contribution rate, employers have found ways to ensure 401(k) plans serve their workers.

In contrast, small companies have not been able to fill the same role as large employers in providing retirement security for their workers, an important policy challenge given that about one-third of Americans work for small employers. In fact, many small companies do not even offer a retirement plan. According to the U.S. Census, just 18 percent of employers with fewer than 50 workers did so, and this number rises to just 39 percent for employers with between 50 and 100 workers.

Even when small employers set up plans, these plans are not nearly as good as large employer plans, particularly regarding fees. Indeed, from our analysis we find investors in the smallest plans pay fees of around 1.42 percent of assets, reducing retirement income by around 20 percent for these participants compared with those working for large employers. So what’s to be done?

Two recent policy proposals have attempted to rectify the issues plaguing the retirement system in the United States. First, automatic individual retirement account (IRA) plans run by states, which are currently in various stages of implementation in California, Connecticut, Illinois, Maryland and Oregon, enroll workers in a Roth IRA if they work for an employer with no 401(k).

Second, Congress has considered various bills that would make it easier for smaller employers to band together to offer retirement plans in arrangements called open multiple employer plans. Both efforts would expand coverage to workers who otherwise might not have had access to an employer-sponsored retirement plan and can help workers improve their retirement security.

In concert, these plans should work, with the additional stipulation that the state IRA plans be nationalized, so that the regulations aren’t balkanized. The recent experience of the United Kingdom suggests that the impact of a consistent, national approach to automatic retirement savings would be significant.

Since 2012, the United Kingdom has required employers without retirement plans to automatically enroll most workers in a plan. British workers in can choose to opt out of automatic enrollment, but fewer than 10 percent have done so because inertia is a powerful force.

To facilitate the effort to automatically enroll most workers in the United Kingdom, the government set up a nationally-funded pension plan called the National Employment Savings Trust, which is not too dissimilar from proposals for a government-run automatic IRA in some U.S. states.

Employers in the United Kingdom can also choose to contract the services of a privately-run pension provider, also known as a contract-based plan, and still comply with the directive to automatically enroll employees. Contract-based plans function similarly to open multiple employer plans, allowing employers to avoid bearing the brunt of recordkeeping and fiduciary duties.

In the United States, policymakers should view open multiple employer plans and automatic IRA as complements, not substitutes, to address the small plan problem. Adopting both proposals would greatly improve the quality of the U.S. retirement plan experience. Congress should create open multiple employer plans, as has been proposed several times, and take control of automatic IRAs from the states, to avoid the inefficiencies stemming from regulatory overlap.

Aron Szapiro is director of policy research at Morningstar.