PEPs vs. 401(k)s: What small businesses need to know
Designed to make it easier for smaller businesses to offer a retirement plan to their employees, as of January 1st, 2021, pooled employer plans (PEPs) are a new retirement plan option available from a limited number of pooled plan providers (PPPs). This article also compares PEPs vs. 401(k)s and other retirement plan options.
PEPs were established with the SECURE Act at the end of 2019 as a “new and improved” version of multiple employer plans, or MEPs. (Both are still on the market as well as several options for small business retirement plans.)
76% of plan sponsors say they’re “very unlikely to join a multi-employer plan (MEP) or pooled employer plan (PEP),” according to institutional investment consulting firm Callan’s latest Defined Contribution Survey, released in February 2021.
Why you need to know about PEPs
Many retirement industry experts believe that PEPs are likely to “grow in prominence” but time will tell if they end up living up to the expectation vs. other innovations in the retirement industry, including technology to improve 401(k) administration. Since PEPs are a new option for providing a retirement plan to employees, considering the pros and cons of a PEP vs. a 401(k) (or another single-employer plan) is critical.
PEPs are available to employers looking to start a plan or looking to switch from an existing plan. As an updated version of MEPs, PEPs are a new option for retirement plan sponsors to consider.
A bit about MEPs
- Designed to help smaller businesses benefit from economies of scale, a MEP is a retirement plan sponsored by multiple employers that are related by industry or region. In fact, MEPs often cost more to both plan sponsors and plan participants:
|Type of Plan||Administrative Expenses ($ per plan participant)|
Source: Shnitser, N. 2020. Are Two Employers Better Than One? An Empirical Assessment of Multiple-Employer Retirement Plans, Journal of Corporation Law 45(3): 743-786.
- Ideally, a MEP also makes it easier to offer a plan, by shifting some of the administrative burden of being a plan sponsor from the business to the MEP provider.
Keep reading to find out the pros and cons of group retirement plans, such as MEPs and PEPs, vs. a single employer plan 401(k).
How is a PEP different from a MEP?
Here’s how PEPs are designed to be an improvement over MEPs:
No more individual Form 5500s
- PEPs allow groups of employers to join a pooled employer plan, which is “considered one plan for the purposes of the Employee Retirement Income Security Act of 1974 (ERISA).” Thus, a PEP’s PPP would file “a single annual Form 5500 covering the entire arrangement,” rather than the individual employers in the plan each having to file their own Form 5500.
PEPs are less restrictive than MEPs
- They do not require employers to be related by industry or region.
- And there is no “one bad apple” rule, meaning, if one employer falls out of compliance, the entire plan can be disqualified.
Something to keep in mind is that, as a new offering, PEPs are almost certain to evolve, and because of their novelty, some aspects of PEPs are, in fact, still difficult to compare with well-established options like single-employer plans. The following benefits and disadvantages may shift in the coming months/years but here is the industry take so far…
What are the likely benefits of a PEP vs. a 401(k)?
PEPs may offer the following benefits:
- Offloading some fiduciary and admin responsibility: Significant fiduciary and administrative responsibility is shifted from employers sponsoring the plan to the PPP, though plan sponsors “retain fiduciary responsibility” for choosing and monitoring the PPP.
- Lower-fee audits (but higher risk of audits): In general, though they are more likely to be audited, any audit fees incurred by a PEP could be lower than those faced by an audit of a single employer 401(k) plan. And, the insurance provided by a PEP will likely be more comprehensive than that of a single-employer plan.
- Potentially lowered administrative costs: While yet to be seen, plan administration may be less costly as a result of pooling employers.
What are the disadvantages of PEPs vs. a 401(k)?
Employers have a fiduciary duty to their employees to find the retirement plan that’s best suited to the business and its team, and doing that due diligence up front can save both parties administrative headaches and money in the long run. Here’s what to know about PEPs:
- Uncharted territory: Services and fees are likely to evolve over the next 12 to 16 months, according to experts.
- Potentially unpredictable costs: Because administration fees could be based on the percentage of assets in the plan, they might be lower than a traditional 401(k) but also more unpredictable. It may depend on the other companies in the PEP with you.
- One size fits all: PEPs are not currently customizable; it’s the same design and same investments for everybody and, so far, PPPs are not offering individualized service.
- Recordkeeping for PEPs isn’t going to be any less expensive, as PEP recordkeeping will be akin to recordkeeping a bunch of individual plans.
- Costs shifted to employees: Employees could bear more plan costs, based on the way PEPs are currently structured. PPPs may want to adjust compensation for recordkeepers or investment managers, a cost that could be passed on to the employer or plan participants.
- Higher risk of audits: PEPs are more likely than single-employer plans to be audited, adding to the costs that may not be baked into the upfront terms.
- Trustee work could get expensive: PEP trustees will have a more involved role than those for a 401(k), which means that fees for their services could also expand. In particular, PEP trustees will need to work out a process for the what-ifs, like sending an employer to collections or getting taken to court. These are likely not baked into a PPP’s advertised fees, and, as PEPs are new to trustees, there is often no clear protocol.
Considering a PEP? Here are the 9 questions you need to ask
If you’re considering a PEP, start by looking at the current design of the plan you have, or list the plan options that are important to you.
Know that there are several different types of PEPs, depending on which party is acting as the PPP. Compare the benefits and features of this versus other types of retirement plans so that you can make sure you’re getting what you and your employees need.
- What is the level of experience of the PEP provider? And exactly what services do they offer?
- Is the PEP actually lowering the cost of offering a retirement benefit? Keep in mind: A PEP could include “additional services.” These could be valuable, for example, loan and hardship withdrawal approvals and oversight, compliance testing, and annual plan audits, but an employer will need to make this determination based on its and its employees’ needs. Some of these costs may already be factored into the costs of a single-employer 401(k) plan.
- Has the PEP bundled recordkeeping and third-party administrator services within the offering? (If they are unbundled employers need to determine if there is an additional cost to the plan sponsor and/or the participants. If there is an additional cost, will the employer need to pay more in administrative costs to keep fees reasonable for their employees?)
- If the PEP is affordable, will it include the flexibility that you as the employer and your employees need?
- If an employer is merging a single-employer plan into a PEP, will their employees protected benefits be offered in the PEP?
- Are there any compliance or data issues with your plan? PEP providers may be reluctant to take add plans that have failed non-discrimination testing or other compliance issues into the PEP.
- What tools and technological investments is the PPP making for their PEP platform? With a PEP, the plan design and investment lineup are chosen by the PPP instead of the employer. This means you would not be able to make changes to key aspects of your plan such as employee eligibility and your plan’s investment lineup. Be sure to request a demo to see what admins and employees will experience.
- Is there a retirement plan adviser specialist or TPA is running the PPP services? (There should be.)
- Will an employer be trading the ability to get support for the PEP’s efficiencies of scale? How will an employer access information and make changes? What about support for employees?
Given all this, it’s not surprising that some experts suggest “it might be wisest for sponsors to remain on the sidelines as the winning ‘shapes and flavors’ of PEPs emerge.” There are still some unknowns about PEPs vs. single-employer retirement plans that are important if you’re a small business. You can figure out what kind of administrative work a PEP is likely to save you, but it can still be hard to determine how much money a PEP might save (or cost) you in comparison to other options.
For smaller businesses looking to find ways of offering a retirement plan or improving on the plan they have, keep in mind there are other options besides PEPs — a 401(k) with Human Interest, for example — which can avoid lots of the current disadvantages of PEPs while still being affordable.
- Certain Human Interest plans take on significant administrative responsibility and liability, allowing us to serve as the plan administrator and 3(16) fiduciary.
- We’ll work with you if you’d like to be involved in plan design and investment lineup decisions. And if you elect to act as a 3(21) fiduciary, you can tailor your plan’s investment lineup.
- With our payroll integrations and automated technology, we take significant administrative work off your plate.
- We’ll work with you to set up a plan that meets your needs. For example, you can choose to have your employees eligible to participate right away or require them to work for a certain time period before being eligible.
If you’re considering a retirement plan for your employees but not sure where to start, we can help.
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.