Summer may be over, but your clients might still be thinking about jumping into a pool — a pooled employer plan, that is.

Historically, an individual employer — no matter how small — has had to set up and run their own individual retirement plan. Regulators and legislators have sought for years to ease this administrative burden by putting multiple employers together into one buying pool — thus offering potential cost savings and reduced legal liability.

Pooled employer plans (PEPs), created under the SECURE Act, have been the latest attempt to make 401(k) plans more accessible for small businesses. Rolled out on January 1, 2021, PEPs have gained attention among financial professionals and employers alike but have been off to a slow start. 

What are PEPs?

PEPs are an updated version of multiple employer plans (MEPs), which permit unaffiliated businesses to participate in the same retirement plan.

But with PEPs:

• There’s no requirement that employers share a commonality, such as being part of the same industry or professional organization.
  
  
• The “one bad apple” rule, in which all participating employers could bear responsibility if just one employer violates the rules and regulations of the plan, no longer applies.
  
  
• A pooled plan provider (PPP) runs the plan, requiring an ERISA 3(16) administrator and typically involving a discretionary investment manager under ERISA 3(38).

The premise (or promise?) of PEPs

Many smaller employers do not sponsor plans for a variety of reasons, including cost, fiduciary responsibility and administrative burden. But the extent to which PEPs resolve these concerns deserves a closer look.

PEP costs

One premise of PEPs is that they may be more cost effective because multiple employers pool their assets and can potentially achieve economies of scale. But are PEPs really more cost effective?

Consider:

• The costs of 3(16) administrative services and a 3(38) investment manager are already built into a PEP. Clients joining the PEP will have to absorb these costs whether or not they want these services. As a result, employers may wind up increasing cost by adding services they don’t really want or need.
  
  
• PEPs are subject to an annual audit and share the associated costs. If a plan is currently paying for an annual audit, pooling the expense can result in a noticeable cost savings, but it is not typically necessary for single-employer plans with fewer than 100 participants. Given that nearly 90% of all 401(k) plans have fewer than 100 participants, with a PEP, clients might be potentially sharing the cost of an expense that does not apply to them.

PEPs and fiduciary responsibilities

In a PEP, the planned pool provider, or PPP, will oversee or outsource some of these functions. But there are some caveats with these services that plan sponsors should understand.

• Joining a PEP does not completely remove the plan sponsor’s fiduciary liability, as they are still responsible for selecting and monitoring the PPP.
  
  
• As previously mentioned, administrative and fiduciary services are packaged together and cannot be separated.

Flexibility may be limited

Pooled arrangements can be restrictive, and control over investments is one of several reasons small businesses have not embraced PEPs, according to Cerulli Associates.

• There is often little or no flexibility when it comes to the investment menu, as the PPP or another 3(38) fiduciary makes the investment choices. These choices will ultimately affect participants’ retirement outcomes, so it’s important that plan sponsors are comfortable with the selections.
  
  
• Plan sponsors will have to consider which features they want to offer as there are differences among the offerings across PPPs (e.g., matching and different vesting schedules).

Options outside the pool with PEP-like benefits

While there are aspects of PEPs that make them seem compelling to plan sponsors, some of the appealing benefits — the potential for lower costs, reduced fiduciary liability and decreased administrative burden — already exist in single-employer plans, including:

• SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) -- An employer-sponsored retirement plan designed for employers with 100 or fewer employees. Participants in the plan can make salary deferral contributions into their account. Employers are required to make contributions for all eligible employees, either a dollar-for-dollar match of up to 3% of pay or a 2% non-elective contribution.  SIMPLE IRAs are not subject to the non-discrimination rules or annual filing requirements that apply to 401(k) plans including PEPs.
  
  
• SEP IRA (Simplified Employee Pension IRA) — Available to employers regardless of head count. With a SEP IRA, only the employer contributes to participant accounts. Contributions are capped at 25% of a participant’s compensation or the annually adjusted IRS limit, whichever is less. SEP IRAs are deemed to meet all non-discrimination tests and are not subject to the annual filing requirements that apply to 401(k) plans including PEPs.
  
  
• Starter 401(k) — For employers who do not sponsor a retirement plan and may appeal to small businesses that might otherwise have concerns about the cost and complexity of starting and administering a plan. These deferral-only starter 401(k) plans created under the SECURE 2.0 Act of 2022 are not subject to non-discrimination testing but must contain an automatic enrollment at a deferral rate of 3% to 15% of compensation, subject to IRA contribution limits. Employees can opt out.
  
  
• 401(k) — Available to all employers, the traditional 401(k) allows employees to direct some of their earnings to an individual account before taxes, or if choosing a Roth 401(k), after taxes. Employers can contribute funds even if employees opt out as well as match employee contributions based on the employee’s contribution rate. Employer funds can be tied to a vesting schedule. Plans must meet certain non-discrimination requirements and employers must perform annual tests to show compliance.

Plan sponsors can outsource fiduciary responsibility and reduce administrative burden without joining a PEP. Retirement plan providers, financial professionals, third-party administrators, payroll providers and others can team up to offer plans and take on most of the responsibilities — even the fiduciary duties. Fiduciary roles that can be outsourced may include a:

• 402(a) named fiduciary — This is the main named fiduciary and decision-maker for the plan and assumes most of the plan sponsor’s duties.
  
  
• 3(16) plan administrators fiduciary — The 3(16) fiduciary duties generally center on administration of the plan such as approving distributions, distributing plan notices and fulfilling reporting requirements.
  
  
• 3(21) investment advisor — Makes investment recommendations to the named fiduciary but generally does not exercise discretion or control.
  
  
• 3(38) investment fiduciary — Fiduciary with the authority to make investment decisions for the plan without needing approval from the named fiduciary. This includes selecting and monitoring the plan’s investment menu.

It’s important to note that outsourcing does not completely remove the plan sponsor’s fiduciary liability, as they are still responsible for selecting and monitoring the appointed fiduciary service providers.

More about PEPs and alternatives

While PEPs address some plan sponsor concerns, the “one-size-fits-all” approach may not actually fit your particular clients’ needs. That’s why it’s a good idea to compare the pros and cons of PEPs versus other solutions in the marketplace. Only leap into a PEP if it’s the best solution for both the participants and plan sponsor.

Read important disclosures