The 411 On 401(k) Plans

But during an economic slowdown, when raises and bonuses are scarce, a retirement plan can not only improve the attitude and performance of your workers, it can also help recruit and secure talented employees. And solution providers who hire workers on contract may want to make those temporary workers permanent when business picks up.

"Our 401(k) plan gives a sense of security to employees that the company they work for also has their best interest at heart," says Bunty Lalchandani, president of Micro World, a Torrance, Calif.-based VAR that provides IT solutions to SMBs. "It also lets us hire better employees. People who are thinking about their future, who are more vision-oriented, tend to ask for retirement savings plans."

Indeed, retirement funds have become a high priority for many employees, particularly in light of Enron's bankruptcy, which caused thousands to lose their retirement savings in 401(k) plans. According to a 2002 survey by John Hancock Financial Services, most respondents were not on track to achieve the 75 percent of preretirement income needed to maintain their lifestyle once they retire. As a result, a sound retirement-savings plan has become a cornerstone of an employment contract.

A survey this year by the Employment Benefit and Retirement Institute also showed that many small businesses without a retirement-savings benefit were unaware of plans and regulations designed to make setting up a 401(k) easier and less expensive. For example, the 2002 Economic Growth and Tax Relief Reconciliation Act established a 50 percent federal-tax credit for the first $1,000 spent during each of the first three years to offset administrative and retirement-education costs of a new small-business retirement plan.

So, where should you start? To avoid sales pitches from plan providers, online tools are your best bet. Take advantage of Web-based tools such as Search401k, (www.search401k.com) and 401(k) Pathfinder (www.plansponsor.com), which can match your needs to mutual-fund, insurance and banking companies offering 401(k) plans. Don't talk to just one of these companies. Compare a selection of offerings.

Another source: recommendations from people with whom you already work, such as your lawyer or financial planner. They know your business and can help you find a good match. (Keep in mind they are acting as brokers and will likely receive a finder's fee from the plan provider.)

"We used our accountants because choosing such plans wasn't our field, and we wouldn't have been able to navigate through it that successfully," says John Ponterfact, principal of Boom Vang Consulting, a small e-business solution provider based in Portland, Ore.

Ultimately, you are the final judge. To help you make your decision, here is a rundown of what you need in a plan provider.

Simplicity And Availability

Most VARs don't want to wrestle with paperwork and questions involved with running a 401(k). And there's no shortage of plan providers willing to pitch you a product. But will your plan provider help employees enroll in a plan and make sound investment choices?

"You want somebody who is willing to work with your workers, as well as with you," says Nevin Adams, editor of PlanSponsor.com, an employee-benefits news Web site. "Put a premium on those people who retain a shared interest in how a plan goes after it's sold."

Readable account statements are also important. "If employees can't understand their 401(k) statements," Adams adds, "they'll likely come bug you."

Good Fund Selection

Plan sponsors aren't liable for participant choices among investments, but they are responsible for providing prudent options. "In an unstable market, any fiduciary [responsibility associated with a plan is more vulnerable to getting sued," says Carol Calhoun, a benefits attorney and president of Calhoun Law Group. "Therefore, it's more crucial than usual to pay attention to which providers have a good track record."

When evaluating funds in a plan, consider net performance: returns on investments after fees. Diversity of options also is important. According to a 2002 survey by CRA RogersCasey/Institute of Management and Administration [IOMA, the average number of investment options offered by plans last year was 13.2. The most popular options were U.S. Equity Large-Cap Active, U.S. Balanced, U.S. Equity-Index, International Equity, U.S. Equity Small-Cap Active and U.S. Bonds.

"In reality, only about one-third of those options get used," Adams says. If you don't think you know enough to select a plan, hire a consultant.

Similarly, plan sponsors don't have a fiduciary responsibility to provide the least expensive plans available, but they are required to make sure that fees are reasonable for services provided.

Because SMBs don't offer as much business to a plan provider as larger companies, fees for smaller companies are typically higher. In some cases, plan providers don't require employers to pay up-front, but offer a more expensive class of shares in a particular fund. For example, instead of institutional shares, the provider might offer retail shares.

According to the 2002 CRA RogersCasey/IOMA survey, the average expense ratio for retail mutual funds is 0.82 percent, compared with 0.71 percent for institutional mutual funds.

"If a plan has less than $10 million in assets, you'll be steered toward a more expensive fund," Adams says. "But if you bring up the institutional shares, you sound like a savvy buyer, and you might get a favorable response."

Another way a plan provider makes money from small companies is to offer only proprietary products,which might not be the best on the market. "No single-fund family has a top performer across all categories," says Ted Benna, president of the 401(k) Association.

Even if the plan provider says a fund isn't proprietary, check if a connection exists. The fund may have a different name than that of the plan provider, but the fund prospectus might reveal that the same company advises both.

Also, ask how the plan provider gets paid. A fund company could give a provider a cut of the revenue for bringing it business, but he fund company could pass along the expense of that commission to participants through higher investment-management fees.

"There are thousands of funds to pick from, and the spread of fees among mutual funds is great," says Pam Hess, defined contribution consultant at Lincolnshire, Ill.-based Hewitt Associates, a human-capital-management consulting and services firm. "So employers can shop around."

Most employers don't realize that investment-management fees are a percentage of account assets, Hess adds. So as an account grows, so does the cost to manage it. According to Hewitt, approximately 70 percent of a plan's total cost is from investment-management fees. On average, administration costs make up 20 percent and trustee fees 10 percent,both of which are typically fixed. When a plan provider bundles investment-management fees with administration and trustee costs, it's harder for an employer to determine each amount.

Even though investment-management fees typically come out of employees' returns and not an employer's pocket, it's important that companies offering 401(k) plans meet their fiduciary responsibility of providing funds with reasonable fees.

"Costs on the fund-expenses side can be controlled," Hess says. "Even if an employer can do [only a little better in this area, it can make a big difference for employees' returns over time."

Investment Advice

Because offering a 401(k) plan builds a bond with your workers, you want those plans to work. The current bear market has revealed that one of the greatest faults of the 401(k) system is that it requires the average investor to know about the securities markets. To help employees maximize returns, an increasing number of employers are seeking ways to offer investment advice.

Most plan providers have relationships with independent advice companies, such as mPower, Financial Engines and Morningstar, which provide tools to help participants evaluate investments. But a Boston Research study showed that while the percentage of employers offering independent advice programs has doubled to 39 percent in 2002, up from 19 percent in 2001, less than 10 percent of 401(k) participants have used them. The reasons? Lack of knowledge about how to use the tools and reluctance to dig through financial records to answer questions. The average 401(k) participant is a passive investor who neglects to adjust his or her portfolios in response to changing market conditions. That's why employers should also consider plan providers, such as Nationwide Financial Services, that offer professional money managers to take over participants' accounts. Employees usually pay for the service. "Most people want more than advice and education," Adams says. "They want somebody to do it for them."

Lifestyle funds,premixed asset allocation funds,can also serve a similar purpose. These funds automatically reduce the percentage of stock ownership as the participant grows older. Lifestyle funds, however, can be expensive. A predetermined package of existing fund offerings comes with their embedded costs, plus a separate advisory fee.

Lisa Meyer ([email protected]) is a freelance writer based in Staten Island, N.Y.