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Simpler, Less Expensive 401(k) Options Emerge for Small Businesses

SEPT. 11, 2015

The way Jon Stein sees it, receiving financial advice for retirement should be a fundamental right.

Betterment, the investment firm Mr. Stein created just five years ago, is now one of the higher-profile robo-advisers — companies that automatically build and manage customized portfolios of low-cost investments for people who can’t afford the type of financial adviser who sits behind a mahogany desk.

He argues that all workers who save using a 401(k) should be entitled to personalized help and investment management services: When an employer offers a retirement plan without any recommendations, Mr. Stein reasons, it’s akin to providing a health insurance plan that lists medications without any doctors.

Given that philosophy, perhaps it was only a matter of time before his firm — with 106,000 customers and $2.6 billion in assets — would plunge into the 401(k) business. Starting in the first quarter of next year, the firm will begin offering the plans to employers, with a focus on smaller businesses (though it’s essentially equipped to handle larger ones, too).

Economies of Scale The costs of running an employer-sponsored 401(k) plan are often higher, relative to total plan assets, for small companies than for larger ones. Big plans tend to have a greater portion of their money invested in index funds, which often have lower expenses than other investments. Moreover, there are some fixed costs in running a plan — and as plans grow in size, those costs can be spread across more employees and a larger asset base.
*Among plans with audited 401(k) filings in the BrightScope database (2012) Source: BrightScope and Investment Company Institute By The New York Times

Small businesses, which employ nearly half of all private sector workers, could surely use the help.

Only 14 percent of employers with fewer than 100 employees offer a 401(k) plan, according to a report from the Government Accountability Office. Even when these workers have access to a 401(k), they often pay three times as much as workers at larger companies, if not more. And if the business owner bought the 401(k) plan from a broker, the investment lineup might be rife with conflicts of interest and high-cost, actively managed mutual funds. As for financial advice, it’s not always an option.

But the landscape is rapidly evolving. In addition to Betterment, several other technology-driven providers have started offering 401(k) plans in recent years, with a focus on reducing costs and the complex administrative burdens for small employers. Vanguard started catering to smaller businesses about four years ago and has already signed up more than 4,000 employers covering 162,000 participants.

Mr. Stein said he hoped to elevate 401(k) plans to the next level, bringing the kind of holistic service that personal finance nerds could only dream of. You know, things like automatic management and rebalancing, taking into account your rollover Individual Retirement Account, a spouse’s plans and future Social Security benefits.

By looking at the entire picture, it can tell you how much you need to save and in which accounts — say a 401(k) versus a Roth or taxable account.

“That is like fundamental stuff that everyone should have a right to if we are going to put the responsibility of saving for retirement on individuals, which is what we’ve done in this country,” said Mr. Stein from Betterment’s offices, a loft space that was formerly a dojo, or martial arts studio, in the Chelsea neighborhood of Manhattan.

Since all of this advice is driven by algorithms, not humans, it helps contain costs: 401(k) plans with less than $1 million in assets had an average cost of 1.6 percent of the plan’s total assets in 2012. That compares with 0.54 percent for plans with $100 million to $250 million, according to a research report by BrightScope and the Investment Company Institute in 2014.

The fees for small plans also tend to vary greatly. The vast majority of 401(k)’s with less than $1 million in total assets had costs that ranged somewhere from 0.68 percent to a scandalous 2.66 percent.

Part of the reason is economics. Small plans have less money to manage, so they generate less in fees and have less negotiating power. But another driving factor is the way the industry is structured.

“It has tended to attract the high-cost providers in part because of the economics, but in part because in this area of the market, the plans are sold, not bought,” said Mike Alfred, co-founder and chief executive of BrightScope, which tracks and rates retirement plans. “So there is an adviser or rep going into that company and convincing the chief executive officer, human resources or the chief financial officer to set up a plan,” he added. “And usually the high-cost providers are the ones that have the economics to pay the adviser to support that effort.”

In case you haven’t already heard, paying all those fees can seriously affect your nest egg: Paying just 1 percentage point more annually could reduce savings by nearly 30 percent over an individual’s working career, according to Labor Department calculations.

Imagine an employee who saved $25,000 in a 401(k); she doesn’t make any new contributions and earns 7 percent over the next 35 years. If she paid 0.5 percent in total fees, the account would grow to $227,000. But paying fees totaling 1.5 percent would leave her with $163,000 — that’s 28 percent less.

For the tiniest companies, Betterment will charge .60 percent of plan assets, plus the cost of the actual investments, which tend to be another .1 percent, on average. There is also a $1,500 setup fee for new plans. The fees decline as the company’s assets grow.

Those expenses are all inclusive, wrapping in the customized, automatically managed portfolio and all of the administrative work that a 401(k) plan demands, a task that is often handled by a third-party administrator or record-keeping firm. (Vanguard, for instance, works with Ascensus.)

But Mr. Stein said Betterment built its own system from scratch, which means the managed investment accounts can talk directly to its record-keeping arm. That, he says, has enabled the company to simplify many administrative tasks and regulatory compliance, making life easier for employers sponsoring the plans.

His team learned a lot when they were shopping around for their own 401(k), back in early 2014 when they had about 50 employees. “We found this process to be super difficult for us, and we are pretty sophisticated,” said Mr. Stein, who ultimately chose Vanguard. Though Vanguard charges a flat fee per participant, he said it cost them the equivalent of 0.82 percent of total assets.

Even though the Department of Labor, which oversees retirement plans, now requires plan providers to itemize their costs of services — separating investment costs from administrative ones — comparing plan prices can still be mind-boggling, particularly for a time-constrained entrepreneur.

The Labor Department is now trying to take its oversight a step further, and has proposed a rule that would require more brokers to act in the best interest of their small business customers when selling retirement plans and suggesting investments, a rule that is now easily bypassed. (Brokers must meet a five-part test before they are deemed a fiduciary, which means they must put their customers interest before their own.) Depending on how the final rule is written, it could force even more transparency.

The financial services industry has argued that such a rule would make it too costly to work with smaller investors and plans, but there are plenty of providers, including Betterment, lining up to take their place, at least in the 401(k) space.

Kevin Busque, a co-founder of TaskRabbit, the online marketplace that connects individuals with people willing to complete small jobs, is gearing up to introduce a 401(k) plan to small employers through his new start-up, Guideline.

Another company, Dream Forward Financial, goes beyond lowering costs and providing a modernized interface. Its 401(k) service will attempt to address the reasons people don’t save for retirement, like buying a home or sending a child to college.

ForUsAll and America’s Best 401(k) are two other newer players, while Employee Fiduciary, Capital One’s ShareBuilder 401(k) and Ubiquity (formerly the Online 401(k)) have each offered lower-cost plans for at least a decade.

“They are using low-cost funds and exchange-traded funds, so it is a lot cleaner and cheaper for everyone,” said William Trout, a senior analyst at Celent who tracks technology-focused financial firms.

Given the rising number of options, there hasn’t been a better time for workers in small businesses to make a case to their employer for a new or improved 401(k) plan.

“This is something of a national scandal,” Mr. Trout said. “We lionize small business in this country. But the fact of the matter is that part of working for a small business means paying a lot more — and in many cases, twice as much more — for their 401(k) plans than big corporate employees.”

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A version of this article appears in print on September 12, 2015, on page B1 of the New York edition with the headline: More 401(k) Options for Small Business.

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