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| The Simple solution By Jinny St. Goar After reviewing a number of alternatives, Frank decided to set up a savings incentive match plan for employees, or Simple IRA. He was so pleased with the plan’s low cost and flexibility that he’s now set up similar plans for six of his clients as well. Frank acts as the local adviser for all seven programs, and Oppenheimer Funds administers the accounts online. Combined, the seven tiny enterprises have 39 participants in the employer-sponsored plans, with $300,000 in total assets. It’s hard to fault the pricing: Simple IRAs are cheap. Each program pays the princely sum of $10 per year per employee as an administrative fee, on top of the standard retail fees for the mutual funds that are included in these “not-so-individual” retirement accounts. That compares favorably with the $80 to $100 per person annual cost of a 401(k) plan, which also requires $3,000 to $4,000 a year to file the proper government reports. With a maximum price tag of $15 per person per year, Simples are selling like hotcakes - to the delight of mutual fund vendors. The plans have been on the market only since January 1997, but they have already garnered $6 billion in assets, according to the Investment Company Institute, a mutual fund trade association. “This is impressive growth for a four-year-old program and shows that small businesses want a retirement program for their employees if there is one that is simple enough,” says David Wray, president of the Profit Sharing and 401(k) Council of America. “We see two forces driving Simples. First, people want to control their retirement savings,” says Marcia Mantell, vice president of retail small business retirement products at Fidelity Investments. In addition, she says, small companies have been helping drive job creation in the U.S. Businesses with fewer than 500 employees have generated 75 percent of the new jobs in the U.S. during the country’s recent economic expansion, according to the Small Business Administration. This past year Oppenheimer Funds saw its Simple sales jump by 42 percent; the firm currently has about $550 million in these assets under management. Fidelity, which experienced a 26 percent sales gain in 2000, has roughly $600 million in Simple assets, while MFS Investment Management claims about $350 million. Mutual fund companies like these have pulled in the lion’s share of the assets, though banks and insurers also offer the programs. The Principal, the leading insurance company in the small-business market, has just over $100 million in Simple assets under management. Other providers include Merrill Lynch & Co., Prudential Securities, MetLife, ManuLife Financial Corp. and Morgan Stanley. Authorized under the Small Business Job Protection Act of 1996, Simples actually borrow some features from the 401(k) and some from the IRA. Simples boast the pretax salary deferral of the 401(k) along with the employer’s matching contribution. And like the IRA, Simples offer unlimited investment options, as well as employer exemption from fiduciary responsibilities. These plans also have some features all their own. Unlike the 401(k), for example, they allow senior managers to contribute to their own retirement accounts even if lower-level employees don’t. In addition, an employer can put in one lump sum yearly while employees contribute monthly. This flexibility has great appeal to very small firms. Utilizing the Internet to reach out to a fractionated, cost-conscious audience, Simples allow vendors to serve a market previously beyond their grasp. “Simples are a clean, easy product that can rely on cutting-edge technology,” notes Kathleen Beichert, who co-manages the retirement business at Oppenheimer. One of the key differences between Simple IRAs and 401(k) plans is that the assets of the former are not held in trust. That means, as with ordinary IRAs, account holders can withdraw funds at any time, with little risk of penalty. Technically, withdrawals that investors make from regular IRAs before age 591/2 are nicked 10 percent. When the IRA was introduced in 1973, there were no penalties on withdrawals. Penalties were added in 1986, with ample exceptions, including unreimbursed medical expenses, education and housing. Since then, savers have been “claiming that they are going to buy a house, and the IRS never checks,” contends the PSCA’s Wray, who thinks the lack of restraints on Simple withdrawals are a drawback. In his view, “employees are just plain better off in a trusteed plan” because of the withdrawals penalty. Another minus: The low cost means Simples tend to take a one-size-fits-all approach. Contribution limits for Simples can’t be increased like those for a 401(k): The $10,500 annual cutoff for a 401(k) can be boosted to as high as $35,000 should the employer decide to add a profit-sharing plan, whereas $13,000 is the absolute ceiling right now for a Simple. Also, under a Simple, employers must match their employees’ contributions dollar-for-dollar up to 3 percent of compensation; if an employee chooses not to contribute, the employer has the option of contributing up to 2 percent of compensation but is not required to do so. By contrast, in a 401(k) an employer is allowed to match up to 25 percent of compensation, though 6 percent is the norm. But in return for these stricter limits, Simple users are freed from the Internal Revenue Service’s discrimination testing rules, which mandate that the same limits apply to all employees regardless of salary. Complying with these rules makes 401(k) plans more cumbersome and expensive to administer. These days, 85 percent of companies with 100 or more employees offer retirement plans, while only 15 percent of companies with fewer than 100 employees have any sort of pension plan, according to a recent report by TowerGroup, a Needham, Massachusetts-based consulting firm. For the target market of Simple IRAs - companies with fewer than ten employees - the percentage with pension plans of any sort drops well below 15 percent. Providers have avoided these markets because they’ve been so expensive to reach. “Industrywide, the typical firm buying a Simple has had five to six employees,” says Elise Pilkington, assistant director of retirement and investor services at the Principal. “Now we are selling to firms with an average of eight employees.” While that doesn’t sound like much, the additional contributors allow the insurer to offer more services at a lower cost. For the plan provider, the economics are daunting, not merely because of the limited number of accounts that can be picked up in one fell swoop. As with any new plan, the account balances also start out tiny - and with fewer than ten participants, that can mean very tiny. Thus the Simple solution: Providers and sponsors are spared much of the regulatory reporting, and human involvement is kept to a minimum. The lack of human involvement is possible because the plans are so straightforward that they can be run almost entirely electronically. Otherwise, the product wouldn’t be economically viable. Oppenheimer Funds has an Internet-based system for collecting plan contributions and sending back confirmation in real time, as does Fidelity. The Principal will be offering customers totally Internet-sold and -serviced Simples in the third quarter of this year. At the moment, MFS is still looking into the possibility of electronic processing. Simple plans are turning out to be what the industry hoped for - a source of new customers. “Now that there is so much emphasis on retirement savings, the Simple IRAs are becoming a door opener,” says the Principal’s Pilkington. “The reps are telling me that Simple IRAs are leading to new relationships.” Accountant and financial planner Frank particularly enjoys the ability to make one large payment per year, which gives him some flexibility in managing his finances. And the contribution limits haven’t posed a problem. Frank’s client with the largest Simple plan (18 participants) is a husband-and-wife team who run a plant nursery. For 2001 the two of them will be able to set aside $26,000 in their Simple, while the first ceiling on a 401(k) would have been $21,000. Despite the fact that Simple IRAs have clear limitations, some small companies have found them to be attractive lures in a tight labor market. This is precisely what prompted Peter Cooper to set up a retirement plan for his four employees last October. Cooper owns Technology Training Solutions, a five-year-old firm in Lyndhurst, New Jersey, that trains educators, administrators and adult learners in technology. Lacking any retirement program, Cooper was starting to find it difficult to recruit new employees, who tend to be teachers considering a career switch. The local school systems generally have attractive benefits packages. “Given the size of my company and the administrative costs and the time required to set up a 401(k), it just did not make sense,” says Cooper. “But an employer has to have a retirement plan to attract and keep employees.” His alternative was Simple. ©Copyright 2001 Institutional Investor, Inc. | |||
