The decision between a PEP and a single employer plan should be based on factors such as company size, desired level of customization, internal compliance capabilities, cost efficiency, and delegation of fiduciary responsibility for the investment and administration of the plan. This article provides an analysis of both options to help businesses determine the best path forward.

In addition, the article highlights a specific business structure that may benefit from the use of a PEP—private equity (PE) firms that hold a portfolio of companies.
 

Advantages of a Pooled Employer Plan (PEP)

A PEP allows unrelated businesses to participate in a professionally managed 401(k) plan, consolidating administrative responsibilities and fiduciary oversight of plan operations and investments under a Pooled Plan Provider (PPP) that serves as the primary fiduciary. (Businesses that join PEPs are called “adopting employers;” however, for ease of reading, this article refers to them by the common name “plan sponsors.”)

The PEP structure offers several advantages:

• Reduced Administrative Burden

A key benefit of a PEP is the ability to outsource plan administration. The PPP is responsible for most compliance-related tasks, including Form 5500 and 1099-R filings; nondiscrimination testing; approval of participant loans, distributions and other withdrawals; and determination of eligibility.

For businesses with limited HR or benefits personnel, the reduction in administrative workload can be important. Instead of managing service providers and ensuring regulatory compliance internally, a company participating in a PEP primarily focuses on monitoring the PEP’s overall performance.

• Lower Fiduciary Responsibility

A single employer plan requires that the plan sponsor act as the fiduciary responsible for prudent investment selection and monitoring, fee oversight for the investments and service providers, and plan administration and compliance. In a PEP, this fiduciary responsibility is transferred to the PPP and designated investment fiduciaries (e.g., the 3(38) investment manager selected by the PPP).

This shift reduces legal exposure under ERISA. In effect, the PPP replaces the plan sponsor as the fiduciary responsible for the selection and monitoring of the plan’s investment manager, and the PPP also replaces the plan sponsor as the 3(16) fiduciary for plan administration. While a company still retains responsibility for selecting and monitoring the PPP, the day-to-day fiduciary responsibility—and risk—is significantly lower than in a single employer plan.

• Potential for Cost Savings

PEPs leverage economies of scale by pooling assets from multiple employers. As a result, these plans can offer lower investment fees, and may offer reduced administrative costs.

For smaller plans—that wouldn’t need audited financial statements for a single employer plan—those savings may be offset by the allocation of a PEP’s accounting costs for its audited financial statements. In that case, plan sponsors should consider the total costs of participating in the PEP and decide whether the additional services and the transfer of responsibilities to the PPP as a professional fiduciary justify the cost.

On the other hand, larger employers who would need an audit for a single employer plan would likely benefit from just paying the lower allocated cost for a plan-wide audit. (For our purposes, a general definition of a large employer is one who will have over 100 participants.)
 

Disadvantages of a Pooled Employer Plan

While a PEP offers some advantages, there are trade-offs that should be carefully considered:

• Limited Plan Customization

A PEP operates under a standardized plan document and a single investment lineup for all of the adopting plan sponsors. This can limit flexibility in areas such as:

    -    Investment lineup
    -    Investment services
    -    Plan design flexibility

Almost all single employer plans offer a broad range of plan design flexibility. For example, safe harbor 401(k) plans, cross-testing to support larger contributions for the highly compensated employees, and a range of matching contribution arrangements.

On the other hand, some PEPs offer only a limited range of design flexibility to support straight-forward and low-cost administration. With regard to investments, those simpler PEPs may only offer a limited lineup of mutual funds for participant selection. A key benefit of the PEP is the ability to outsource plan administration. Where that straight-forward, low-cost approach is appropriate for a company and its employees, the PEP can be a good solution. Where more flexibility is needed, some PEPs are highly flexible for plan design and investments. For example, some PEPs allow brokerage accounts and even company stock investment options.

Where a business wants a high level of flexibility, though, the first option to consider is a single employer plan. The next step would be to see if there’s a PEP that offers the same flexibility at a competitive cost.

Of course, plan sponsors should always consider the quality and reputation of the PPP and the fiduciary protection that a PEP can offer for plan investments and administration.

• Limited Investment Control

Investment selection in a PEP is typically managed by a 3(38) investment manager designated by the PPP. While this reduces fiduciary responsibility for participating plan sponsors, it also limits control over investment options.

In addition to the examples above, a single plan arrangement could be a better option where the plan sponsor wanted to offer a broader range of investment choices to participants, for example, a real assets investment alternative or a real estate fund, or had other strong preferences about the investments, e.g., all index funds or all actively managed funds. The investment lineup in a PEP is usually limited to a set of 12 to 20 specific funds.

• Potential Cost Disadvantages for Some Plans

In some cases, a single employer plan may be less expensive than an available PEP. Where that’s the case, a single employer plan may be the better option unless a PEP would offer value to the participants that would offset the cost differential. To make this decision, a plan sponsor should consider the all-in costs of a single employer plan and the all-in costs of the available PEPs and compare that to the value offered by each option.

• Reliance on the Pooled Plan Provider

Since a PEP is controlled by a third-party provider, the quality of plan management is dependent on that provider’s performance. If a PPP undergoes leadership changes, increases fees, or experiences operational failures, participating employers have limited ability to make direct plan adjustments and may face challenges transitioning out of the arrangement.
 

Advantages of a Single Employer 401(k) Plan

For businesses that prioritize control, flexibility, and direct oversight, a standalone 401(k) plan offers distinct benefits:

• Full Plan Design Customization

A single employer 401(k) plan allows complete flexibility in designing plan features, including:

    -    Employer contribution formulas tailored to workforce demographics
    -    Flexible withdrawal policies.
    -    Optional provisions, such as student loan payment matches.


Companies that use their retirement plan as a strategic tool for talent attraction and retention may benefit from the ability to fully customize plan design.

• Investment Selection and Fee Negotiation

A standalone plan gives employers direct control over investment offerings and expense structures. This may enable a plan sponsor to:

    -    Negotiate for lower cost share classes of mutual funds with lower expense ratios.
    -    Customize the investment lineup based on employee demographics or company values.
    -    Incorporate specialized investment options, such as self-directed brokerage accounts.


For businesses with significant plan assets, the ability to leverage bargaining power for better pricing could result in long-term cost savings.

• Direct Relationship With Service Providers

In a single employer plan, the business maintains a direct contractual relationship with recordkeepers, advisors, and third-party administrators.

This provides:

    -    More control over vendor selection and plan changes.
    -    The ability to replace underperforming providers.
    -    The ability to negotiate for lower costs for plan recordkeeping services (and renegotiate as the plan assets increase).


Companies that prioritize direct oversight and accountability may find this structure preferable to a PEP.

In a single employer plan, the business maintains a direct contractual relationship with recordkeepers, advisors, and TPAs.

Disadvantages of A Single Employer 401(k) Plan

• Higher Administrative Burden

Unlike a PEP, where administration is largely outsourced, a single employer plan requires a plan sponsor to handle:

    -    Service provider oversight.
    -    Investment selection and monitoring.


For companies without benefits personnel or that are thinly staffed, managing these responsibilities can be difficult and time-consuming.

• Increased Fiduciary Responsibility

A single employer plan places the full fiduciary responsibility on the employer, requiring careful adherence to ERISA and its regulations, investment monitoring, and compliance management.

Failure to properly oversee plan investments or ensure reasonable fees can expose a business to fiduciary liability and government investigations.

While some companies mitigate the investment risk by hiring investment advisers or 3(38) investment managers, these services add additional costs. Similarly, fiduciary risk for plan administration can be partially offset by hiring a 3(16) fiduciary administrator, which can also involve added costs. In both of those cases, the plan sponsor must prudently select and monitor the adviser, manager or administrator.
 

PEPs and their Value to Private Equity Firms

In some cases, a PEP can offer other advantages. One example is for PE funds, where a fund can own controlling interests in multiple companies. In that case, the fiduciary exposure and the administrative cost can be better managed by having the portfolio of companies adopt the same PEP.

For example, the investment lineup selected by the PEP’s 3(38) professional investment manager should reduce the risk of a claim for imprudent and overly expensive investments. And, in any event, if there’s a claim or lawsuit about inappropriate investments, it would be against the 3(38) investment manager (and possibly against the PPP for a claim that the PPP failed to prudently select and monitor the 3(38) manager). In other words, the primary claims (and perhaps all of the claims) wouldn’t be against the portfolio company or the PE firm.

As another example, the administrative responsibility would also transfer to the PPP who’s acting as the PEP’s 3(16) fiduciary administrator.

And yet another example is that, to the extent that the portfolio companies are under common control or affiliated, the single PEP structure would facilitate the coverage and discrimination testing that would need to be applied to those companies.

As this discussion illustrates, the full potential of PEPs has not been fully explored. As there’s more experience with PEPs, new opportunities and solutions will undoubtedly surface. 

Concluding Thoughts

For plan sponsors seeking a low-maintenance plan with the transfer of most fiduciary responsibility, the right PEP can be a compelling solution. However, for companies that prioritize customization, investment control, and maximum flexibility, a single employer plan will likely be a better fit.

In both cases, though, plan sponsors should consider the costs for both PEPs and single employer plans and compare that to the value offered by each. There isn’t a formulaic answer. It depends on what’s right for the participants and the employer, and, of course, the cost and the value.