By Konstantin Litovsky, Guest Writer
Your CPA informs you that profits for the year will top expectations, and that you should start thinking about using a retirement plan to shelter some of that income from taxes because you will be in the highest federal and state brackets. After doing some research, you find that there are two types of plans available for a small practice: a Safe Harbor 401(k) with profit sharing and a SIMPLE IRA.
Table 1. Summary of key provisions for SIMPLE IRA and Safe Harbor 401(k) with profit sharing. ‘Safe Harbor’ refers to the matching formula used by this type of plan.
401(k) vs. SIMPLE IRA
How would you go about selecting the right plan for your practice? Here are some rules of thumb that can be helpful:
- A SIMPLE IRA might be a better plan for your practice if (together with your spouse) you can contribute less than $40K a year (or ~$20K just for the owner) and/or the cost of 401(k) employer contributions is high (with less than 70% of plan contributions going to the owner and spouse).
- On the other hand, 401(k) with profit sharing might be a better plan if (together with your spouse) you can contribute close to the plan maximum (~$75K if both you and your spouse are under 50) and your 401(k) employer contribution is reasonable (with more than 70% of plan contributions going to the owner and spouse).
- If your practice has a large staff with nearly everyone participating in the SIMPLE, and/or you have highly compensated staff, the cost of doing a SIMPLE IRA might be high, so even if your 401k plan % to owner is lower than 70%, you might actually be better off with the 401(k) in that scenario.
The decision can be straightforward if you fit into any of the above scenarios, but what if you are somewhere in the middle? What if you can contribute the maximum, but your employer contribution expenses are relatively high? Being in the highest tax brackets might still justify selecting the 401(k) over SIMPLE despite the higher expenses. What you’d need to do first is to get a plan design illustration from the TPA that takes into account your practice demographics to see what your potential plan contributions and expenses would be. Once you have an illustration, your retirement plan advisor should do a 401(k) vs. SIMPLE IRA side-by-side analysis that takes into account your specific situation so that you can select the right plan for your practice.
Choosing a Retirement Plan Provider
After doing the analysis with your retirement plan advisor, you decide that a SIMPLE IRA is not going to allow you to save enough, and that you want a custom-designed 401(k) plan instead. Once you start looking around for a retirement plan provider for your practice, it does not take long to realize that plans offered to small practices are sold as a product rather than custom-designed for each practice based on your specific practice needs. When looking for the lowest cost option, small practice owners often opt for plans with lower recurring administrative fees, and end up paying significantly more than they anticipated over the long term because most of the cost is hidden in the asset-based fees charged for plan investments and services. Moreover, many retirement plan providers are large record-keepers which don’t have much interest in working with small practice retirement plans, so their service quality for small plans can be significantly lacking, and this will end up costing you money.
If you could get the best plan services for the right price, what would be the components of an ideal retirement plan?
#1 Highest Service Quality
Will your calls and emails be returned promptly, or will you have to wait for days or weeks to get an answer? How will your plan providers treat you after you’ve signed up for the plan? Will you have a direct line to your plan administrator and/or your plan fiduciary/investment advisor, or will you be dealing with layers of intermediaries? Just because you use a ‘low cost’ provider does not mean you should compromise on the quality of service.
#2 Open Architecture Service Providers
‘Open architecture’ means that a plan can be assembled using independent providers vs. ‘bundled’ plans which come with all of the services already integrated. Almost all bundled platforms make money from asset-based fees and you have no control over the quality of the service providers.
A typical participant-directed 401(k) plan will have a Third Party Administrator (TPA), a record-keeper and an advisor (who takes on the role of a plan fiduciary). You do not want your TPA to accept revenue sharing (which is a standard practice with bundled plans) because this makes them biased towards using platforms that carry high expense mutual funds that pay revenue sharing fees. Your TPA should also be independent of the record-keeper because any issues with the plan might be overlooked if your TPA works for the record-keeper.
Another reason to have the TPA separate from the record-keeper is because plan design is done by a single person, so just because you hired a large record-keeper does not mean that the person doing your plan design is experienced or competent. A large record-keeper usually specializes in working with larger, vanilla plans, and they have less expertise and interest in serving smaller plans (such as those for medical or dental practices), that require a lot more attention to detail and a customized approach to plan design. The key to having the best plan is to make sure that your plan is designed and administered by a competent team, so for the best results, select your TPA separately from your record-keeper, with the greatest care taken to select the TPA. There are plenty of open-architecture record-keepers that work with any TPA.
#3 Customized Plan Selection and Design
Which plan will work best for your practice? Should you start with a SIMPLE IRA or would a Safe Harbor 401(k) with profit sharing make more sense in your particular situation? When do you need to upgrade to a different plan design to allow higher contributions ($54k for a 401k plan in 2017)? Can a Defined Benefit /Cash Balance plan work for you? Instead of using a cookie-cutter plan design typical for large record-keepers, a customized plan design might work better for your practice, and can potentially save you significant money by minimizing your employer contribution while maximizing your own. If you’ve gotten a single illustration from your TPA (or worse yet, none at all), chances are it is not the best design for your plan. Have they considered any changes to your practice going forward? Have they used too aggressive a design so that any changes in your plan demographics (such as hiring an older employee) will make it top-heavy requiring you to make extra employer contributions to employees later on? A smaller practice might need a number of design iterations based on your practice demographics and potential future changes, so this is something to consider when working with your TPA.
#4 Fixed Plan Fees and Expenses
There is no reason to pay any asset-based fees for your plan. Small plans pay some of the highest asset-based fees, which will be a significant cost over the long term. The best way to avoid paying asset-based fee is to use open architecture providers who charge fixed/flat fees for their services, including investment advisors, TPAs and record-keepers.
#5 Low Cost Index Funds
There cannot be any compromise here – low cost index funds should be the only investments in your plan. Vanguard funds contain most asset classes necessary to build a globally diversified portfolio inside your plan. There is no need to pay more than about 0.15% on average for your plan’s investments. While some participants might want self-directed brokerage windows, this is not necessarily a good idea, since everything that you will ever need (about 25 funds across multiple asset classes) can be added to the plan investment lineup.
#6 Full Fiduciary Oversight
Your plan has to receive a minimum level of service that is necessary to help you and your employees achieve your retirement goals. You might be an investment pro, but your employees are not, so at the very minimum your plan needs the services of an ERISA 3(38) fiduciary (also called ‘investment manager’). An ERISA 3(38) fiduciary’s role is to select investments for the plan and to take full responsibility for investment selection. And ERISA 3(38) fiduciary can also create and manage a number of model portfolios so that plan participants can simply invest into one without having to worry about constructing one of their own. Your employees are definitely a lot less sophisticated than you are, so model portfolios can help all plan participants achieve better investment results.
#7 An Advisor (Fiduciary) to Put It All Together
Why is it so difficult to buy an ideal plan? For one thing, most companies that offer retirement plans specialize in working with larger clients, and smaller plans simply don’t bring enough revenue for them. Sometimes smaller plans are ‘loss leaders’ – they need to get many of them to turn a profit, so they engage in marketing tactics to bring in any and all plans without providing the right level of service to the smaller plans. Even when the right services are provided, the cost for small practice plans is usually high because of asset-based fees.
The biggest issue is that few if any of the companies offering retirement plans are working in your best interest. What is needed to get you the best plan money can buy is actually very simple: you need to be working with an advisor who always acts in your best interest so they will be looking for the best solution for you. If all of the above conditions are met, you too can have the best retirement plan for your practice cost-effectively.
[Editor's Note: If you have no employees (or your only employees are your spouse and minor children), selecting and managing a retirement is dead simple- just use an individual 401(k). If you have employees and you're sure you want to use a SIMPLE IRA, it's not a lot more complicated. But if you have employees and want to put away as much as you can, it's time to get some professional help. There are basically 3 types of firms involved in this–a TPA, a record-keeper, and a financial advisor–although occasionally two or even all three roles will be played by one firm . Mr. Litovsky's firm functions as the advisor. A (3)38 advisor has a fiduciary duty to the sponsor (you, the practice owner) as well as your employees. If you only hire a (3)21 advisor, the sponsor (you) still retains the fiduciary responsibility. Some WCI readers have chosen NOT to pay the additional costs of a (3)38 advisor OR a (3)21 advisor, figuring that if they just fill the plan with low-cost Vanguard index funds and target retirement funds, their risk of being successfully sued for breach of their fiduciary duty is awfully low. Like with all financial advisors, you want to do the math on the fees. An AUM based fee is not the end of the world, as long as the total fee is no more than you can get from a flat-fee advisor offering comparable service. Unfortunately, that's usually not the case, especially as the plan grows. As one of my financial advisor friends likes to say, “AUM fees are the best kind of passive income there is.”]
[Editor's Note: Konstantin Litovsky is the founder of Litovsky Asset Management, a wealth management firm that offers flat fee retirement plan advisory and investment management services to solo and group medical and dental practices. Konstantin specializes in setting up and managing retirement plans, including 401(k) and Defined Benefit/Cash Balance, and serves in an ERISA 3(38) fiduciary capacity. Remember that a SIMPLE IRA is not the same a regular old traditional IRA. Litovsky Asset Management is a paid advertiser and a WCI Recommended Practice Retirement Plan Provider, however, this is not a sponsored post. This article was submitted and approved according to our Guest Post Policy.]
What do you think? Have you instituted a practice retirement plan? What type did you select and why? How do you pay your TPA, recordkeeper, and advisor? Comment below!
Table 1 and the side-bar of ads are overlapping, creating readability problems on my machine. Can the table be re-formatted as an HTML table instead of a graphic file?
You can click the image to see just the image and thereby make it readable.
Sorry about that. I must have missed that in the editing process. Should be fixed now.
Konstantin, a question for you…
Do you find the 401(k) plan makes sense even when you’ve got, say, a high income business owner who wants to get the larger contributions for himself/herself but all employees are happy beneath the SIMPLE limits.
I.e., can a 401(k) make sense when only person who wants or needs higher limits is business owner.
I’m thinking about issue of essentially having business owner pay for more expensive plan to get a higher contribution limit for just one person, the owner…
That’s a great question. There is no blanket answer. Practice demographics often dictates whether a 401k is better than a SIMPLE, but a rule of thumb is that if the owner wants to max out and they can get a good design for the 401k plan, then a 401k plan is better. I typically do a side by side analysis/projection after getting an accurate illustration from the TPA to make that decision. It also depends on how good the TPA is. For example, I talked with someone just today, and they have a paychex 401k where profit sharing is done pro-rata, which is just plain bad and expensive. So provided you can get the best possible plan design from a really good TPA, the next step would be to do the analysis to determine which plan is better in a specific situation, including all costs, expenses and employer contribution. This type of analysis requires a lot more input from the business owner, and none of the providers I know would do it. I do it because as a fiduciary I can’t possibly recommend an inferior plan without doing the math and looking at different scenarios. It is often the case that a SIMPLE is a better choice, especially for dental practices with young owners and multiple higher compensated and older staff. So one size definitely does not fit all in this case.
A 401k is just a better platform because one can also add a Cash Balance plan to it, so this would be the set up for those who want to eventually contribute significantly more than a 401k plan allows, but this is not for everyone.
Very good post Konstantin. And although I hate to bring this up, as I am not trying to take away from your post there were no groups recommended to use when starting a 401K. Obvious, using a service such as yourself can be very helpful to people not wanting to learn what it takes to set up a 401K, but you did not mention specific options (I realize this was likely intentional). Through this website I was made aware of a company called Employee Fiduciary who helps set these things up. They are very low cost. They have an excellent set of funds. They are very helpful and have great customer service. I have no financial interest in this company but wanted to share that my experience with them has been very good.
One issue with guest posts written by financial professionals is they are unlikely to mention their competitors. Employee Fiduciary isn’t a bad option. I’m disappointed that there are only a handful of firms out there that seem to be doing this for small practices at anywhere near a fair price.
Just want to clarify one thing. EF and Vanguard/Ascensus are NOT my competition by a long shot. I have put together a list of two dozen record-keepers some of which are much better quality of service and also a very low price, and I personally have plans with Vanguard/Ascensus and had plans with EF before. They are a record-keeper, but both are too expensive (and not of the highest quality) for a record-keeper only platform, and do provide high quality TPA services. Also neither does pooled plans for a competitive price (Ascensus just doesn’t do pooled, and EF does them but for the same high price as the participant-directed).
My job as a fiduciary is to pick the best providers. I sometimes use Vanguard/Ascensus for larger group plans, so again, they are just one of the available choices. I often recommend other open architecture record-keepers that have better quality of service all around, and who can provide me (and my clients) with better pricing. So the reason I don’t mention a bunch of record-keeper is that without a good TPA and an ERISA fiduciary who knows what they are doing it is not particularly useful because retirement plans (unless they are solo 401k types) are really not something that I would expect the doctor/dentist to be able to run purely on their own due to their general complexity (especially the profit sharing and Cash Balance plans).
Thus I always recommend that a fiduciary should be at the top of the team making sure that all of the parts are working together and have the best quality and the lowest possible cost.
Well, if you view your competition as the fiduciaries and not the recordkeepers, who are your competitors? Also, have you published your list of 20 recommended recordkeepers/providers?
Sorry for the long reply, I do have strong opinions on this topic. I would not publish this list for a number of reasons:
1) Many record-keepers don’t offer their services directly to people and prefer to work through advisers.
2) Any arrangements that I make with some of the ones I work with can only be obtained by working through me. No kickbacks involved, I’m simply negotiating better pricing for my clients that is not available to others.
3) Some record-keepers might not be on my recommended list, but if we are overseeing their work, we would sometimes use them as a record-keeper only (such as Ascensus), even though some of them are doing low quality TPA work that I would not recommend.
4) My individual TPAs will not be well served if I go around recommending their competitors.
5) An individual doctor will have no way of evaluating what record-keeper will work for their practice, and just sending them off to a list of 20 is a dis-service, in my opinion.
6) I might be able to negotiate even lower fees for some plans on some record-keepers on top of what I’ve already gotten (and in the future), something that can save significant money, but something that is not possible for a single plan to do.
7) To maintain the best quality control, I prefer to be the one selecting a record-keeper. There is just too many variables to consider when selecting a record-keeper.
My competitors are the likes of Merrill Lynch and Edward Jones, as well as Fidelity (which tries to do everything in-house, at a significant cost too). They have the size and tons of plans, so most people will go to them first (and if you look at the number of plans, ML and the like still dominate the industry).
What we do is fairly unique. Most firms that try to do ‘all inclusive’ services are either not fiduciaries or they are rarely going to include all of the best components, and most charge AUM fees. Most plans offered by advisory firms are sold rather than custom-designed because they are not doing open architecture plan set up to select the best providers/services (since they have their own and sell their own services), and very few actually have the expertise or the interest to offer the best/lowest cost solution for a fixed fee. There are ERISA 3(38) fiduciary firms, but again most significantly overcharge, and their services are limited to investment selection. We do everything from the ground up, from provider selection/oversight to ERISA 3(38) for a very competitive fee.
In addition, we’ve built an expertise in very complex plans and in fixing older plans (as far as fiduciary/administrative compliance), something that is not true in general of most other firms offering complete retirement plan solutions.
As a fiduciary, I believe that while investments are important, there are many other parts of the plan that have to be selected and set up correctly, and that the best providers have to be selected. Someone has to put it all together, and it won’t be the plan sponsor or TPA/record-keeper. However much doctors/dentists want to set up DIY retirement plans, there is just no way that they can do all themselves, so the next best thing is to hire someone who can handle everything and do it as a fiduciary in their best interest (rather than as a bundle that always comes with higher cost and lower quality services).
When we set up our 401k we got a few options/quotes done. Employee Fiduciary was one of them and their pricing was low, but when I asked for different scenarios they didn’t know what to do, then they just stopped returning my calls and emails.
I may have just got someone new who didn’t understand all the instructions and outs, but I wanted a few different scenarios since we have a lot of employees and the profit sharing can get out of control.
I would definitely get a quote from them again and maybe even use them now as they have such low fees and I understand it all much better. However, the customer service and individualization of the plan was much lower than what I needed at the time at the time.
Employee Fiduciary and Vanguard/Ascensus are basically record-keepers. They are not going to spend time optimizing your profit sharing plan design, and they do not provide advice that’s necessary by some of the more complex plans (such as group practice plans).
To have the best plan you need the following:
1) An independent TPA who specializes in profit sharing plans (EF and Ascensus have barely several % of their plans that are profit sharing). All of our plans are profit sharing plans, or 100%, so we have a lot more expertise than they do in that regard.
2) An independent ERISA 3(38) fiduciary. Vanguard/Ascensus does not have one, and EF has a captive ERISA 3(38) that is a subsidiary (not an independent fiduciary) and that basically just selects some funds, and that’s all. The role of an ERISA 3(38) for a small practice plan is extremely important. Not only do they have a responsibility to select a low cost index fund lineup, but they also do many more things such as work with the TPA to optimize the design, engage ERISA attorney for the plan if such services are required, build and manage model portfolios for the plan, provide enrollment support, and serve as an adviser to the plan sponsor. None of which is fulfilled by an entity that you never get to talk to.
3) Open architecture record-keeper. While EF is low cost, there are lower cost record-keepers out there which are significantly better quality than EF. I prefer working with smaller ones because you get better service and often better pricing. Also, many record-keepers such as EF and Vanguard/Ascensus do not do pooled plans, which means they can’t do pooled 401k or even a pooled Cash Balance plan. For that you need to go elsewhere, hire other providers, etc. We are capable of using the same record-keeper for all of these types of plans, and also provide all of the necessary services cost effectively.
One thing to remember is this. A record-keeper such as EF or Vanguard/Ascensus will sell you a plan, but because they are not a fiduciary, they will not provide you with advice on whether the plan is a good fit for you, and you will never know whether your plan design is optimal, as well as advice on how to upgrade your plan (such as going from a 401k to a combo 401k/Cash Balance). Also if you have an existing plan there are just too many moving parts that require the attention of a highly qualified TPA, actuary, ERISA attorney and an ERISA 3(38) fiduciary. So my advice is to start with a fiduciary who knows how to put together plan cost-effectively, and the choice of the record-keeper, while important, is simply secondary.
Thank you for your comments on these topics. Very good info.
If you decide to use a 401(k), at what point do you have to start looking at the non-discrimination testing? I remember going through all of the testing of a 401(k) plan in a corporate environment and that many of the Highly Compensated Employees were restricted in the amount that could be contributed to the 401(k), often far less than the statuatory maximums.
As soon as you have an employee you have to look at it.
Big companies often do not have Safe Harbor plans because they can get away with it since they have many more rank and file staff than HCEs (and they can save money by giving only a small match). On the flip side, they have to do the testing every year. If you have a practice, and if you set up a 401k with profit sharing, your TPA will do the testing every year in order to maximize your contribution while minimizing employer contribution. Typically a cross-tested design is used (when it works out well) because in that case you get the most bang for the buck. A plain Safe Harbor 401k without profit sharing does not need to do discrimination testing, but I typically like a SIMPLE as a start up plan unless you can max out your 401k plan.
Great article. As usual, right on the mark. I agree with the comment at the end that it would be hard to get in trouble as having the Vanguard Target Retirement Fund as the default fund. Vanguard lets us automatically default into the target fund appropriate for the employee’s age. Can you imagine an employee suing because they were defaulted into a Vanguard Target Retirement Fund appropriate for their age? It has been our experience (over 10 years now) that the employees are thankful they have been defaulted into the Target Retirement Fund.The 401k is one of the biggest mistakes I see most practices make. In my view, the fiduciary responsibility for the practice owners is straightforward. We used the government’s website to come up with a detailed plan (checklist) to confirm this responsibility is being met. This includes free Vanguard videos, education packets, mandatory sign off on educational materials, and all of the other hot buttons recommended on the Department of Labor website. For my (financial) clients, and our private medical practice as well, I advise against a “brokerage window” because we want to encourage behavior that fosters success, and not trading individual stocks with the possibility of encouraging the gambling mentality. The most important mistake I see in my review of physician plans is that the administrator does not put the profit share and safe harbor money in early. Most of the plans I have reviewed wait until after the fiscal year to put in most of the money (profit share and safe harbor). Although that may sound trivial, I did a back of the envelop calculation that reveals this costs the typical participant 750k to 1m over their investing lifetime. Put the safe harbor money in as you go along, and as soon as practicable (within the regulations of the law) fund the profit share. Money invested earlier in the year—year after year—really adds up in a major way because you are earning money on your money throughout the year versus waiting until the end of the year. It takes a lot of prodding from many TPAs to get this done. For example, the S and P is up 11.49 percent year to date, and the practices that have been funding the profit share and safe harbor, have benefited from that return. Granted, in 2008 the converse argument could be made. However, investing is a game of probability, and most years the market is up—thus on average getting the money in earlier is better. Over an investing lifetime, this should prove advantageous.
I think I already replied to one of your posts in another thread, but I’ll do it again here:
1) TDFs are not appropriate for high earning doctors because they do not have control over the asset allocation. Selling stocks into a 10-15 year recession prior to retirement is not my idea of a good investment approach. It is not about being sued, it is about having an appropriate allocation. This has to be coupled with a strong education component (which you won’t get from a record-keeper) to make sure participants understand what their choices are. Group practice plans can afford to get really good education and advice so that the staff knows what to do, because many doctors are simply not knowledgeable enough about many aspects of retirement planning (not just investing).
2) There are just too many issues with retirement plans and doctors are not trained to deal with them. Reading a website won’t change things one bit. This is just my experience. While excessive fee lawsuits are not the biggest problem, administrative and compliance penalties are a lot more common, and when doctors try to manage their plans themselves, this is what happens. Hopefully hiring a good team to clean up their old plans can help.
Retirement plans, especially group practice plans, are not DIY. They are not designed for doctors to manage themselves. When they do so, bad things eventually happen. And it costs money to fix them. Especially for group practice plans I always recommend the same trifecta: independent TPA, independent ERISA fiduciary and an open architecture record-keeper (overseen by the TPA and ERISA fiduciary, not the other way around). You can’t trust a large under-staffed record-keeper to keep your plan in compliance AND to provide you proactive advice on what you can and can not do. This is never a good recipe, and nobody is saving any money by essentially driving blind. Not to mention that record-keepers won’t provide you with any advice regarding many other issues such as Cash Balance plans and how to fix fiduciary compliance problems.
So if you have a plain Safe Harbor startup plan for a small practice, going with just a record-keeper might be OK, but for a more complex profit sharing plan you absolutely must hire the right providers (ideally, flat/fixed fee compensated and working in your best interest at all times).
Gang,
Is there a centralized reference source that I can use to learn about this stuff? I’m trying to cobble together information from reading different sources but it’s challenging because I keep running into things I don’t understand. Very frustrating
Not only is there no centralized source, but I don’t think all the information you need is out there anywhere. If you’ve got a practice with employees, you almost surely need to hire some professional help to figure out how to structure the plan best to meet your goals. It is far more complicated than just getting an i401(k) for an independent contractor.
Actually, I will be reworking my current website so that it has all of the useful information in one place, and it will be up shortly. For now, my blog has lots of articles on this topic, several of which were originally published by WCI:
http://litovskymanagement.com/articles/
Group practice plans are very complex and many have radically different set ups, with each one having its own specific things to consider. If you have a specific situation you want to address, there is just so many things that have to be considered, so I’d be more than happy to review what you have.