Thinking "Small" About Plan Design

From the employer’s perspective, says Andrew Oliphant, vice president of Retirement Services at The Newport Group, the type of industry they are in (professional services, or a more technical business) and the makeup of the workforce are primary drivers in choosing a retirement plan. Next, what is the sponsor trying to accomplish with a retirement plan? Is the plan merely a savings vehicle, or is it part of a benefit package that is being used for retention and recruitment? Some employers want to tie the plan into other benefits, such as deferred compensation and health care benefits.

Smaller businesses often have higher turnover of staff, notes Oliphant. The service industry or those businesses that have high turnovers typically use a 401(k) plan, he says. “The design gives effective tools to manage the eligibility provisions and to deal with the turnover and any ensuing complexity,” he tells PLANSPONSOR. “You can structure eligibility provisions so people are required to work certain periods of time—say, six months to a year—and then you can drive benefits to those individuals.”

A Savings Incentive Match Plan for Employees Individual Retirement Account—a SIMPLE IRA—is an employer-sponsored IRA. “Smaller employers should consider that the rules of a SIMPLE IRA are relatively restrictive,” Oliphant says. The employer must have fewer than 100 employees, and there is no flexibility in the eligibility requirements.

Pros and Cons

Contribution limits for the employee are lower than they are for 401(k) or 403(b) plans. On the pro side, the plan provides guardrails and an easy way to implement the retirement plan if the employer can work with the rigid rules that define this plan, Oliphant says.

The cost of administration is a key concern for smaller sponsors, Oliphant says. Access to investments in the SIMPLE IRA can be the same as in a 401(k), and the limits are slightly lower for a maximum deferral. But it is not subject to the regulations of the Employee Retirement Income Security Act (ERISA), and offers simpler and less costly administration rules. It can be funded with pretax salary contributions. Oliphant points out there are no tax filings and no Form 5500 associated with the plan.

What About DBs?

A defined benefit (DB) pension plan promises a specified monthly benefit on retirement that is predetermined by a formula that factors in the employee’s earnings history, length of service and age, rather than on direct individual investment returns.

The PLANSPONSOR DC Survey found that among employers with less than $25 million in defined contribution plan assets, nearly 11%, on average, also offer a traditional DB plan. Just 1% offer a cash balance plan. In a cash balance plan, a type of DB plan, hypothetical individual employee accounts are maintained, much like a defined contribution plan. The hypothetical nature of the individual accounts was crucial in the early adoption of these plans because it allowed conversion of traditional DB plans without declaring a plan termination.

Cash balance plans are not necessarily new vehicles, but they are gaining broader acceptance, says Oliphant. Many DB plans in this size are from mature businesses that have been in existence for a period of time with closely held ownership. “We are seeing a transition of DB plans into cash plans,” Oliphant says. In part it helps to ease the communication of the benefit concept.

Cash Balance Growth

Robert Smith, president and CIO of Sage Advisory Services, feels the cash balance plan is poised for a lot of growth, because it fills several needs. Cash balance plans can be used in conjunction with a 401(k) plan, so high-income earners can shield some savings from tax while accruing more for retirement, he tells PLANSPONSOR.

Cash balance plans work well for proprietorships, partnerships and individually owned businesses because they can establish a separate cash balance plan for senior management and a separate one for employees, Smith says. “You can have different variables,” he says. “The 401(k) is all or nothing. A DB plan is all or nothing. You can’t segregate your workforce. Cash balance plans don’t discriminate. As DB plans are backend loaded – you have an accrual curve that goes up."

Cash balance plans do not have age weighting, Smith points out. The plan uses only two crediting rates: the service crediting rate, which is the value of an hour’s worth of work for the organization, whether it’s person A or person B, young or old. “An hour is worth an hour,” Smith says. The market credit rate is whatever rate of return the sponsor thinks the plan is going to assume, based on a 30-year Treasury yield, or a six-month T-bill. “Add those two rates together – that’s what you’re credited in the plan and that’s how much money I’m putting in the plan for you.”

The cash balance plan tends toward a very conservative, low-volatility approach. Smith says the plans usually contain no equities, no high-risk assets. It is geared toward return-certain instruments.

Smith feels employees want the paternalism of a DB plan. “They are not finance experts, and the world has gotten more complex,” he says. The growing diversity of investment choices and of purveyors of services make it difficult for people to navigate investing. “I probably don’t have a client today that is interested in starting a DB plan,” he says. “The regulations of a DB plan can make them difficult to sustain, because they’re onerous. Sponsors do not want the liability.”