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PERSONAL BUSINESS

12.4.98  
Figuring the Costs of a 401(k) Plan
You'll need to invest time and energy — and watch out for hidden expenses

The second of two parts

With U.S. unemployment a mere 4.6%, a 401(k) plan is no longer a dispensable frill if you want to hire good people. And these plans offer employers some tax benefits, too. Still, a 401(k) is hardly a free lunch. Running one means you'll incur certain expenses, even if you don't match your employee's contributions. And the psychological costs -- the time and headaches -- are almost as tangible.

In a plan for 100 employees, a company typically pays from $2,000 to $5,000 annually to an outside administrator (the low end of this spectrum is for bare-bones offerings, and the high end is for plans with such features as 24-hour, toll-free phone service). These costs cover a blizzard of federal filings, which require you to demonstrate that highly paid employees don't consume the lion's share of benefits and that enough eligible employees participate in the plan. Although outside administrators take a big share of this burden, you still have the chore of providing them with an abundance of material. E. Thomas Foster Jr., counsel for John Hancock Funds in Boston, says the fairness rules require that at least 70% of employees participate in a plan. These rules can be a real administrative headache. "The impact is actually greater than I expected," concedes Ted Kesten at Belmay Inc., a Yonkers (N.Y.) fragrance manufacturer that didn't pass the federal test one year. Kesten has had to work closely with an actuary and his accounting people to ensure compliance.

Why the fuss over fairness? Because Congress wants employers to encourage participation in a pension plan as a matter of public policy. Most employers have responded by matching employee contributions, a practice adopted by 80% of all small companies offering these plans, according to Jeff Close, a pension consultant with Spectrem Group in Connecticut. The matches range from 25 cents to $1 for each dollar that employees contribute and on anywhere from 3% to 6% of their earnings. That's a risk-free return of 25% to 100% given to your prized staffers, which ought to be irresistible. Other lures you can offer employees -- depending on how much you pay to your 401(k) administration company -- include multiple investment options, 24-hour account-information lines, and the option of borrowing against the account for big-ticket items and family emergencies.

DECISIONS, DECISIONS. Small plans usually offer at least four to seven investment options. Although that may seem onerous for a small employer, it illustrates the concerns that go along with offering 401(k)s: With too few options, you run the risk of becoming liable for bad investment choices; with too many options, employees can become bewildered. You're also supposed to provide educational materials to help workers make decisions. But, in practice, any decent 401(k) vendor will include these as part of the deal. And offering investment information to employees should be your top priority if you truly care about their financial fate. "You can have the world's greatest mutual funds. But if you don't have a strong educational program, at times of volatility people are going to throw in the towel," says Dawn Bennett, a financial adviser at Legg Mason Wood Walker in Washington, D.C.

The most likely candidates to provide 401(k) services are mutual-fund companies, brokerages, insurance firms, and consultants. In addition to services, pay close attention to your administrative costs and fees charged to your employees.

The latter are particularly nettlesome, because these fees don't always show up as a formal bill or charge. Instead, the expenses are deducted from the assets of the mutual funds in which your employees invest, which silently reduces their net return. There's nothing nefarious about this -- it's how all mutual funds make money -- but some make more than they should. Ask for the "expense ratio" of each mutual fund, and be skeptical if the number exceeds 1% of assets. The best index mutual funds charge as little as 0.18%.

And if your mutual-fund provider wants employees to pay a sales charge or "load" -- a commission that can cost up to 7.5% -- think about going elsewhere. You're bringing the fund guaranteed business, so a commission isn't warranted. In fact, competition within the industry is so keen that vendors will give you a break on prices if you ask. Belmay's Kesten says if he had to pay all the expenses of regulatory compliance, "I wouldn't have done it. The money managers absorb a lot of these costs."

The trick to minimizing aggravation is to select your plan provider carefully, and remain vigilant. The idea is to get a one-two punch out of your 401(k): Let the provider keep most of the headaches while you keep the best workers.

By Timothy Middleton in Short Hills, N.J.

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