The Ideal Retirement Plan for Your Practice
[Editor’s Note: This is a guest post from Konstantin Litovsky, a blog advertiser and the founder 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.]
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.
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 adviser 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 adviser, 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 adviser, 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 adviser (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 advisers, 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 Adviser (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 adviser 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.”]
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!