Morningstar: Small-employer retirement plans need legislative fixes

Using 'open MEPs' and auto-IRAs might close the coverage gap and reduce plan costs.

Two fixes would go a long way toward solving the problems entrenched in the small-retirement-plan market, namely high costs and a wide coverage gap, according to a new policy paper issued by Morningstar.

Those tweaks—adopting legislation that favors “open multiple-employer plans” and automatic enrollment for individual retirement accounts—would help bring retirement plans such as 401(k)s for small employers more in line with the arrangements seen among large employers, the authors argue.

Open MEPs would allow employers to pool assets in one retirement plan. Auto-IRA programs would have private-sector employers offer a 401(k) or a workplace IRA, into which employees would be automatically enrolled.

While 91% of private-sector firms that employ more than 500 workers offer a retirement plan, only 67% of those with fewer than 100 employees do so, according to the Bureau of Labor Statistics. For those with fewer than 50 employees, it’s just 48%.

The issue affects millions of people, since roughly one-third of Americans work for employers with fewer than 100 workers. Experts have found that workplace savings plans are the most effective way to save for retirement.

SUBPAR PLANS

And, when small companies do offer plans, they’re often not as good as the plans of large corporations, since fees for investors in the smallest plans are almost twice as high as fees for those in large plans, according to a Morningstar analysis. That fee difference leads a worker at a small company to miss out on more than $100,000 in savings over a career, according to Morningstar.

“It’s predominantly a coverage problem. But it’s also a cost problem,” said Aron Szapiro, director of policy research at Morningstar. He co-authored the report with John Rekenthaler, vice president of research, and Jake Spiegel, senior research analyst.

So-called open MEPs and auto-IRAs have been in the public spotlight as ways to potentially address these persistent issues. A national auto-IRA program would mandate that private-sector employers offer auto-enrollment plans to employees, and would be largely hands-off for the employer, which would facilitate payroll deduction.

LEGISLATIVE ISSUES

California, Oregon, Maryland, Connecticut and Illinois have passed legislation to implement such programs at the state level, though they are hotly contested by Republicans and industry groups such as the Investment Company Institute.

Instead, the retirement industry has heavily promoted loosening rules around MEPs, which reduces administrative work and liability for employers while reducing costs to participants through scale. Policymakers have sought to eliminate a rule for MEPs that requires employers to share a commonality in order to band together. This would open up MEPs to more small employers.

Such a proposal was included in a bill—the Retirement Enhancement and Savings Act—that unanimously passed the Senate Finance Committee last year, but wasn’t taken up in the full chamber before the end of the congressional session.

“I think open MEPs are an inevitability and will happen maybe very soon,” Mr. Szapiro said.

Opponents of auto-IRAs among states have suggested open MEPs are enough to substantially close the retirement-plan coverage gap. However, Mr. Szapiro believes that offering open MEPs on their own wouldn’t lead to much new plan creation.

“Sooner or later we’re going to have these two systems operating in parallel,” he said.