[Editor's Note: This is a guest post from Konstantin Litovsky, a financial advisor specializing in small practice retirement plans. While this is not a paid post, he is a paid advertiser on this site.]
At first glance, the only difference between small practice and large company retirement plans is the number of participants. Everything else would seem to be identical – both plans have a Third Party Administrator, a record-keeper, a custodian, an investment adviser, mutual funds, contributions to employees and individual participant accounts. Despite the apparent similarities, small practice and large company plans cannot be more different from one another. Understanding how small practice plans are different from large plans is important for small practice owners because most plan providers specialize in working with large companies and they are not capable of addressing the full scope of issues that small practice plans will encounter. In this article, we’ll explain how small practice retirement plans are different from those of large corporations, and discuss a number of important issues, including the types of services a small practice plan needs and the criteria that can be used by practice owners to select the best small practice plan providers.
Small Practice Demographics
Small practice demographics can have a significant impact on plan design, and any changes in practice demographics can require changes to the plan design, which is not true for large company plans.
1) A practice with a younger owner and older employees or an older owner and younger employees might require two very different plan designs, and if a younger owner hires an older employee the plan might need to be redesigned.
2) Adding family members to the payroll can have a significant impact on small practice plan design and has to be taken into account, especially if this happens after a plan has already been adopted.
3) Bringing in a partner might require a plan redesign if both partners want to participate. Even if a partner does not want to participate in the plan, they will still have to share in paying the plan’s administrative expenses and employer contributions.
4) Employees working for small practices, particularly younger, lower-paid employees do not typically make 401(k) salary deferrals. For this reason, small practice plans (but not large company plans) have to be Safe Harbor and provide either a 3% non-elective or a 4% elective match to employees. If the practice owner wants to maximize their 401k contribution by adding Profit Sharing, this will not be possible without the Safe Harbor. Often, low participation will require a plan to have a 3% non-elective contribution vs. a 4% elective match.
5) Small practices might have high turnover, and this, too will have an effect on plan design. Practice owners can limit the expenses associated with high turnover by adding a 6-year graded vesting schedule. Any money forfeited in this way can be used to make employer contributions to all of the remaining employees.
For a small practice, failure to update plan design might result in the plan failing testing which can lead to significant IRS penalties if the matter is not addressed promptly.
Plan Design and Architecture
When selecting the best plan design and architecture, small practices will require a much more comprehensive approach than do large companies. Because practice owners will get the most benefit out of the plan, small practice plans will need significantly more customization and support to find and implement the best solution.
1) Owners might want to maximize their contribution ($53k in 2015) while minimizing their expenses. Most large companies will end up with a basic 401k with just the salary deferral ($18k in 2015) and possibly a small elective match, while small practices can benefit from having a customized 401k with Profit Sharing or a Triple Match design.
2) Small practices don’t have the resources to overspend on their 401k plan. To get the best design, a design study has to be performed to take into account practice specifics and to estimate the potential cost of the plan in terms of employer contributions and administrative expenses.
3) Many small practices might benefit from a pooled plan vs. a participant-directed plan, which is more appropriate for large companies. A pooled plan eliminates the need for a record-keeper, and you can open a single pooled account directly at Vanguard to get access to low-cost Admiral Shares. A pooled plan is often a better choice for a small practice because of significantly lower complexity and lower cost than a participant-directed plan.
4) When practice owners start the process of adopting a plan later in the year, they might miss the October 1st deadline for a Safe Harbor plan. However, it may still be possible to get a plan and make a full contribution for the year via a design called QNEC (Qualified Non-Elective Contributions). This is something that large companies will not be doing, but small practice owners can benefit from this option if the plan providers are able to move quickly.
5) Adding a spouse to the payroll (and having them perform services for the practice) can be another way in which practice owners can increase their plan contributions. If done correctly, this is not only legal but a great way to save money on taxes.
6) Many small practices will want to add a Defined Benefit or a Cash Balance plan in addition to a 401k plan to maximize the owners’ contributions. These types of plans are very complex, so before adopting this plan, a thorough analysis needs to be done to select the best plan design.
Large plans have different issues and concerns than do the small practice plans, and these issues are often addressed differently. Small practices have a wide array of tools available at their disposal, but the added complexity will require a much higher quality and scope of advice than is necessary for larger plans.
Part 2, running tomorrow, will discuss investment management, explain essential services for small practice plans and also offer recommendations on the criteria that can be used by practice owners to select the best small practice plan providers.
What retirement plan do you offer for your small practice? A 401(k)? A SIMPLE IRA? What problems have you run in to with it? What do you wish you had done differently? Comment below!