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Small firms' pension pitfalls

Too busy to scrutinize retirement plan details, some employers may get stuck with poor returns.

October 29, 2006|Walter Hamilton | Times Staff Writer

Bill Korth thought he was getting a bargain when he hired an insurance company to run the retirement plan for workers at Vernon's Maas-Hansen Steel Corp.

The family-owned steel supplier was paying a bank $30,000 a year to manage the plan, which now has 95 participants and $14 million in assets. When Principal Financial Group offered to do the work for no charge, Korth eagerly accepted.

Three years later, he wishes he'd left well enough alone. The company has found itself stuck with the bulk of its retirement assets in a poorly performing fund and handcuffed by restrictions that made transfers impractical, he says.

"There have been too many roadblocks that they didn't disclose to us," said Korth, Maas-Hansen's vice president of finance. "We have a reputation of taking care of our customers through thick and thin, and we expect the same treatment."

Independent retirement experts say the company's experience illustrates the challenges that small businesses face in running retirement plans. These plans often are complex, and unlike larger companies, small employers typically lack the time and expertise to understand their intricacies.

"It's a lot tougher for small employers because they don't have the resources," said Rick Blain, a 401(k) consultant in Orange County's Trabuco Canyon. "They don't know who to trust or who to go to. Their focus is on running their business."

Their size works against them in other ways. Vanguard Group, which made its reputation on low-priced mutual funds, generally won't manage corporate retirement plans with less than $10 million in assets, said Gerry Mullane, head of 401(k) sales at Vanguard.

Employees at small companies may consider themselves lucky just to have a retirement plan. Of the 66 million people who work for companies with fewer than 100 workers, only 32% have employer-provided retirement plans, according to the Employee Benefit Research Institute in Washington.

At the smallest companies -- those with nine or fewer workers -- only 15% have retirement plans. That contrasts with 70% of employees at companies with 1,000 or more workers.

Like larger employers, small companies typically farm out management of their retirement plans to mutual fund companies, employee benefit firms or insurance companies.

Retirement experts say there are advantages and disadvantages to each of those three options. Plans run by insurance companies, however, often are burdened by two features that critics say saddle workers with extra costs.

First, insurer-run plans are often structured as group annuities, which are insurance-based investment contracts. Insurers say group annuities benefit participants because they can easily be transferred to individual annuities upon retirement. But critics say group annuities are expensive and difficult to understand.

For example, the total fees that workers pay sometimes aren't listed in one place in the annuity contracts, said Parker Payson, executive vice president of Employee Fiduciary Corp., a 401(k) administration firm in Mobile, Ala.

Second, insurance plans are known in the industry for the lucrative commissions they provide to brokers, industry experts say. Mutual funds may also be sold by brokers, but insurers often pay full commissions upfront on multiyear 401(k) contracts -- a big enticement that mutual funds generally don't offer, said David Wade, president of 401(k) Direct Inc., a record-keeping and consulting firm based in Agoura Hills.

The promise of rich commissions can lead brokers to recommend plans that may not be the best for employees and time-strapped small-business owners, who usually are too busy to scrutinize the details, said W. Waldan Lloyd, an employee benefits lawyer in Salt Lake City.

"The insurance company holds all the cards," Lloyd said. "They are the financial sophisticate and know what they're doing. The small employer is just busy making widgets. He's relying on the person across the table who's selling him the contract."

The insurance industry rejects such characterizations, saying its broker-driven model provides top-notch service at fair prices.

"There are plenty of insurers getting 401(k) business in a competitive market going head-to-head with mutual funds, and I don't believe they'd be getting that business if they weren't providing good value for the prices they charge," said David Wentworth, vice president of research at the American Council of Life Insurers.

Korth has a different point of view.

Maas-Hansen, which sells steel to home appliance makers and furniture manufacturers, managed its retirement plan in-house until 2000, when Korth said concerns over stock market volatility and fiduciary responsibility prompted executives to seek professional help.

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