by: Frances Denmark
from:  Plan Sponsor Magazine
January 2000

Micro-size and start-up plans have long been treated like second-class citizens when it comes to 401(k) pricing and service. But the tables are beginning to turn.

Their assets may be small or nonexistent, but their demands are anything but. At places like Giage, Ltd, an Internet start-up company in Cincinnati, fierce competition with large e-commerce firms is driving some rather sophisticated design choices, and begging the question, "How much?"

Giage CFO Christopher Baucom had to keep prices in check; his company has grown from two people working out of the owner’s garage in 1995 to almost 30 employees today. The company started off in July 1997 with a "bare bones retirement (savings) plan that gave tax-deferred investing, but was lean on the services," hoping that offering potential employees Fidelity fund options would be a hiring inducement, Baucom says. Previously, it had used Fidelity’s small business program, which included eight fund options, administration and some of the recordkeeping (not including 5500 forms filing or testing). But Baucom wondered how long its much sought-after workers would remain satisfied with the plan. So, when Fidelity approached Baucom to switch total plan administration plus fund options for its $250,000 401(k) to Fidelity’s new Internet-based e401(k) product, he seized the opportunity.

Voila! With e401(k), launched last October, Giage employees’ investment options jumped form eight to 35. Workers are now able to join the plan any time, instead of waiting a full year. They also can make changes to payroll deductions any time, not just once a month, and, instead of dedicating staff to fill out forms, employees do it all online. "We don’t need a big inventory of prospectuses (anymore)," Baucom says happily. The old plan cost between $2,000 and $3,000 a year to run. With e401(k) – a product designed especially for small plans with under 100 employees – Giage pays annual recordkeeping and trustee fees of $1,750, plus $20 per plan participant annually, plus a one-time $750 set-up fee, for a grand total of $2,050. According to a 1999 report by Cerulli Associates in Boston, Fidelity is the first company to offer a "do-it-yourself service platform to plan sponsors" via the Internet. e401(k)’s success "may be defined by Fidelity’s adeptness at keeping plan sponsors off the phone," Cerulli concludes.

Small plan sponsors have certainly faced their share of challenges. Experts say that federally approved SIMPLE plans for the smallest businesses, including start-ups, have not lived up to the expectations of the policymakers who established them in 1997. One reason for that is that, while dispensing with discrimination testing makes life simpler foe employers, they "trading one type of cost for another," says Paul Yakoboski, senior researcher at the Employee Benefit Research Institute in Washington, who notes that, to use the SIMPLE, employers must maintain a minimum level of contributions for workers. "That remains an issue for small employers" with uncertain revenue streams.

The good news

And yet, there is a light at the end of the tunnel for even the smallest retirement plan sponsors with less than $1 million in 401(k) assets, especially since the Internet can lend a hand with such unappetizing burdens as loan administration, enrollment, and payroll deduction changes (see "Education.com," May 1999). Besides Fidelity’s product, another recent development in the computer-enabled 401(k) market is "401(k) Easy," also known as the "run-it-yourself 401(k)," launched in September 1999. 401(k) Pro President Jim Gilbert first targeted the small plan market 15 years ago, providing traditional services at the Pension Service Association in Los Angeles. After developing proprietary 401(k) software, Gilbert decided to patent and offer a version of this software to start-ups and other small employers looking for a cost-effective retirement program. "We are not trying to replace TPAs," says Gilbert. "We are just trying to serve an underserved market" he says, describing his software product as "a good solid Volkswagen, not a Ferrari." Gilbert charges $2,395 for the software plus $25 per participant. The program is not much different from Quicken Quick Books or Turbo Tax. Participants are privy to a brokerage window offering choices from Schwab or another discount broker of their choosing. Gilbert runs monthly compliance tests through the software, which is customized for each client company.

Frequently, however, finding the right vendor is an arduous process, particularly where plan sponsors are starting from scratch. Building its 401(k) began as a "tortuous" journey for Kevin Higgins, CFO at East Brunswick, New Jersey’s Builders FirstSource-Northeast Group, for instance.

The building material distribution company, now with $3.5 million in plan assets and 410 employees, got started on its retirement savings plan in July 1995. "It was horrible in the beginning," Higgins explains. Vendor after vendor could nor begin to deliver all of the services on Higgins’ wish list, which called for quarterly statements, an 800 number/voice system, recordkeeping, a brokerage window and, ultimately, Internet service. Higgins and his assistant ran interference as problems arose over the course of three years.

"When there are no assets in the plan, you have nothing to negotiate with," notes consultant Trisha Brambley, president of Resources for Retirement Plans in Newtown, Pennsylvania. Whereas most plan sponsors have between 300 and 400 full-service 401(k) providers to choose from, only a handful focus on the under-$1 million market, she notes, although there are at least a couple of hundred vendors now focusing on the $1 million-plus market. This is why, "in a start-up, you often get a disjointed or expensive plan" Brambley views a plan as "disjointed" when the plan sponsor does a large amount of the work itself, even though it is paying for separate trustee services and recordkeeping. So, while the choice set is still limited for start-ups, things are looking brighter for businesses with retirement assets in the $1 million to $10 million range.

Competition Heats Up

Despite some discouraging growth trends, the truth is that competition is working in favor of small retirement savings plans. While 80% of all 401(k) sponsors are microplans with fewer than 100 employees, the microplan market has only expanded at an 11% compounded annualized growth rate over the past three years. But that has not prevented vendors from fighting "a fiercely contested battle" for this business since the mid-‘90s, according to Cerulli Associates. The obvious question is, why? One reason is growth potential. "The number that causes otherwise rational professionals to have such high levels of interest is that less than 15% of employers with less than 100 employees have a 401(k) plan in place," Cerulli found. These plans represented just 15% of a total of $1.4 trillion in 401(k) assets and 16% of 401(k) plan participants as of the end of 1998. Another reason is that, as certain providers continue to abandon this market segment (see "Small plans blues," February 1999), opportunities are created for new players. Peter Starr, managing director at Cerulli, observes that the small end of the market continues to have "abysmal penetration rates" because vendors find it very costly to service small plans. "It is one thing to have growth potential, but another to produce a profit." Cerulli concludes that competition for microplan business remains fierce all the same, because this is the only portion of the 401(k) market that has not yet consolidated (see table, page 28). Some vendors are also targeting start-ups, but "they are not as attractive as small but established plans," says Starr. Retirement services giants are, however, taking a chance on this business; Fidelity is looking to garner enough market share to make it worthwhile.

Meanwhile, providers clamoring for small-plan market share have finally moved beyond the "classic eight" investment choices, says Pat Burns, president of Actuarial Consultants in Torrance, California. The trend toward offering 25 to 30 choices among 10 to 12 different fund families is growing, says Burns. For example, Merrill Lynch might offer a small plan 20 choices from a total of 700 funds, only 100 of which are Merrill Lynch funds.

Experts agree that plan sponsors should have less of a hassle getting the services they want from their retirement plan vendors, as long as they are willing to spend some time learning about the needs of their participants. Some advise asking for referrals from other small businesses, similar to the way one finds a physician or attorney. Others recommend using a consultant to review company needs and vendor choices. Says Builders’ Higgins, "You need someone like Trisha (Brambley) on your side to understand these things."

Higgins turned to Brambley after sampling two different unbundled provider schemes which included an insurance company, recordkeepers and a broker. When he was dissatisfied with their services – quarterly statements were chronically late and he was never able to speak to the same person twice regarding his plan – he went searching for another vendor. Brambley helped the sponsor assess his needs with a questionnaire (see "Time for a change" below), issued seven RFPs, and whittled down the choice to one bundled provider, Diversified Investments Advisors of Purchase, New York. Higgins says that the Diversified team provides timely, accurate reporting along with a phone line that includes a Spanish language option. An added plus: There are many more investment choices in the new plan at Builders, including fifteen Diversified funds, and a brokerage window to Charles Schwab that enables participants to transfer money from the fund options and buy individual stocks. The consultant’s fee was paid by Diversified after it was selected. The prototype plan, which includes recordkeeping and administration, costs $5,000 per year plus $20 per participant. Participants are charge for additional services: $75 per participant loan and $50 per year for use of a brokerage window, for instance. Fund management fees are also paid by employees.

Keeping workers in the loop

Notwithstanding the benefits of technology and competition, it is clear that, where employers are not in touch with participants’ wants and needs, some of the best retirement plans may fail. At Firstlogic, a 270-employee software development company in La Crosse, Wisconsin, Deb Severson, human resources director, describes the workforce as "very savvy as far as their retirement dollars and investments are concerned." When about 10% of the workforce complained about the former retirement plan provider by sending e-mails to Severson after quarterly statements arrived, the plan sponsor sat up and took notice. The employees’ wish list included better fund performance and options, a loan and hardship withdrawal provision, online services, easy-to-read reports and fund performance history.

A 10-month search process ensued. Working as a three-member team, Severson, the company CFO, and another finance official Whittled down a list of 10 to 12 prospective vendors to just three finalists. Then about seven interested employees were given the task of evaluating the three choices or even finding alternative choices, if necessary. Mostly on the strength of its web site, the employee group selected Strong Retirement Plan Services in Menomonee Falls, Wisconsin, Strong bundles recordkeeping, investment management and participant education into its 401(k) package. Employees were especially happy with online services including statements and performance information. "We see employees’ wish lists becoming more and more a part of the 401(k) provider decision-making process," says Peter Littlejohn, senior vice president and national sales manager at Strong.

Employee input is also a integral part of the $4 million 401(k) at Landoll Corporation, a manufacturer of heavy apparatus such as forklifts, trailers, de-icers and tillage equipment in Marysville, Kansas. Landoll’s plan has garnered 240 of the company’s 383 eligible workers. Seven employees sit on a 401(k) committee on a rotating basis. Each of these employees represents a job function such as welding, accounting, or the third work shift.

Courting cost concessions

Unhappy with the pricing schedule of TPA Allen Gibbs & Houlik in Wichita, John Schmidt, the former president of Landoll’s 401(k) committee, decided to investigate the pricing structure and to demand a different cost format with lower fees. Schmidt’s first step was to analyze fees against statements to see if they matched the original plan agreement. When he had verified that costs were correct, Schmidt came up with a single, annual cost figure, divided it into total assets, and used that number to arrive at a single, bundled annual fee, which he believes has saved the company $23,000 this past year. Where, previously, the TPA’s quarterly invoices nickeled and dimed Landoll for everything from processing stock splits to the stamps and envelopes used in mailings to participants, now there is just one simple fee of 50 basis points on plan assets. Schmidt plans to renegotiate that charge as assets increase, since he does not expect the number of participants to increase substantially in the future. The bundled fee is in addition to a 1% investment management fee Landoll pays Merrill Lynch.

Despite the price concessions, Schmidt’s TPA has dutifully added plan features requested by the employee committee. These include more detailed quarterly reports, a 24-hour 800 number and a loan feature. Internet access to account information is expected on or before April 1, 2000.

Cost remains the overriding concern for small sponsors such as Oasis Technology and Consulting of Falls Church, Virginia. "Conventional wisdom was, if you are small, you can’t afford a 401(k)," says Ralph Vastag, principal and co-owner of Oasis, an information Technology consultant to companies such as GTE and FirstUSA Bank. "It hasn’t turned out the way," he says. All 12 Oasis employees participate in the company’s $135,800 401(k) plan, which utilizes Retirement Plan Strategies in Braintree, Massachusetts. Oasis found RPS through an online search. As Vastag’s biggest concern going in was price, the sponsor was willing to forgo services such as daily valuation and Internet account access. "Employees haven’t mentioned they missed Internet access in managing their accounts," says Vastag. John Mulligan, president of RPS and a small-business owner himself, provided Oasis with a bundled product incorporating plan design consulting, compliance testing, five investment options, plan administration and reporting. Fees include a one-time $25-per-person start-up charge; a $48-per participant recordkeeping fee; $500 per year for plan administration; and a $200 annual trustee fee. Management fees are limited to the expense ratios for the five investment options, which range from 0.82% for a stable value fund to 1.37% for an international equity fund.

With its workforce more than doubling in a short period of time, speed and flexibility were what Karl Rea, executive vice president of Alexandria, Virignia-based Core Processes wanted when he went looking for a 401(k) plan. As employees were all new workers transferring from their previous employer’s 401(k)s, we "needed something that was at least comparable to what they had while, at the same time, allow[ing] us flexibility to set up a plan without a lot of prohibitive entrance requirements." Core Processes hires senior management talent to provide consulting services to the defense industry. The company wanted a program that would serve both full and part-time workers with a larger menu of investment options. His solution: Fidelity’s e401(k). Core Processes had eight employees at the end of 1999, and was expecting to go to 20 in early 2000. The e401(k) plan can enroll members immediately, and "at least half of the investment choices are high performers," which appealed to Core Processes’ "older, more mature, more sophisticated investor-type employee base," says Rea. All 25 of its mutual fund choices are Fidelity funds, including seven growth funds, two international funds and four aggressive/small company funds.

What’s next?

What is next for small plans? Strategic alliances among providers is "a trend that is going to explode," says Roxanne Fleszar, president of retirement plan consultancy Financial Resources Management in Peabody, Massachusetts. Providers of ancillary service enhancements, such as investment advice and asset allocation or recordkeeping, are teaming up with 401(k) providers to co-offer their products. Now, through alliances between 401(k) providers like Aetna and fund managers like Charles Schwab, small plans can access asset allocation advice on the Internet from companies like mPower (formerly 401(k) Forum) in San Franciso and Financial Engines in Palo Alto. Fleszar predicts that recordkeepers, too, will begin forming such vendor alliances, since it is difficult for many 401(k) providers to deliver recordkeeping in a cost-effective way. Someone who focuses just on recordkeeping and does it well can team up with the provider to deliver a total package. Financial Engines plans to serve the smaller end of the market through alliances with distributors such as Prudential and State Street. Financial Engines’ vice president Christopher Jones notes that his company’s initial focus was the Fortune 1000, but the company is seeing increasing demand from much smaller sponsors – and means to capitalize on it.