PEPs vs. 401(k)s: Understanding the trade-offs of pooled employer plans

At the end of 2019, pooled employer plans (PEPs) were established as a new and improved version of multiple employer plans (MEPs). Before the SECURE Act, MEPs faced limitations that hindered widespread adoption. PEPs were created specifically to address these issues. In a PEP, the fiduciary responsibility is transferred to a third-party pooled plan provider (PPP), unlike a single-employer plan, where this responsibility remains with the employer.

PEPs can help increase access to retirement benefits, but they have shortcomings compared to single-employer 401(k) plans. Although intended to reduce administrative burdens, plan sponsors still retain some fiduciary responsibilities and may face unexpected difficulties if they need to change or terminate a PEP. Despite the promise of lower costs, PEPs can introduce new audit expenses for small businesses.

While designed to offer a low-burden solution—especially for small to medium-sized businesses looking to streamline administrative and fiduciary responsibilities—PEPs come with fundamental trade-offs. This article reviews how PEPs may offer less control over flexibility, plan design, and investment options compared to single-employer 401(k) plans.

What are the disadvantages of a PEP vs. a 401(k)?

• Limited plan design flexibility: Employers often have less control over plan design features such as eligibility, vesting schedules, loan provisions, and more. This means participating companies are unable to customize these to meet their unique needs.    

• Limited or no control over investments: The PPP chooses the investment options and manages day-to-day changes for the entire pooled plan. Organizations won’t have the flexibility to choose what investments are offered to their employees. 

• Audit requirements for small plans: While single-employer plans with fewer than 100 participants are generally exempt from annual audits, PEPs are subject to an overall annual audit. The cost of this audit is shared among all participating employers, which can introduce a new expense for very small businesses that would otherwise not incur an audit if sponsoring their own plan.   

• Not easy to leave: Leaving a PEP can be more complex than leaving a single-employer 401(k). While employers can usually terminate their own 401(k) plans, in a PEP, the PPP holds the authority to terminate the entire plan. This means the employer’s only option is to cease participation. The employer can then move assets to a new plan (a "spin-off") or leave those assets in the PEP, both of which can be logistically challenging and require more work for the employer than a simple plan termination.  

• Ongoing employer fiduciary duties: Employers do not completely eliminate their fiduciary role. They must prudently select the PPP and continuously monitor the PPP to ensure its reasonable to continue participation in the PEP.

• Potentially limited education and support: Education and resources for plan participants are centralized with the PPP and may be limited for participating companies, reducing the likelihood of personalized service unique to each organization.

• Trustee work could get expensive: The cost of trustee services for a PEP is generally higher and more complex than for a typical single-employer 401(k) plan. The higher cost is due to the significantly increased scope, risk, and administrative complexity the trustee must manage in a PEP environment. This additional cost may be passed to the employer and participants.

• Increased risk of litigation: Litigation involving retirement plans typically focuses on very large plans with substantial assets. Joining a large PEP may increase the likelihood that the employer will at some point be part of a fiduciary breach class action lawsuit.

What are the benefits of a PEP vs. a 401(k)?:

• Offloading some fiduciary and admin responsibility: Significant fiduciary and administrative responsibility is shifted from employers sponsoring the plan to the PPP. The PPP takes on the legal responsibility for the plan's day-to-day operations, compliance testing, and annual reporting.

• Administrative simplification: The PPP prepares and files the annual Form 5500 for the entire plan, handles participant enrollments and distributions, removing these tasks from the employer, and ensures the plan remains in compliance with ERISA and the Internal Revenue Code. Note: plan recordkeepers may take on similar responsibilities under the service contract with the sponsor. . 

• Lower-fee audits: PEPs are typically large and have more than 100 participants, meaning that most will require an annual financial audit for Form 5500 purposes. The audit expense will be shared across all employers in the PEP, making the audit fee smaller for each as compared to those faced by an audit of a single-employer 401(k) plan. 

• Potentially lowered administrative costs: PEPS may be able to negotiate better investment fees and administrative costs due to their size, potentially lowering costs for the employer and the participants. 

Considering a PEP? Here are 9 questions to ask

Selecting a retirement plan vehicle can be confusing. An employer that does its due diligence upfront can prevent administrative headaches and costs in the long run. If considering a PEP, the employer can help assess its features and suitability by asking the following questions.

• 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? 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’re unbundled, employers need to determine if there will be additional costs to itor their employees and consider if the total fees are reasonable. 

• If the PEP is affordable, will it include the flexibility that you, as the employer, and your employees need?

• Can the PEP handle any features/benefits that are legally required to be protected (if you are merging your existing single-employer plan into a PEP)? 

• Are there any compliance or data issues with your plan (if you are merging your existing single-employer plan into a PEP)? PEP providers may be reluctant to add plans that have failed nondiscrimination testing or other compliance issues into the PEP.

• What tools and technological investments is the PPP making for its 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 running the PPP services?

• 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?

The bottom line: Know your options

Traditional 401(k) plans can offer greater flexibility and customization, even though employers are required to take on full fiduciary duties and potentially higher administrative costs. Choosing the right plan depends on your business's size, resources, and need for control over plan design. By carefully weighing these factors, employers can select a plan that best supports their employees’ financial futures while aligning with the company’s goals.

Human Interest can offer greater freedom and control over plan design and investments, and more flexibility around fiduciary services. Organizations considering a PEP should explore how a Human Interest 401(k) can meet their needs. 

• Improved freedom over plan design: When joining a PEP, organizations turn all plan design to the PPP, which determines vesting, eligibility, loan provisions, and more. They optimize for all companies in the PEP, not just yours. With a Human Interest 401(k), you’re in charge of creating a plan that best suits your organization and employees.  

• More investment choices: The PPP determines which funds your team can access and makes day-to-day decisions. With a Human Interest 401(k), you can choose from existing funds and have full control over the investments offered to your employees.  

• Transparent fees: Human Interest offers access to low-cost index funds and CITs with zero transaction fees.*

• Flexibility of fiduciary services: PEPs take on managing the day-to-day fiduciary responsibilities, but lack the breadth of options a growing organization may need. To assist our sponsors with the fiduciary burden associated with a single-employer plan, Human Interest offers select 3(16) services and the opportunity to select a financial advisor of its choice. 

Interested in converting from a PEP to a 401(k)? Want to learn more about starting a 401(k) today? Click here to get started.

* Applies to all transaction types. For non-rollover distributions, shipping and handling fees may apply to requests for check issuance and delivery.