Many small-business owners and their employees are getting hosed on their retirement plans, thanks to costs that are starkly higher than larger companies, and now we have proof.
Fund-research company Morningstar has found that the average fees in small company plans are twice those in big companies. Just the higher fees alone mean that someone working at a small company would on average end up with 9% less in retirement savings after 35 years as someone at a big company, even if they saved exactly the same amounts and invested the money exactly the same.
(That’s how much higher fees hurt you over time.)
But what really stands out is that the range of costs charged by some small company plans is huge.
Some of them run at very low costs: So we know it’s possible. But many others are being charged simply extortionate fees by their 401(k) providers or consultants, mainly for fees like record-keeping, legal advice and third-party administration.
Morningstar defines “small” plans as those with $25 million or less in investments. (There are over 650,000 of them nationwide.)
Some charge 0.4% of assets or even less per year in total costs, including fund management and administration costs. Meanwhile a third of small plans charge, in total, 1% of assets or more per year.
Some, staggeringly, charge 2% or more.
The average across all small plans is 0.84%. The average in the biggest plans—those with $500 million or more—is just 0.4%.
The biggest variation is in administration costs, not in the money paid to the mutual funds
Why the variation? Morningstar analyst Lia Mitchell, who wrote the report, says that many small-business owners simply may not be aware of low cost options.
Let’s also point out that many not fully understand how much they are really paying. Or the long-term costs of paying these higher fees. They may not even know what they don’t know.
After all, if you are running a doughnut factory, you know doughnuts, not 401(k) plans.
But if this is your business you’re getting hosed. And there are simple, cheap options out there.
Since 2019 small companies can join multiemployer plans, known as “pooled employer plans” or PEPs, to share the costs. And big well-known investment companies have used that to launch low-cost, off-the-shelf options for small businesses, in some cases costing just a few thousand dollars a year.
There was already a pre-existing low-cost alternative designed for small companies, called the SIMPLE IRA, which was open to employers with fewer than 100 employees. The annual savings limits are lower than for a regular 401(k). For example in a SIMPLE IRA, employee contributions are limited to $15,500 in 2023 (plus another $3,500 in catch-up contributions if you are 50 or older). In a 401(k) it’s $22,500 (plus another $6,500 in catch-ups). But the costs and administration fees are also lower.
Bottom line: Costs matter. If you are running a small business, you owe it to yourself and your staff to make sure you’re getting the best deal possible on your retirement plan.