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Why Do Some Small Businesses Offer Retirement Plans?

Industry Trends and Research

For many years now, Congress has tried to make it easier for small businesses to offer a retirement plan, but there still has been little movement in closing the coverage gap.  

With enactment of the SECURE 2.0 Act and one of its main goals to help make it easier for small businesses to offer a retirement plan, identifying what companies view as impediments to offering a plan can help identify those small firms most likely to offer coverage in the future. To that end, a recent issue brief by Anqi Chen and Alicia Munnell of the Center for Retirement Research (CRR) at Boston College looks at why some small businesses offer plans while others don’t.

In fact, only about half of private sector workers in the U.S. at any given time are covered by an employer-sponsored retirement plan and few workers save on their own without one. Consequently, many households end up with no retirement savings, while others with frequent job changes and coverage gaps end up with only modest balances.

And the smaller the firm, the less likely it is to offer a workplace retirement plan. Among the largest firms, 95% offer plans compared to only 48% of the smallest firms, according to the research, which cites 2019 data from the U.S. Bureau of Labor Statistics. Yet, firms with less than 100 workers account for most businesses and 35% of private sector workers.

Chen and Munnell observe that, among smaller firms, average firm size does not appear to vary much by coverage, as the firms with coverage have only slightly more employees. Earnings, however, are an important differentiator. Those with retirement plan coverage average $67,500 compared to $36,800 for those without coverage. Similarly, hourly workers constitute a much smaller share of covered employees than of those not covered, the CRR researchers note.

Although the earnings level of workers is, by far, the biggest factor in determining whether a small firm offers retirement coverage, it is not the only factor. The size of the firm, the industry and the educational attainment of workers also have a statistically significant effect, Chen and Munnell explain.

Notably, while small employers are less likely to offer a retirement plan, most still believe that offering a plan is important for hiring and employee retention. Yet, a significant discrepancy exists for small firms (under 100 employees) between the percentage thinking retirement plans are important and the percentage offering such a plan, with nearly 7 in 10 (69%) believing that it’s important, but only half (50%) offering a plan.

Three Main Barriers

As to the reasons, the CRR researchers explain that over the last two decades three institutions—the Employee Benefit Research Institute (EBRI), the Pew Charitable Trusts, and the Transamerica Institute—have surveyed small firms about their failure to offer a plan. In these surveys, firms have consistently cited three main barriers:

  • uncertain revenues that make it hard for a firm to commit to a plan;
  • employee preferences for wages and other benefits; and
  • the cost associated with establishing and administering a plan.

The No. 1 concern in the Transamerica findings is that the firm is not big enough, which, combined with “difficult business conditions,” suggests that a firm does not feel established enough to offer a workplace retirement plan. “Indeed, firms that have been in business for less than five years constitute most small firms. These firms may simply have too much on their plates to add an additional benefit,” Chen and Munnell observe.  

Turning to costs, it also always ranks in the top three reasons for not offering a plan, but the story is a little more complicated, they note. While cost and administrative complexity have always been an issue for small businesses, Congress has repeatedly tried to minimize paperwork, recordkeeping, and reporting and fiduciary responsibility for these companies, going as far back to the Revenue Act of 1978 that established the Simplified Employee Pension (SEP), as well as the creation of the Savings Incentive Match Plan for Employees (SIMPLE) in 1996.

“The EBRI and Pew surveys, however, both found that many employers were unaware of these low-cost options, and the EBRI survey also found that many did not realize that an employer match was not mandatory in 401(k) plans. Thus, lack of accurate information may be a significant obstacle,” Chen and Munnell write.

Another major reason cited by employers for not offering a plan is lack of employee interest. With earlier surveys showing that small employers without a plan had a younger workforce, has higher turnover and paid lower wages, it’s reasonable to assume that these employees would prefer cash wages over benefits, the brief observes. Moreover, employers have no interest in offering benefits that their employees will not appreciate.

As such, from an employer’s perspective, it might not make sense to offer a benefit that their employees do not value, but evidence from State auto-IRA initiatives in Oregon, California and Illinois may tell a different story, the CRR researchers note. “Even though lower-paid workers may not have thought they wanted a retirement plan, only about one-third of them have opted out, and testimonials suggest that many are grateful to have some money in reserve that they can either accumulate for retirement or withdraw in case of emergency,” Chen and Munnell write.

What’s more, while the barriers of uncertain revenues and employee preferences may be difficult to overcome, the “less compelling reason” for not offering a plan is the concern that establishing one would be too costly, they further observe. “Surveys have indicated a substantial lack of knowledge about the options, the costs, and even the need to provide a match in a 401(k) plan. This area seems like fertile ground to make inroads into expanding coverage—especially with the advent of PEPs (Pooled Employer Plans),” the CRR researchers further emphasize.