Small businesses have historically presented challenges for adviser and company owner alike. Now, however, they are poised to gain from the retirement industry’s evolution. The confluence of changes in plan design, technology, the workforce, and, potentially, legislation now make the small plan market increasingly attractive and rife with opportunities, Musto says.
For one, the small business sector is no drop in the ocean: It accounts for 99% of U.S. businesses. It employs 48% of the entire American workforce, or over 59 million employees, and creates 63% of the nation’s new jobs annually. Further, 81% of small businesses are sole proprietorships, with 51% of their owners over age 50 and focusing on preparing for retirement.
The growing gig economy also contributes to the numbers—maybe as much as 13.3% to the total workforce, according to the U.S. Small Business Administration.
“We often think about gig workers in the context of Uber and the ‘on-demand’ economy, or as service labor, many of whom are still in school,” says Musto. “But we’re also seeing an increase in professional roles—engineers, attorneys, technology workers, and even entrepreneurs may be considered gig workers.”
One particular segment of this group “will be substantial savers a few years down the line.” What wealth managers have called HENRYs (’high earning, not rich yet’), these individuals are still paying down student loans and saving for their first mortgage. “In the gig economy, there’s great opportunity for advisers to help workers who need substantial guidance with regard to choosing benefits strategies and retirement plans,” he says.
While many of these individuals and businesses are yet unserved, the total number of American workers without access to an employer retirement plan is 55 million. They comprise the “coverage gap,” well-known in the industry. Less known, Musto says, is the “quality gap” between the thousands of small business plans that do exist and their large business counterparts.
He details a few of the key differences:
• A small plan will often spend more to offer less than a large plan does. Morningstar found that plans covering 1,000-plus participants pay 0.4% annually in plan expenses, whereas a plan covering 50 or fewer participants pays about twice that much. Scale effects and investment selection are meaningful drivers of this expense differential.
• Many small companies’ retirement plans lack important plan design features. If the company has a plan, it is less apt to use automatic features, which could increase participant savings. As many small businesses are recent startups, their plans are simple and just beginning to accumulate assets. Small business employees’ wages tend to be lower than those at large companies, too, which also discourages saving.
According to data from Vanguard, there’s a notable difference in employee outcomes as a result of this gap. The average balance in all plans is 65% higher than that of the small plan subset.
Musto points to reasons for optimism, however: Competition and industry innovation are reducing costs and helping quality plan design migrate from large retirement plans to smaller plans.
Seismic ChangesAffecting large and small plans alike are “seismic changes occurring in the retirement landscape,” Musto says. If advisers are proactive, they will gain from—and advance—them.
Several individual states are at various stages of rolling out government-facilitated auto-IRA savings plans for private sector workers in businesses that do not offer 401(k) plans. The state programs currently underway could, by themselves, reduce the nation’s plan coverage deficit by 17%. It is important for business owners to note, through consultation with their financial adviser, that the opportunities for annual savings in these programs are less than those in full DC plans.
At the same time, Congress continues to discuss proposals for open multiple-employer retirement plans (MEPs) that would allow small employers to participate in workplace savings plans together with other employers. Such proposals, which have bipartisan support, could help mitigate the cost and administrative burdens of plan sponsorship.
MEPs enable small companies, working closely with an adviser and provider, to enjoy the economies of scale historically reserved for larger plans. At the same time, MEPs can still offer each adopter flexibility in plan design features, including matching or discretionary employer contributions.
Either way, advisers are a crucial lynchpin in evaluating the best path for small businesses, ready to educate their clients about new options and helping them to understand the labor market and tax-benefit implications of private plan sponsorship.
Adviser Opportunity“Plan sponsors, advisers, and recordkeepers have made steady progress on market practice innovations that, collectively, have created a huge opportunity for advisers,” says Musto.
The combination of a high-quality financial adviser and a local third-party administrator (TPA), steeped in plan design, administration, and compliance expertise, is a natural, industry-driven solution to small plan challenges.
Advisers and TPAs can gather a team of experts that is highly flexible, ensuring that challenges in plan servicing are backed up by the right partners. Among the additional services that TPAs can “layer” onto the adviser’s offering is acting as a fiduciary in the context of ERISA’s section 3(16). This allows the adviser to more seamlessly bundle fiduciary oversight of plan administration with his or her own 3(21) or 3(38) investment services.
For small businesses that are profitable professional practices, one suggestion could be a cash balance plan. These hybrid plans, combining the flexibility of workplace savings and the high contribution limits of a defined benefit plan, are gaining significant traction in this part of the small plan market. According to the Kravitz Cash Balance Research Report, their number surged from 3,500 to over 23,000 in the last 10 years.
Their generous tax advantages make them a boon to firm owners who have delayed retirement saving and want to contribute over $50,000 a year. These plans can also greatly benefit employees, with employers typically increasing their contributions to employee accounts by 50% or more when adding a cash balance plan.
A similarly tax-advantaged savings vehicle that has become the talk of the industry in recent years is the health savings account.
“HSAs have a dual-utility when it comes to workplace savings plans,” says Musto. HSAs can play a significant role in protecting retirement savings from unforeseen medical expenses. And HSA savers can, after age 65 or upon Medicare eligibility, withdraw HSA savings not used for eligible health expenses and pay tax at the same rate as they would for a standard IRA distribution.
As the HSA market continues to mature, advisers will play a crucial role in integrating HSA investment into broader, holistic planning strategies for their clients.
The Rise of the Purpose-Built ProviderPlan sponsors and advisers today are looking for recordkeepers that offer expertise, technology, and independence, ensuring that they offer contemporary best practices that allow advisers to concentrate on what they do best. Such “purpose-built” providers, whose core focus lies with retirement plan servicing, are creating even more efficiency for advisers in the small market.
• Expertise: Advisers benefit from these providers’ specialized expertise in the small market. They are capable of providing plan design, servicing, and technical consulting both directly or through TPA partners in a way that large-plan-focused providers may not.
• Technology: Platforms purpose-built for the small market deliver efficiency and quality at a cost structure that enables advisers to drive investment selection independently and provides the information and insights most helpful to them in managing their practice.
• Independence: Increasingly, these purpose-built firms are looked to as a source of conflict-free, open-architecture solutions offering best-of-breed services from different providers. This enables advisers to work in a completely conflict-free model on behalf of their client.
Today, several diverse trends are converging on workplace savings markets that promise to contribute to both increased retirement savings levels and broader coverage, notably in small businesses, says Musto.
“Advisers will ultimately be at the heart of this continued transformation, guiding America’s small business owners to make informed decisions about their future and the future of their employees,” he concludes.
To learn more about the adviser opportunity in the small business segment, visit bit.ly/SmallBizOpp.