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Fix the Retirement Plan Gap for Small Employers

Few small businesses offer retirement plans to their employees. An October 2009 a study by the General Accounting Office reports that only 29% of businesses with fewer than 25 workers (which make up 65% of all U.S.businesses) offered a retirement plan to employees, according to data from the Census Bureau's Current Population Survey. A separate March 2010 study conducted for the Small Business Administration's Office of Advocacy by Kathryn Kobe shows that large businesses are more likely to offer defined benefit pension plans or to offer a choice of retirement plans to their employees.

The owners of small businesses themselves also have low rates of participation in retirement plans. A March 2010 working paper by Jules Lichtenstein of the SBA's Office of Advocacy, which draws on the 2004 Survey of Income & Program Participation, indicates that only 36% participate in IRAs, a mere 2% possess a Keogh plan, and just 18% own a 401(k) plan. His report also shows the odds that the smallest business—those with fewer than 10 employees—have a 401(k) plan is only 1-in-10, controlling for the effects of other factors.

Why Few Small Businesses Offer Retirement Plans

Few small businesses offer retirement plans in part because they offer fewer benefits of any kind to their employees. Many studies show that large businesses are more likely than small ones to offer health insurance, pension plans, and paid time off. But other factors are at play as well.

Two of the biggest are cost and complexity. The 2003 Small Employer Retirement Survey, a review of 300 employers with five to 100 employees, shows that 43% don't offer pensions because their financial prospects are too uncertain or because the plans cost too much to establish and run.

The per-employee cost of establishing retirement plans is high for small businesses, because these plans have a cost that is independent of the number of participants in them, the Kobe study explains. Much higher, in fact, according to a January 2010 Forbes article, which showed that the average 401(k) plan for a business with fewer than 100 employees cost four times that of the average plan for a business with more than 10,000 employees.

Another reason small businesses don't offer retirement plans is their complexity. Research by Peter Orszag and Robert Greenstein shows that the extensive rules and regulations governing retirement plans deter many small business owners from setting up these plans. Moreover, as Kobe explains, the need for the companies sponsoring these plans to adhere to substantial regulation and to accept fiduciary responsibility keeps many small business owners, who aren't experts on the regulation and can't afford to hire specialized retirement plan experts, from offering the plans.

What Can Be Done To Fix the Problem

Offering additional specialized retirement plans for small businesses probably isn't the answer. As Kobe explains, despite the existence of specialized programs for small businesses for many years, we have seen little increase in the proportion of these businesses offering retirement plans to their employees.

Making these plans less complex and burdensome on small business owners needs to be part of the answer. It's difficult to get anyone to do anything they don't understand, particularly if those actions involve undertaking a legal obligation. That's as true for getting small business owners to establish retirement plans for their workers as it is for anything else.

In addition, these plans need to be made easier to close down and change and cheaper to establish and manage. Too many small business owners report either that their revenue is too uncertain or too low or that the plans are too expensive. Unless these changes are made, the share of small businesses offering these plans is unlikely to increase.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

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