Workers with smaller employer-sponsored retirement plans who are saving just as much as those with larger plans could have around 9% less in assets at retirement due to higher fees, new research from Morningstar’s Center for Retirement and Policy Studies claims.
People who work for smaller employers and participate in small plans pay around double the cost to invest as participants at larger plans—around 84 basis points in total compared with 40 basis points at smaller plans, according to a Morningstar report released today.
Also, 35% of small plans cost participants more than 100 basis points in total, the report said. The small plan market also has many “outlier” plans that charge unusually high fees relative to their peers, particularly outside of the largest thousand or so plans in the U.S., Morningstar reported.
The size of a participant’s retirement plan is likely to have a much more significant effect on their balance size than even the investment selection their plan offers,” said Lia Mitchell, a senior analyst at Morningstar and the author of the study.
“In short, the U.S. system does not work nearly as well for people who are not fortunate enough to work for larger, established employers, the general sponsor profile for larger plans. The creation of pooled employer plans in 2021 cannot yet be fully studied, but they could help close this gap if there is sufficient and smart uptake,” Mitchell reported.
The distribution of total costs for small plans is also much wider than for larger ones, meaning any worker is much more likely to be in an expensive plan if she works for an employer with a small plan.
Meanwhile, the majority of DC plan participants are in larger plans and benefit from the lower costs of these plans, with 80% of participants in the U.S.’s defined contribution plans charging less than 80 basis points.
There are logical reasons for some of this cost dispersion, including the likelihood that new plans—which have little to no bargaining power— tend to be small and have investment minimums that potentially limit the ability to cut investment costs, Mitchell said.
Over time, new plans may be able to reduce costs through cheaper investment options, restructured administrative fees, or both, but by then the plan may have more than $25 million in assets and move out of the small plan range, Morningstar found.
“While investment minimums have come down, plans with fewer assets can still struggle to meet these, particularly if assets are spread across the full investment lineup, which can create a barrier to offering cheaper share classes.
“Nonetheless, not all small plans are expensive. Some employers with small plans report total costs that are competitive with larger plans. In fact, 24% of small plans cost participants less than the median cost for medium plans of 61 basis points,” Mitchell said.
Costs are coming down, but small plans are still twice as expensive as larger plans. “Despite investors paying less to invest than they ever have, even compared with just one year prior, the basis points saved are not shared equally by all DC plan participants,” Morningstar reported.
The larger the plan, the less expensive it is likely to be for participants to invest for retirement. Morningstar analyzed asset-weighted expenses associated with the plan, overall plan administration expenses and the total cost on a plan-by-plan basis.
“As is clear, in both regards, scale is an enormous advantage. While the median costs have dropped across all plan sizes, small plans remain on average more than twice as expensive as mega plans. The median small plan moved the needle slightly faster, dropping 4 basis points in 2020 compared with 2019, while medium, large, and mega plan total costs fell by 2, 3, and 1 basis points, respectively,” Mitchell said.
The struggle by smaller employers to offer low-fee investments partially motivated Congress to create pooled employer plans, or PEPs, to allow more small employers to pool their assets to achieve the economy of scale and negotiating power of large employers, she added.
While their impact needs to be studied, “PEPs have the potential to reduce fees for participants as these new plans grow. However, there will be challenges due to the complex structure of allowing multiple employers to operate in one plan. If there is a proliferation of PEPs without significant enough asset concentration to provide the benefits of scale larger single-employer plans enjoy, the benefits to workers could be muted,” Mitchell said.
In the meantime, however, lawmakers and regulators should be mindful that policy changes that target new plans are likely to have little or no impact, since they come and go and are often eligible for exceptions.
“Almost all of the plan-level churn in the retirement system is among smaller plans, which has significant policy implications. Plans with fewer than 100 participants accounted for 93% of plan terminations and 97% of newly created plans from 2012 to 2021. The high concentration of small plans, particularly among plans added to the system, can provide a guideline for the limitations of policy enacted only on newly created plans,” Mitchell said.
For example, legislation passed in December 2022 included a change to ERISA which requires newly-created 401(k) and 403(b) plans to put automatic enrollment in place starting in 2025.
“The intentions here are good (automatic enrollment can increase participation in retirement plans as inertia keeps some employees contributing who would not have even started participating if required to actively enroll), but there will be limitations to the effectiveness due to the termination of newly-created plans,” Mitchell added.
Since the vast majority of new plans have fewer than 100 participants, such policies will only reach a small segment of the workforce, Mitchell said.
The effect is even less since the law also provides exceptions to the automatic enrollment for new companies in existence for less than three years and small companies with fewer than 10 employees.
Over the 10-year period from 2012 to 2021, on average, 96% of newly created plans reported 10 or fewer eligible employees at the end of the first year, meeting the small-business exception, she noted.