Small Business Retirement Time Bomb Ticks On

In what's being billed as the most significant advance in retirement plans in a decade, the U.S. Labor Department has finally cleared the way for employers to automatically enroll their employees in 401(k) savings plans without facing legal liability.

About 70 percent of employees voluntarily join 401(k) plans. The Labor Department ruling this week will let employers enroll the remaining 30 percent, who for one reason or another fail to join on their own. As significant as this step forward is, however, it will do little to ease the looming crisis.

The small business retirement crisis is a ticking time bomb that will explode over the next two decades as baby boomers start retiring in earnest. Perhaps, because it's still relatively far off, it isn't drawing as much attention as the small business health insurance crisis. But retirement savings plans are even less available than health insurance. According to one survey, 59 percent of businesses that employ fewer than 100 employees offer health care benefits. Yet only about 45 percent sponsor some type of retirement plan.

This grim situation is unlikely to change in the short term. A column I wrote in May, Small Business Retirement Crisis on the Horizon, reported on a wide-ranging survey by Transamerica Center for Retirement Studies. It found that nearly three-quarters (73 percent) of small businesses that don't offer a retirement plan are unlikely to add one in the near future.

Small businesses are a critical part of the retirement problem because they create as much as 80 percent of the nation's net new jobs every year. Thus, many young people are likely to start out working for a small business that doesn't provide a savings plan when they most need to start one. In addition, low-income workers, who are least likely to save for retirement, are also most likely to be working for small firms.

As a result we are on a course to become a nation of retired poor. At least 35 percent of baby boomers in their mid-50s to early 60s are not expected to be able to maintain their standard of living in retirement, and the percentage worsens for those who are younger, says Jim McCarthy, managing director of Retirement Plan Services at Morgan Stanley, who testified recently on Capitol Hill. Simply put, we aren't saving enough.

Congress, of course, has been well aware of the problem. Over the years, it has taken a number of important steps to make it easier for small businesses to offer savings plans. But significant barriers still remain, according to testimony at the House Small Business Committee hearing. Among those barriers, cost and complexity top the list.

Right off the bat, business owners must budget for startup costs to establish a plan and be ready to make contributions on behalf of employees. In most cases, business owners must also hire a consultant, financial adviser, and accountant to navigate the process. Often, that is not a "good value proposition," says McCarthy.

Once a plan is established, business owners must follow complex IRS regulations such as top-heavy and antidiscrimination rules, and a jumble of other red tape. And owners, in most cases, must assume fiduciary responsibility for the plan, which means they can be sued if anything goes wrong.

To deal with the problem, over the last several years Congress has developed the SIMPLE Individual Retirement Account (IRA) and the related SEP IRA. "Unfortunately, the very structure which makes the SIMPLE desirable also makes it less effective for ensuring retirement income security for retired small business employees," according to Paula A. Calimafde, who testified on behalf of the Small Business Council of America (SBCA).

With a SIMPLE plan, a small business simply goes to a bank or brokerage and sets up separate IRAs for eligible employees. The company makes contributions into IRAs without assuming any fiduciary responsibility. SIMPLE plans, however, contain restrictions that make them less attractive as a savings vehicle compared with 401(k) plans. For one, contribution limits are lower and penalties are higher for early withdrawals.

Calimafde says SIMPLE plans should be considered "starter plans." As such, she says, the SBCA opposes any effort to make them more competitive with 401(k) plans by enhancing their features or raising contribution limits. "In the long run, true retirement security for employees is better served by strengthening qualified retirement plans," she says.

The Bush Administration, meanwhile, continues to push for Employer Retirement Savings Accounts (ERSAs), which it first proposed as part of its FY 2004 budget, and has included again in its FY 2008 proposal. The accounts would be a stripped-down version of a qualified retirement plan. ERSAs would replace 401(k) plans, related plans for nonprofits (403b), government employees (457b), and all SIMPLE plans.

Small business owners are already facing a dizzying alphabet soup of plans, so any effort at simplification would be welcomed. The administration's ERSAs, however, have never been able to muster support in Congress. So the crisis continues. Today, people simply aren't saving enough for retirement. The most effective way for them to save has proved to be through employer-sponsored plans that allow for automatic deductions from paychecks.

Thus, the Department of Labor's decision to allow automatic 401(k) enrollment is significant. But it doesn't address the bigger problem. Only Congress can do that. It needs to make retirement saving a top priority. The time bomb is only ticking louder with each passing day.