How Small Businesses Can Help Close the Retirement Gap

Is there at least a partial solution for the United States' retirement gap? Policy changes to ease the formation of so-called multiple employer plans might be the rare bipartisan idea that, even given the current dysfunction in Washington, D.C., could come to fruition.

First, some background information: Experts do not agree on the size of the retirement gap in the United States--the amount of additional money Americans need for a secure retirement--but there is consensus that it is pretty large. Jack VanDerhei of the Employee Benefit Research Institute estimates the retirement gap at a little more than $4 trillion. Alicia Munnell, who runs the Center for Retirement Research at Boston College, believes it is nearly twice as large. To put those numbers in context, the Investment Company Institute reported that in 2014, there were about $24 trillion of retirement assets in 401(k)s, IRAs, defined-benefit pension, and other retirement accounts. In the aggregate, then, it's likely that Americans need an additional 20% to 30% of investments for retirement.

It is hard to imagine that gap closing without increased access to workplace retirement plans. Although individuals who lack workplace retirement plans could, for example, fund IRAs on their own, few of them do it. Among those with a household income of $30,000 to $50,000, EBRI found that more than 70% participate in a workplace retirement plan when it is available, while less than 5% fund an IRA when a workplace plan is unavailable. Put another way, lower-middle and middle-class workers are 16.4 times more likely to save for retirement when they have access to a workplace retirement plan.

The lack of workplace retirement options particularly takes a toll on those who work for smaller companies. According to Jamie Kalamarides, head of Institutional Investment Solutions at Prudential and CEO of Prudential Bank & Trust, only about half of companies with fewer than 100 employees offer a retirement plan. This makes it hard to close the retirement savings gap, because nearly all of the country's net job creation occurs within small businesses, according to Kalamarides.

This lack of workplace retirement options can have a particularly large, negative impact on minorities. According to Bennett Kleinberg, who is a vice president of Prudential Retirement, a business unit of Prudential Financial, a study in California found that about 75% of Hispanic employees lack access to a workplace retirement plan. "Covering the Latino population is an important factor in meeting America's retirement challenges," Kleinberg says.

Why don't smaller companies offer retirement plans? Kalamarides said smaller employers usually cite concerns about costs, complexity, and liability. To address at least some of these issues, lawmakers from both parties would like to make it easier for smaller companies to band together to form a multiple employer plan, or MEP.

What Are MEPs Anyway? Functioning as a single plan, an MEP allows two or more employers to provide retirement benefits to employees on a consolidated basis--allowing them to offer retirement plans that are normally available only to larger businesses. In grouping together several employers, an MEP allows providers to spread out risk and cost--giving each employer a more manageable portion of the burden--while providing higher-quality retirement options. Effectively, MEPs are designed to provide such benefits by leveraging economies of scale. Businesses can use MEPs to provide retirement options as a group, despite not being related as controlled groups, trades/businesses in common control, or affiliated service groups. In essence, this is seen as a way to overcome retirement gaps that threaten small-business employees.

It is important to draw a clear distinction between multiemployer plans, which have attracted a lot of news coverage in recent years, and MEPs. Multiemployer plans are generally offered by companies with unionized workforces and collective bargaining agreements. By contrast, MEPs can be sponsored by employers that may not have the same sorts of relationships and without a collective bargaining agreement in play. However, the flexible nature of MEPs means that they fall under several regulatory rules that can complicate matters.

A host of IRS rules govern MEPs. These rules are sweeping in scope and, at times, unclear. The requirements can be split into three categories, as shown by the IRS: codes to be met by the whole of the MEP, codes for the MEP itself, and codes for each participating employer. The plan is governed by rules that determine things such as qualifications, eligibility, and vesting requirements. Meanwhile, each participating employer must meet requirements such as nondiscrimination rules. Some requirements fall under similar code sections, meaning that one portion of a code may apply to the plan, and another to the individual participating employers. As a result, MEPs and participants must meet a variety of standards at differing levels to ensure that the entire plan is not disqualified.

Effectively, MEPs allow small businesses to offer higher-quality retirement plans to employees, while avoiding unreasonable levels of risk and cost. However, the regulations covering these plans are still rather unrefined and in need of clarification.

So, Why Aren't MEPs More Popular? If MEPs can potentially solve so many problems for employers and provide a better deal for employees, then why don't more small businesses offer them? In a recent white paper, Prudential identified four main impediments to the widespread adoption of MEPs:

Tax Law All qualified retirement plans must comply with a variety of regulations, including fairness testing to ensure that the benefits of a retirement plan are not concentrated among the highest-compensated employees. Under current rules relating to MEPs, a single company's failure to pass the fairness test could imperil the tax status of an entire plan with dozens of participating companies--even if the rest of the companies met their compliance obligations.

ERISA The U.S. Department of Labor allows only companies with a "commonality of interest" to band together to form a retirement plan. The department applies this "commonality of interest" requirement pretty strictly, so organizations like local chambers of commerce cannot form MEPs, according to Prudential.

Fiduciary Liability Many small employers report that they are unwilling to offer any retirement plan, including a MEP, because of fears of litigation. Given that many small businesses lack robust balance sheets, it is no surprise that they shy away from potential fiduciary liabilities.

Enforcement The Labor Department has expressed concern that some operators of MEPs have cut corners on compliance matters, including forming MEPs with companies that do not meet the "commonality of interest" requirement. Phyllis Borzi, the department's assistant secretary of labor of the Employee Benefits Security Administration, has repeatedly said that she worries that operators of these so-called open MEPs will take advantage of small businesses and their employees by providing subpar offerings at inflated prices.

Congress Steps In? Although the Republican-controlled U.S. Congress seemingly cannot pass a budget or raise the debt ceiling with a minimum amount of drama, legislation to improve the regulatory environment for MEPs appears to have broad support. Kalamarides calls the MEPs legislation "the one retirement policy that [Congressional leaders] all agree on."

And indeed, bills to improve the regulatory framework for MEPs have received strong support. To take just one example, Sen. Susan Collins, R-Maine, and Sen. Bill Nelson, D-Florida, have introduced legislation to make it easier to form and run MEPs. Collins and Nelson's Retirement Security Act would allow unrelated businesses to band together to form "open MEPs," though the provision would apply only to companies with 500 or fewer employees. Collins and Nelson also propose directing the Department of Treasury to get rid of the "one bad apple rule," in which one company's failure to pass nondiscrimination tests could have tax implications for the entire plan. Sen. Orrin Hatch, R-Utah, introduced similar MEPs legislation in 2013, and as of this writing reportedly will reintroduce MEPs-related legislation sometime in 2015.

Legislation making it easier to form MEPs also got a thumbs-up from a bipartisan Senate Finance Committee working group that was tasked with finding bipartisan solutions to tax, retirement, and other issues. Senate Finance Committee Chairman Hatch and ranking member Ron Wyden, D-Oregon, appointed several groups of lawmakers to make recommendations for a potential tax overhaul. The group that focused on retirement savings, the Savings and Investment Working Group, theoretically could have recommended paring tax benefits for retirement savings. Instead, the working group recommended expanding retirement programs, including removing barriers to forming MEPs. In particular, the group recommended that Congress pass legislation allowing the formation of open MEPs.

The expansion of MEPs is promising, but has the time for such an idea come? In recent years, Congress has been visibly dysfunctional. For example: The two most recent sessions of Congress have been among the least productive in terms of number of bills passed. Congress has recently passed fewer than half as many bills as in the 1970s. One cannot be certain that any bill--even one that seems so needed and appears to have such bipartisan support--can be enacted.

Nevertheless, in our view it is likely that, in the coming years, MEPs legislation will move through Congress, as such legislation has a lot that appeals to both major parties. Republicans have tended to favor legislation rolling back regulations on business, while Democrats have supported policy experiments that broaden access to workplace retirement plans; the proposed MEPs bills would accomplish both goals. Here's hoping that Congress will overcome its dysfunctional ways and pass bipartisan legislation to improve retirement security for millions of Americans.

This article originally appeared in the December/January 2016 issue of Morningstar magazine. To subscribe, please call 1-800-384-4000.