WCI is 10 years old this Spring and we're now on our third 401(k). It's been a long and winding road. Our first 401(k) was a simple, cookie-cutter Vanguard Individual 401(k). And when I say “our”, I mean “my”, since I was the only one working here and the only one contributing to it. It certainly served my purposes.
When I gave away half the company to my dear wife, she also started contributing to this individual 401(k).
When the Tax Cuts and Jobs Act was passed and the 199A deduction was born, our financial situation was such that it no longer made sense for WCI to make tax-deferred 401(k) contributions on our behalf. The Vanguard plan wouldn't allow us to do Mega Backdoor Roth IRA contributions, so we had to look elsewhere. We had staff members at that time, but they were all still independent contractors, so, with Mark Nolan's help at mysolo401k.net, we simply restated our individual 401(k) into a customized individual 401(k). The money itself moved from Vanguard to Fidelity. The new individual 401(k) came with the additional benefit of being a true checkbook, self-directed 401(k). We never got around to taking advantage of that particular feature, but we did our Mega Backdoor Roth IRA contributions each year with it.
Fast forward to 2020, we were hiring like mad and our general counsel said we could no longer justify telling the IRS that our staff members were independent contractors, not employees. Most of the new ones we hired as employees anyway, but we made plans to transition the rest to employees starting in 2021. That brought up three challenges to solve:
- We could no longer use an individual 401(k). If you have any eligible employees besides your spouse, you need a real 401(k).
- Our staff members who were previously independent contractors with their own individual 401(k)s didn't want to lose the ability to make the large contributions to retirement plans that they were currently doing.
- We promised the new hires the world's best 401(k) starting in 2021.
The Process of Creating the World's Best 401(k)
So we embarked on a process that took us most of six months. We started by reaching out to folks on our recommended retirement plan list. While we eventually had to decide on just one, we were very pleased with the input and assistance we received from others on the list. The reason it took so long was that I was very picky. I really did want the world's best 401(k). Let me define what I mean by that:
- The lowest possible costs for the employees
- The lowest reasonable cost for the employer
- All expenses possible to be paid by the employer as business expenses
- The best possible investments
- Excellent default investment options
- Easily automatable investment process
- Automatic rebalancing process
- Automatic enrollment (opt-out, not opt-in)
- Automatic increase in contribution rate
- Roth Contributions
- 401(k) Loans
- The ability for every employee interested to max out the account ($58K/$64.5K for 2021)
- A true self-directed account, at least for owners
- The ability to do after-tax contributions
- The ability to do inservice withdrawals/rollovers
- The ability to do in-plan Roth conversions
Unfortunately, we were not able to get every single item on my list. But we got 11 1/2 out of 16, which wasn't too bad, and we can live with and work around all of the others.
- The lowest possible costs for the employees
- The lowest reasonable cost for the employer
- All expenses possible to be paid by the employer as business expenses
- The best possible investments
Excellent default investment optionsEasily automatable investment processAutomatic rebalancing process- Automatic enrollment (opt-out, not opt-in)
Automatic increase in contribution rate- The ability for every employee interested to max out the account ($58K/$64.5K for 2021)
- 401(k) Loans
- Roth Contributions
A true self-directed account, at least for owners1/2- The ability to do after-tax contributions
- The ability to do inservice withdrawals/rollovers
- The ability to do in-plan Roth conversions
Why couldn't we get them all? Well, it turns out it was mostly Vanguard's fault. We began by talking to the retirement plan providers to see what was possible to do with this wish list. They found it immensely challenging. None of them had ever tried to accomplish all this in a single retirement plan. Numbers 13-16 were particularly challenging. In order to get even some of them we had to give up a few items. Actuaries, third party administrators (TPAs), custodians, and advisors went back and forth trying to figure out how to give us most of what we wanted. Some, such as Vanguard, told us they simply could not customize to the level we wanted. We actually could have had 5, 6, 7, and 9 with them as the custodian, but they weren't willing to give us 14 too, which was the most important feature for Katie and me.
Employee Input, Compensation, and Education
Early on in the process, we had to go to our staff members and ask them what they really wanted. That meant we had to educate them right along with us about what was really possible in a 401(k). We also helped them to recognize that their compensation package all came out of a single pot. We asked questions like:
- Do you want more in salary or more in retirement account contributions?
- Do you want more in health insurance premiums or more in retirement account contributions?
- How much do you really want to contribute to a retirement plan?
Within legal limits (and there are many), we then designed their employment contracts around their desires for the form of compensation they most valued. It turns out that in this company (surprise, surprise) the employees highly value the ability to reduce their taxes, protect their assets, and grow their investments through the use of a retirement plan. We even discussed putting in a cash balance/defined benefit plan (DBP). However, the employees really didn't want to put enough into it to justify the costs, and Katie and I had no interest in it given the negative tax arbitrage it would involve for us due to the 199A deduction. (DBP contributions reduce ordinary business income and thus the 199A deduction, so we were looking at saving only 29% on the money going in and then paying 37% on the money coming out).
Once we knew how much they wanted to put into the plan each year, the actuaries could run the numbers. It still took them a long time to understand that my goal as the owner, apparently unlike most business owners, was not to screw the employees. Once they realized it was not a problem for me to make additional contributions into the retirement account on behalf of the employees should the law so require, solutions were found. Trust me when I say most TPAs have no idea how to design a 401(k) so every person in the company can get $58K into it each year despite some not making all that much more than that.
The 401(k) Plan We Created
We ended up selecting iQ401k (a Division of FPL Capital Management) to run our plan. We've known the guys from FPL for a long, long time. They've been sponsoring the blog for years and have sponsored every single WCICON. They even send us King Cakes. We know they're not afraid to be creative and that they understand the importance of keeping costs low. Naturally, being able to say “We do the 401(k) for The White Coat Investor” has a certain amount of marketing value to it. So we asked for and received a bit of a discount on our fees. But I think they deserve every bit of publicity they get from this. They did a bang-up job putting this all together and are still working hard to make this the world's best 401(k).
They normally work with Vanguard Retirement Plan Access (VRPA) as a custodian, but had to shift when VRPA couldn't handle the Mega Backdoor Roth IRA contributions. We ended up with a more laborious/cumbersome plan for all involved (us and FPL), but we did get the features that were most important to us.
Okay, let me brag for a bit about this cool 401(k) we all created together. We'll again use that list of my desired features.
Employee Costs
There are no mandatory costs to the employees aside from the expense ratio on Fidelity index funds. These generally range from 1.5 basis points for their Total Stock Market Fund to 12 basis points for their Fidelity Freedom Index Funds (the equivalent of Vanguard Target Retirement Funds).
Employer Costs
The costs are reasonable for the business and the lowest of the quotes we got (still several thousand a year, of course).
Pre-Tax Dollar Plan Expenses
All plan expenses are paid by the company using pre-tax dollars (it's a business expense). We spend so much time and effort getting money into retirement accounts, why would you want to pull it out in order to pay fees with it, especially when you can already pay them with pre-tax dollars?
Investment Freedom
The custodian is Fidelity, so the plan allows us to buy anything available in a 401(k) at Fidelity and then some. This is a bit of a two-edged sword, but I'm confident my staff can handle it. You see, they can buy Tesla stock, triple leveraged ETFs, and all kinds of other investments that never show up in a typical 401(k). Laws don't permit them to short stocks, buy options, or buy on margin. Fidelity doesn't let you buy their Zero index funds in 401(k)s either. But other than that, if you can buy it in a brokerage account, you can buy it in this 401(k). That means ALL of the following is available:
- Fidelity Index Funds
- Vanguard Index Funds
- Vanguard ETFs
- iShares ETFs
- DFA Funds
- Schwab ETFs
Pretty hard to complain about that fund line-up, eh? The access to DFA funds is because of FPL being a “DFA-approved” advisor, not every Fidelity 401(k) gets that. All ETF transactions are free. Unfortunately, neither Vanguard nor DFA funds are on the Fidelity no transaction fee list. In our particular 401(k), Vanguard fund transactions carry a $30 commission and DFA fund transactions carry a $10 commission. So that's a little quirk our staff will have to work around. Basically, if they want to use traditional mutual funds they can just use the Fidelity line-up. If they really want Vanguard funds (or prefer ETFs), they have the entire Vanguard line-up available. To minimize commissions, they could even invest in the Fidelity funds all year long and then transfer into Vanguard or DFA funds once a year. If you can't construct a decent portfolio out of this line-up, you really need some help. Speaking of help, our staff can also go to FPL for assistance with their portfolios and asset allocation. All included.
Default Investment Options
With a typical recordkeeper like Vanguard (VRPA), we could have set up default investment options such as Target Retirement Funds. But we couldn't get the flexibility we wanted, too. So we let this one go. A lot of our staff members are just fine with the cash account being the default option anyway, but we figured we could work around this one with good education.
Automation
One thing we had to give up was an easily automatable investment process. Fidelity will let you set up “automatic buys”, but only for mutual funds and only after you've purchased them once. It only lets you set them up as dollar amounts, not a percentage of what is contributed, but it's better than nothing and I think some of our staff will choose this option.
Rebalancing
Likewise, we don't have an easily automated rebalancing process in the 401(k). Frankly, everyone in the company has multiple investing accounts already so they can't really use this benefit, but it would be nice to have.
Automatic Enrollment
Automatic enrollment is more an HR function than it is a 401(k) function, but our automatic enrollment is 6% of salary going into the 401(k). Since this is a discussion we have while putting together their contracts, we certainly have the process in place. I mean, we might have the highest 401(k) participation rate of any company in the world. Not only are 100% of eligible employees contributing, but 100% of employees plan to max it out. And not just at the $19,500 limit. At the $58,000 limit.
Automatic Annual Contribution Increase Option
Retreats? The world's best 401(k)? No wonder these WCI staffers are all smiles.
Best practice for a 401(k) is to have the option to increase your contributions each year automatically. It's a nice feature to have, but it's hard for our staff to increase contributions beyond maxing out the account. Again, I think this is a feature that the typical FPL/VRPA plan has, but it just isn't useful for us at this stage of the company.
Maxing It Out
Now we're getting into the really cool aspects of this plan. As mentioned above, this involved everything from how we write our contracts to the calculations done by the actuaries. With a company this small, how much you contribute can affect how much others can contribute, so we all had to work together in order to make sure everybody could max it out. But it's definitely a priority for all of our staff members at the present time. As the company grows and more people become eligible for the 401(k), it could cause issues with the calculations, but so far so good. Speaking of eligibility, you have to be at the company for a year before you become eligible, unless you were employed as of 1/1/2021. So all of our independent contractors turned employees became instantly eligible.
401(k) Loans
I basically wanted every feature possible in a 401(k), including 401(k) loans. Unlike IRAs, you can borrow from a 401(k)—the lesser of 50% of the balance or $50,000. The terms are a little better than they used to be, since if you separate from the company you now have until the next tax day to pay the money back, rather than just 60 days, as the law used to be. A 401(k) loan isn't something I would make a habit of using, but it's nice to have it available if you need it. Like borrowing against your cash value life insurance or your taxable investing account, you don't need good credit or a bank's approval to do it.
Roth 401(k) Option
This was actually ridiculously easy. We told them we wanted a Roth 401(k) option and they gave it to us. If your 401(k) still doesn't offer Roth contributions as feature, call HR and tell them to get out of the stone age.
BrokerageLink
There are really three kinds of 401(k)s. Most of you have what I call a “typical 401(k)“. This contains a line-up of mutual funds you can choose from.
The second type is sometimes available in a nice 401(k). It basically gives “advanced investors” the opportunity to opt-out of the fund line-up and access a brokerage window where they can buy whatever stocks or ETFs they want. At Schwab, they call this PCRA—Personal Choice Retirement Account. My clinical partnership 401(k) offers this for an additional fee. At Fidelity, it's called BrokerageLink.
The third type is a true self-directed 401(k), one you can use to buy the property down the street, physical gold, Bitcoin, etc.
Our 401(k) is the second type. However, even private investments can be purchased in the 401(k), so long as the fund has a CUSIP number and is “on the list” at Fidelity. Two of the three private real estate debt funds we invest in are on the list, so this will give us the opportunity to move that asset class into a tax-protected account, which will help us with our asset location issues.
Mega Backdoor Roth
A really important feature for Katie and me was the ability to do a Mega Backdoor Roth. We definitely want to max out our retirement accounts, but it doesn't make sense for us to do tax-deferred retirement contributions from WCI due to losing the 199A deduction. In order to do that, we needed to be able to make after-tax (not Roth) contributions. In this plan, we can contribute $58K in after-tax money. So I did. That leaves my employee contribution available to be used in my other 401(k). Interestingly enough, we learned that there are two separate tests that must be done on the 401(k) to ensure the non-highly compensated employees aren't getting hosed. One is done on pre-tax “profit-sharing” contributions and a separate one is done on after-tax contributions. Unfortunately, this means Katie and I have to decide to either give her a raise this year (and pay the associated Social Security taxes), or not max out her 401(k). We're still trying to decide whether it's worth paying another $8,000 in Social Security taxes in order to get another $25,000 or so into a Roth 401(k) instead of investing it in taxable. It might make sense in the long run, but it's going to be a long time to break even. #firstworldproblems
Roth Conversions
The other requirement to do a Mega Backdoor Roth is to be able to convert those after-tax contributions immediately into a Roth IRA. There is no tax cost for that, since there was no deduction for the contribution. Voila! A “$58K Roth IRA”! Cool right? Well, there are two ways a plan can allow the conversion. The first is to roll the money out without separating from the company. Our plan allows this.
In-Plan Conversions
The second way to do a Mega Backdoor Roth IRA is to do an in-plan conversion. Our plan allows this, too, and in fact, this is what I did since I have more investing options (although similar asset protection in my state) in the 401(k) than my Vanguard Roth IRA. One little phone call to Fidelity and I had done our 2021 Mega Backdoor Roths. That was even easier than with our last plan.
The Bottom Line
We have an awesome new 401(k). It costs us more than the old one, but there was no getting around that now that we have employees. If you're in the market for a 401(k) and have employees, this is no longer a do-it-yourself project. Be sure to check out iQ401K and our other recommended retirement plan providers. There are also people on that page that can help you with a true self-directed individual 401(k).
What do you think? Are you jealous of our awesome new 401(k)? Ready to come work for WCI? Have you put a 401(k) in place for your company or group? What features did you want in it? Comment below!
Love this 401K, and yes it is awesome and I am totally jealous! LOL
Can you post the approximate costs to the business? Even a range would be very helpful.
https://www.whitecoatinvestor.com/iq401k/
I reached out to iQ401k and they quoting me minimum annual fee of $2500 for ERISA fiduciary and $1,650 for TPA. Does your plan have a TPA?
All medical/dental plans should have a TPA. This is not just to make you spend money, but this is because if you want to make profit sharing contributions or don’t want to be the in-house HR all by yourself, TPA is a must. Record-keepers that perform basic TPA functions can sort of do some of this, but they will be inefficient, not nearly as responsive, and they’ll make you do a lot of things yourself that a TPA can help you with. They will not provide you with advice, whereas a TPA can provide you with valuable advice regarding your plan design and administration. They also rarely if ever take care of compliance and compliance issues, and if there are any mistakes, TPA is the best entity to handle those.
Yes. iQ401K arranged it all for us.
This is a really great post- and I would love to see this used as a template to implement strong 401ks at other companies. It’s interesting to think about the adjustments or trade offs you might have considered had you had 100 employees, or 1,000, and they were not all able to be gung-ho savers.
There would have definitely had to be adjustments.
Great write up. Honestly, for those of us considering starting something, I really appreciate the leg work.
Was curious which of the debt funds have a CUSIP number?
Thanks!
DLP. Arixa.
Nice work…
Question… My dental practice (15-ish employees) has a 401k plan. I added my spouse as an employee and we contribute her full 19.5k. I am considering also doing employer contribution for her as well (or possibly Mega back door Roth). Is there a limit on what we can contribute based on income? (ie. can her employer contribution exceed her income? which we have set at around 22k). I’ll need to check on fairness testing as well… Any other pitfalls to share?
The employer contribution could, but the total compensation still has to be reasonable for the work done. MBDR contributions have to come from her income, so they can’t exceed her income.
Fairness testing is where you’ll run into issues.
There is little chance that after-tax will work. However you can still convert tax-deferred assets to Roth inside your plan via ‘in plan Roth rollover’. This does not require any testing to work. You can also convert as much or as little as you want to Roth inside the plan.
Employer contribution plus salary deferral can not exceed her W2, but she can potentially max out with ~$60k in W2 income (full employer contribution in addition to $19.5k in salary deferrals, $58k total), as long as total employer contribution for the practice does not exceed 25% of payroll, and in cross-tested plans this can sometimes work, but not always.
A master piece. We wanted to promote good behavior and therefore did not allow loans or individual stocks. The biggest mistake I see is people keeping the money in cash and not getting it invested. Be careful with adjusting Katie’s salary based on tax savings. Pay her fair market value for her work. If that costs $8,000 in taxes, you are simply following the letter and spirit of the law. The 29 percent going in for the DBP vs 37 percent going out is an interesting calculation. The 29 percent would grow a lot, and the 37 percent won’t come out all at once. Jim Lange has some calculations on that concept. Major kudos for what you have done for your employees.
It’s not an issue of her not getting paid enough to appease the IRS. There’s a pretty wide range of what is reasonable for a “blog executive”.
Impressive. I particularly like the employee consultation. I suspect most employees would choose free drinks in the kitchen over some of the more esoteric stuff that gets funded by employers, for example. Also the 100% participation rate suggests good hiring decisions were made!
One of the best things about the consultation was educating the employees about their great benefit. Our employees had a DB plan and only complained that they could not have access until retirement! Not one thank you! My fault
You’ve put together a really great plan! Just be careful with your default fund as you continue to grow. A money market fund does not meet the Qualified Default Investment Alternative (QDIA) rules, which means you, as the plan sponsor, have fiduciary liability for the selection of investments for any participant that does not make an affirmative investment election.
One last feature the best plans have that you might want to investigate is loan continuation. When a participant terminates employment, they can continue to repay loans via ACH debit rather than having to repay the entire loan by tax day.
https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/default-investment-alternatives-under-participant-directed-individual-account-plans#:~:text=A%20QDIA%20must%20be%20either,contributions%20directly%20in%20employer%20securities.
Are those still proposals or are they active rules now?
The final QDIA rules became effective in 2007 and follow what you posted. The vast majority of 401(k) plans now use target date funds as their QDIA, but balanced funds and managed accounts are ok too.
Well, we can implement that, but it would have to be somewhat manual for each new employee.
It looks like you don’t really need a QDIA in your set up. It sounded like you picked an official QDIA that is money market (which means all participants will get a QDIA notice, etc). If that’s not the case, you don’t need to do it then. This is mostly for fund menu plans with lots of non-sophisticated staff that need to be placed in a specific investment.
I’m not sure I follow your comment. A money market fund cannot be a QDIA, and therefore, does not provide 404(c) protection. If the participant fails to make an affirmative investment election, the plan sponsor is liable for the investment. With a small plan with lots of hand holding by the plan sponsor, this may not be a big deal, but it’s not a risk I would be willing to take as a plan sponsor.
I agree, but it does not appear that they can set it up at the plan level. For example, if everyone has a self-directed brokerage accounts, then QDIA is moot – can’t have it at all since everyone is self-directing.
“So how do we protect WCI from liability for “abandoning our fiduciary duty” to our employees by letting them buy whatever they want? We make them sign a release. That was the fastest document we ever got signed in the history of the company. I guess if there had been anyone who didn’t want to sign it we would have just had FPL construct an interface to give them the “dumbed down version” of the 401(k).”
I don’t believe this release will work as intended. Plan sponsor fiduciary duty can’t be abrogated, regardless of what employees sign. Under Federal law the employer is always responsible for plan investments and for oversight of options offered to participants, this is a continuous duty. I would consult an ERISA attorney, but I’m sure they’ll say the same thing. If it was this easy, every plan sponsor would have employees sign such releases, and we wouldn’t be having an avalanche of ERISA lawsuits. Not that the risk is high for a small plan, but for larger group plans it is always better to set up a simpler/less sophisticated plan to avoid unnecessary risk. Smaller partner-only groups can definitely use some advanced features such as MBR 401k with after-tax especially if they also have a non-PBGC Cash Balance plan that limits their PS to 6%, but for most groups, tax-deferred Roth conversion is the best approach.
Also, there is no way to give some participants one set of features and other participants another set of features, as that would violate benefits, rights and features under ERISA. All features, good and bad, have to be available to everyone. Another reason to keep the set up as simple as possible for larger group plans with staff.
As far as SDBAs (self-directed brokerage accounts), I’ve written on this topic here:
https://www.whitecoatinvestor.com/how-to-best-group-retirement-plan/
Rather than offering a free-for-all SDBAs, it is a good idea is to offer SDBAs that are ERISA restricted (which means they are set up with extra set of features that allow higher degree of control by the plan sponsor), and to review investments in these SDBAs periodically. Especially for larger group plans, SDBAs should be restricted because if they are not, investments that are not ERISA compliant can be bought without any limits, subjecting all partners in the group to unnecessary liability. There is no reason to utilize complex options strategies in a retirement plan either, and ERISA restricted SDBAs have the ability to turn off things like that.
I second Jeff’s concern above regarding QDIA.
“A QDIA may be:
Life-cycle or targeted-retirement-date fund;
Balanced fund; or
Professionally managed account.”
This is definitely a very unique plan setup and this is probably not going to work for a typical medical/dental practice given how different their demographics and needs are.
“I would consult an ERISA attorney, but I’m sure they’ll say the same thing. If it was this easy, every plan sponsor would have employees sign such releases, and we wouldn’t be having an avalanche of ERISA lawsuits. ”
We did consult with an ERISA attorney before providing this document to plan sponsors/plan participants. In fact, we have consulted with an ERISA attorney regarding all aspects of our ERISA retirement plan offerings.
I’m a bit confused as to the nuances between #’s 12 (Roth contributions), 14 (The ability to do after-tax contributions) and 16 (The ability to do in-plan Roth conversions). Aren’t these different ways to acheive the same thing?
If I am a super-saver and practice owner who has made a decision to simply contribute after tax dollars rather than pre-tax dollars at this point because I think I’ll be in a higher tax bracket in retirement, which of these features would allow me to do this? We have a 401k in place currently with a PCRA that I use, and I could always ask about adding one of these options… but not sure what the difference is.
BTW I would still want to do a backdoor ROTH each year if possible.
Just being in a higher tax bracket is not good enough. You contribute at your highest marginal brackets, say 37%. In retirement even if you are in a 37% bracket, if your net income is just barely in the highest bracket, your average tax rate on withdrawals will be as low as 27%, so you will have a tax rate differential available to you. Yes, taxes can go up, but in order for your tax rate to be the same as highest marginal bracket, your net income has to be a lot higher than $1M so that more of your income lands in the 37% bracket. So if you will no longer practice in retirement, it might not be that easy to land in the 37% tax bracket.
Yes, you can convert both after-tax and tax-deferred to Roth. For QBI purposes, after-tax is better, but if that’s not in play, both achieve the same goal. For you it would most likely make sense to do in-plan Roth conversions, but those are best done when you are in lower brackets. However, if you are sure your income will be in the millions in retirement, you might as well convert now.
One way to get a big Roth IRA in retirement is to potentially use a Cash Balance plan for the purpose of getting a lot of money into it that is tax-deferred, and then moving that money to your 401k plan on termination, and then converting it to Roth. Taxable is fine as well, but having a big Roth can be a good idea if you retire in high tax bracket.
In addition, you definitely do not need to use a self-directed brokerage for Roth conversions! Many good record-keepers are able to track Roth conversions in-plan whether after-tax or tax-deferred, so you will simply need to add the ‘in-plan Roth rollover’ option to the plan document and request the right forms to do it. The conversion itself is done pro-rata from all of your investments, you can’t just convert one specific investment, and your service provider has to do it for you.
Both features.
You can do a Backdoor Roth IRA.
You can do Roth employEE contributions ($19.5K if under 50) and
You can do Mega Backdoor Roth IRA contributions (after tax contributions plus either in plan conversions or in service withdrawals to a Roth IRA)
A word of caution on in-service withdrawals. If this is after-tax contributions, there is just no way you can do this because of pro-rata rules stating that you have to take pro rata after-tax and tax-deferred assets (and you can’t pull out tax-deferred assets prior to age 59 and 1/2). So unless you are 59 and 1/2 and your plan allows in-service distributions starting at that age, there is really no way for you to move after-tax money into Roth IRA from a 401k plan.
401(k) plans which record keep pretax and after-tax contributions separately do not need to distribute between both buckets on a pro-rata basis. Any earnings in the after-tax bucket would have to be withdrawn pro-rata, although you could rollover the pretax to a traditional IRA and the after-tax to a Roth IRA. Almost all plans that allow traditional after-tax contributions allow for after-tax withdrawals. Conversely, Roth 401(k) contributions are subject to the same withdrawal restrictions as pretax 401(k) contributions (hardship, age 59.5 or termination of employment).
That’s also my understanding. Employer contributions are also limited.
While it is rare to see it, there is a way to access employer contributions while still employed. You can draft a plan document to allow inservice withdrawals of match and profit-sharing contributions under the 5 year, 2 year rule. Participants with at least 5 years of plan participation can withdraw their match or profit-sharing balance at any time for any reason. Match or profit-sharing contributions which are at least 2 years old could also be withdrawn at any time for any reason.
That is correct, however, believe me, people still try to take after-tax from their 401k plan and move it to Roth because they read that it can be done without understanding the fine points. The only time you can do that is when they reach 59 and 1/2, that’s my point.
Can you cite chapter and verse on that one?
https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans
Specifically this (and I also confirmed this with several people familiar with the process):
Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:
-pretax amounts to a traditional IRA or another eligible retirement plan, and
-after-tax amounts to a Roth IRA.
Here’s an article from Fidelity on point. It all comes down to whether the recordkeeper is separately tracking the different contribution type buckets. While a pro-rata share of the earnings on any after-tax contributions (post 1986) must be withdrawn, there is no requirement to pro-rate across the other contribution buckets.
https://www.fidelity.com/viewpoints/retirement/IRS-401k-rollover-guidance
This falls under exactly the same rules I mentioned above, there is no difference in any way. Simply, you can take a portion of your after-tax contributions provided there is a gain. Why would anyone keep after-tax in their account rather than immediately convert it to Roth? That’s not likely to happen if whoever is doing after-tax understands the purpose (unless in-plan Roth conversions are not allowed, which can potentially happen with some plans).
Here’s the relevant line:
Now I don’t know who to believe, but I do generally believe IRS.gov over Fidelity. I guess it comes down to whether they’re referring to all the money in the plan or just the money contributed to the after-tax subaccount.
This is say the same thing said differently. They are just saying that to account for pro-rata, enough tax-deferred money has to be rolled out to compensate.
Once again, it comes down to whether the recordkeeper separately accounts for your 401(k) bucket and your after-tax bucket. As long as they are recordkept separately, only the earnings in the after-tax bucket would apply. The 401(k) bucket remains untouched. Here is a recent article from the Ed Slott group explaining the difference.
https://www.irahelp.com/slottreport/more-after-tax-plan-contributions
I’m confirming that IRS allows this, neither of the two articles mention the source of their information. In this case it would most likely have to be the TPA that does these types of calculations, not all record-keepers have the ability to track even after-tax vs. tax-deferred to Roth conversions. Short story is, if after-tax is contributed, convert right away, and to minimize any issues down the road, avoid rolling it out, regardless of what the rules are, just to keep things clean. Allowing these complex transactions to proceed without oversight and limitations can end up creating unnecessary administrative and compliance errors, so keeping things simple is the best way to go.
Well that’s interesting. So all those people out there doing Mega Backdoor Roth IRAs from their corporate 401(k)s to an outside Roth IRA must not have any money in pre-tax accounts in the plan.
Yes, that is what’s going on. Worse, some advisory firms are actually encouraging it, and some TPAs are not stopping them. There are writings on the internet saying you can do it (without explaining the details that pretty much prevent them from doing it). Or they explain how to do it, but in a very narrow case of solo 401k plans
With solo 401k plans, if all you have is a Roth plan (no safe harbor, etc), then after-tax to Roth IRA can be done. But only if your whole account is Roth, which is really easy to do if you are not doing any PS, just Roth deferral and after-tax. This is the exception. For corporate plans, not so fast. I actually submitted a post to Jill explaining this because I want to make sure that those with corporate plans are aware that after-tax to Roth IRA rollover probably won’t work for them in most cases unless they are able to convert everything else that can’t be rolled out before age 59 and 1/2 (which includes Safe Harbor match) in the plan to Roth or they are 59 and 1/2.
This is why it is important to use a good record-keeper vs. SDBA so that they can track money types and make sure that all transactions are done properly, which would also require good TPA to oversee plan administration and compliance to catch any mistakes as record-keeper by itself is not always able to track things correctly (which I’ve seen happen as well, requiring corrections after the fact). With SDBAs it can become a big mess as participants do all types of wrong things with their accounts without any oversight, subjecting the plan to compliance risks as this goes on over time, and no amount of education is going to fix this. Eliminating the opportunity for mistakes is the only way this can be done long term.
I found the source for the claim that you can use just the after-tax account and ignore the rest. Even if record-keeper is able to track it, I don’t believe this is as credible as people say it is. The source for those claims can be found here on top of page 17:
https://www.irs.gov/pub/irs-prior/p575–2019.pdf
It is an obscure and old example that is not even in the 401k section, but in a section on annuities. The problem is that IRS also said the opposite here on page 8 where they affirmed that all tax-deferred sources have to be considered (which is arguably a more recent example):
https://web.archive.org/web/20130418062238/http:/www.irs.gov/pub/irs-tege/rne_fall08.pdf
So I would definitely recommend consulting with a Tax and/or ERISA attorney before trying to take after-tax distributions out of your 401k plan into a Roth IRA, and not assume that this a given. At the very least I’d like to see a written legal opinion on the matter, as none of the articles refer to original sources or IRS for that matter, which is highly suspicious given that IRS on its webpage explicitly says the opposite.
Sounds like a gray area.
In our case, I don’t think it matters much. Only someone who wants a true self-directed Roth IRA instead of the somewhat self-directed Roth 401(k) we’re already offering them is going to care. Our plan is good enough that nobody is really asking to roll money out to an IRA.
You didn’t say if your plan allows roll-in from traditional iras. That was the magic feature of my 401k that let me do backdoor roths.
Yes, we allow that too. Thanks for pointing it out.
I like your plan, except for this part: “you have to be at the company for a year before you become eligible.” I can see a waiting period for employer contributions, but why not let new people contribute their own money right away? You’re dooming them to higher-than-necessary taxes for the first year they work for you (unless I’m reading that wrong).
The difficulty with automating investments is kind of a pain as well, but I could make it work.
Reading this made me want to come work for you (maybe only part-time for the first year).
Unfortunately it does not work like that. Once you are eligible to join, you are eligible to receive employer contribution. The problem is if you are an HCE, if you come into the plan immediately, you come in as an NHCE. As an HCE you are eligible for limited employer contribution (usually at the discretion of the employer if there are only HCEs employed). If you enter as an NHCE, you are eligible for potentially large employer contributions. Some practices allow partners to come in immediately as NHCEs, but they are responsible for potentially large contributions for them. Also, NHCEs can wreck certain plan designs, and can mess up after-tax contributions as well. So this is a decision each plan sponsor has to make and it quite often depends on demographics, and in this case waiting for a year will make the entry into the plan clean without unduly interfering with set-up.
A valid criticism. The main reason we did it was the problem outlined by Kon, it screws up how much those already at the company can contribute.
It was also a little sneaky that we deliberately made someone’s hire date a few days after the date that all prior employees (who were contractors the day before) were grandfathered in. But the new hire was well aware of it when we hired them and otherwise compensated appropriately. Plus we already established precedent with our new hires last year who weren’t eligible (so Katie and I could use your i401(k) for 2020).
As I mentioned in the post, it’s really tricky to allow all your employees and owners to get $58K into the plan as either pre-tax or post-tax contributions as they desire. All the contractors (who’ve been with us for years) could put $58K into their i401(k) last year and it was really important to them to be able to do it even after becoming employees. So that was a big priority as was Katie and I being able to do $58K post-tax contributions. We couldn’t also let new employees have access and make all the testing work.
Besides, in this business people aren’t worth nearly as much to the business their first year as their second, so maybe the 401(k) design just acknowledges that and incentivizes them to stay a long time. We do allow their match/profit-sharing etc to vest immediately though.
Jim,
On behalf of FPL Capital Management, I would like to thank you for selecting our retirement plan platform (iQ401k) to design the ideal 401(k) plan for White Coat Investor staff. We also appreciate the kind words. I know the whole design process took some time, but we believe we designed a plan that caters to all your needs (well almost all). We look forward to working with you and WCI for many years to come.
Virajith
Thanks also for sponsoring the conference. It’s been a really great couple of days here in Salt Lake. I miss seeing everyone in person but it’s a heck of a conference that Chrislyn and Katie have put together here!
Chrislyn, Katie, Cindy, and staff have been very helpful. Hopefully, we can have WCICON 2022 in person.
Yes, we hope so too since we put down six figures toward it this week at the hotel! It would really stink to lose that deposit!
Always glad to have you on board.
Hi Virajith,
I am setting up a new 401k and WCI suggested I direct this question to you (see comment below)- who does WCI use as TPA for their 401k? Who ultimately designed the plan? Also, what is FPL’s role? Kind regards,
No idea if they’re following this. You might want to just give them a call tomorrow.
Hello Jesse,
TPA for WCI Plan is Farmer & Betts (https://www.fbpension.com/). Farmer & Betts ultimately drafted the plan docs, but the designing process was a collaborative effort that included WCI, FPLCM, and Farmer & Betts. FPLCM is the ERISA 3(38) Fiduciary responsible for creating and maintaining the Plan’s investment menu (funds and and asset allocation models). We also provide participant services relieving Plan Sponsors/Employers from these responsibilities. If you have additional questions, please shoot me an email or give us a call. Happy to hop on a call.
Virajith
awesome Jim your employees will be very happy. do you guys need to hire a neurologist? 🙂 did you think adding the 401k loan feature is actually a negative? Is this something you saw an advantage to yourself or employees, despite the potential catastrophic pitfall of not being able to pay it back? or was it your employees that begged for this feature, despite you trying to educate them of potential disastrous consequences and trying to avoid debt overall?
Nobody asked for it, nobody has used it, but we figured why not have it available as needed. It’s a pretty convenient way to get a short term loan.
Amazing and congratulations. This blog is a keeper. It’s definitely a high water mark.
Great post. I’d love to hear more about educating your employees and getting them on board!
Well, they have all taken FYFA and read the blog posts regularly, so that helps. But mostly it’s just a meeting to explain the 401(k).
I’ve been following your real estate investments since the beginning and was curious as to where you would end up place your debt funds. I invested alongside you in DLP Lending through cityvest in a taxable account. And, like you, once that goes round-trip I’d like to put it (and some more) back in the same fund directly, but I hate the tax inefficiency. You’ve given me a new idea as to how to do that. I already have a Fidelity solo 401(k) that I use for side work contributions and previous rollover contributions. It sounds like I should be able to talk to Fidelity about adding on a brokeragelink option and then I could have access to DLP in a retirement account?
Yes, I believe you can do that and I think it is a good move and I may very likely do it myself.
What a great post and so much to learn in the comments too. As a tangent,I would ask you to consider a post on pros/cons of real estate debt/equity options (aside from REIT) in fully self directed as well as Corp 401k .
Fidelity has a “alternative asset” platform and i am hoping more offerings like DLP will be available
My main broker is Schwab however I am not sure they will serve as custodian for a checkbook solo 401k
Yes, Schwab will as well, but I think Fidelity does a little better job.
Excellent timing for this post. My anesthesia group is bidding out our 401k in the next month or so. Will any of the recommended 401k small business plan providers work with my group of 50 partners/250employees? Our CFO and I are working together on this project that was abandoned last March…go figure.
I think so. Just make sure you ask in your first contact with them.
We specialize in working with medical groups of your size. In fact, that’s all we do – work with medical/dental ERISA retirement plans. We don’t sell any plans or platforms, and we often work with existing service providers unless there is a good reason to make a change. We also do custom Cash Balance plan evaluations and proposals, and unlike other service providers, we always act in a fiduciary capacity at all stages of the process, and rather than sell plans, we provide advice to the plan sponsor on all aspects of their retirement plan needs.
Here’s an example of how we approach working with larger plans that are far more complex and have many more moving parts than a typical retirement plan:
https://www.whitecoatinvestor.com/how-to-best-group-retirement-plan/
If you are looking for details, you can find additional information on our website regarding fiduciary services we offer, service providers we use, and fees. There is also a fee calculator on the site that will quote you a fee.
Can you explain more how employees are able to maximize the full 58K? Is the employer doing the max contribution for all employees?
There are two ways to do this:
1) Via after-tax contributions. If your W2 is above $61k, you are allowed make a Roth + after-tax contribution to the 401k plan (and convert after-tax to Roth), if the plan allows it, allowing you to contribute $20,500 in Roth and the rest after-tax. This only works if after-tax contributions are made by NHCE staff (if you have any). Otherwise it won’t work because it will fail testing if only HCEs are doing it. So this will never work if you have NHCE staff, as they would most likely never want to do after-tax. If all you have is HCE staff ($135k+), then anyone can do after-tax contributions, however, most HCE doctors (and staff) will want to make tax-deferred contributions, not after-tax.
2) Via employer making tax-deferred profit sharing contributions and lowering W2s by this amount for non-partners. This is another way in which someone who’s not an owner make the full contribution (assuming their W2 is high enough and the cost to the plan is not significant in terms of increasing profit sharing contribution the plan sponsor has to make to HNCE staff as a result). This is usually reserved for highly compensated staff/doctors, allowing them to max out, but this will not always work if the increase in cost is too high (as this will increase employer contribution to HNCE staff, so this will depend heavily on practice demographics).
Enough of them, yes, that’s basically what we do. Weird huh? Want to come work here? And it’s $61K this year.
Awesome summary. We are going through this process right now, and despite a half dozen meetings, we are having trouble finding any TPA/Custodian combo that can handle after-tax contributions. Might I ask who you use for TPA? Thank you for your time
The big question is, why use a custodian? This increases the complexity of the plan multi-fold as the TPA now has to act as a record-keeper (and no TPA will want this). And you still will need multiple accounts to accommodate after-tax and Roth. There is no cost savings here either because record-keeping will cost at least as much if not more than a record-keeper will. Also, you can’t avoid ERISA compliance issues, which will be front and center as custodial accounts can not be reasonably restricted, so you will end up in a position where you have to check each account on an annual basis to ensure ERISA compliance, not to mention that collecting information from multiple custodial accounts can be a big task (which will also incur costs).
There is absolutely no benefit for a medical practice to set up this type of plan, only compliance and administrative headaches. We are currently dealing with several such plans, and once the practice grows, this becomes a big burden, that’s for sure. Getting set up with a record-keeper that has access to in-plan self-directed brokerage accounts is the best possible solution, and although you won’t be able to invest in some types of assets (most of which by the way have no place in ERISA plans – just look at bitcoin which DOL specifically singled out as something that would be scrutinized heavily), this is the most prudent approach and as a plan sponsor and a fiduciary, the partners should set up a plan that takes into account everyone’s needs, not just the needs of the few. Any record-keeper can easily handle after-tax contributions and Roth conversions (without having to move the money around), and TPAs can track it easily, so this is not problem that needs to be solved as it already has been.
Especially if the practice has NHCEs, using custodians instead of a record-keeper will have multiple ERISA and compliance challenges, but even if this is a partner-only plan, eventually everyone would want to open their individual accounts at custodians where they want to allow adviser access, so any such plan is by design will grow into a monster that would have to be handled eventually, so there is few if any reasons to go this way for a multi-partner and/or growing medical practice.
Good morning Kon, and thank you for your detailed response. In the WCI article above, there is a line which reads “They normally work with Vanguard Retirement Plan Access (VRPA) as a custodian, but had to shift when VRPA couldn’t handle the Mega Backdoor Roth IRA contributions” and that is what I am talking about in terms of a custodian. The 401(k) custodian’s job is to hold plan assets on behalf of the plan sponsor/participants. For example, imagine a case where Vanguard or Ascensus was the custodian, there was also a TPA/recordkeeper (in my experience these are in fact usually the same entity, but they could be different); the TPA/RK sets up the plan and keeps records, does compliance testing etc, and participants could log into vanguard to manage their account and investments. That’s basically what we are envisioning here. Kind regards.
Please see my responses below.
“Good morning Kon, and thank you for your detailed response. In the WCI article above, there is a line which reads “They normally work with Vanguard Retirement Plan Access (VRPA) as a custodian, but had to shift when VRPA couldn’t handle the Mega Backdoor Roth IRA contributions” and that is what I am talking about in terms of a custodian. ”
VRPA is Vanguards’ institutional platform, so this would be a record-keeper, not a custodian. There is also Vanguard custodial accounts called VRIP, which has nothing to do with VRPA, so I just wanted to make this distinction. VRIP is a custodial account with no record-keeping. VRIP is very limited, and they never had MBR 401k unless you wanted to open a second VRIP account to make it happen (and use a good TPA to make sure that record-keeping is taken care of).
As far as VRPA, if it is indeed what we are talking about, we don’t work with them, so I wouldn’t know what issues they may be experiencing. We’ve been working with Vanguard/Ascensus, and there hasn’t been any issues doing after-tax conversions to Roth.
“The 401(k) custodian’s job is to hold plan assets on behalf of the plan sponsor/participants. For example, imagine a case where Vanguard or Ascensus was the custodian, there was also a TPA/recordkeeper (in my experience these are in fact usually the same entity, but they could be different); the TPA/RK sets up the plan and keeps records, does compliance testing etc, and participants could log into vanguard to manage their account and investments. That’s basically what we are envisioning here. Kind regards.”
Again, let’s not confuse a custodian (which is just an all purpose account with no record-keeping) with a record-keeper, which typically has a record-keeper integrated with a custodian (Ascensus Trust would be the custodian and Vanguard/Ascensus would be the record-keeper). So for example, TD Ameritrade or Schwab is a custodian. To turn this into a record-keeper platform would take a lot of effort. This is what Vanguard/Ascensus does. TPA is nothing to do with a record-keeper. They provide administration, not record-keeping. Some platforms include TPA work, but Vanguard/Ascensus is not a good TPA (and neither is VRPA). You always need to hire an independent TPA to provide compliance and plan design/administration services. While Vanguard/Ascensus can process your transactions, it would be the TPA that makes sure that these transactions are processed/documented correctly when they do their trust accounting/valuation reports at the end of the year. This is a much more sophisticated function than that of a record-keeper.
In short, record-keeper (integrated with a custodian, which is a separate entity but usually seamlessly integrated) provides the website and records and processes transactions, TPA does compliance and administration as well as annual reporting and trust accounting, so with those two in place you should have no trouble at all doing the most sophisticated strategies for your plan as long as those are possible to do (MBR 401k is definitely one of them).
Kon,
Thank you once again for the detailed reply. I just now realized that you (mis)interpreted my statement of “TPA/Custodian combo” as meaning that I wanted them to be the same party. Sorry that was confusing the way I wrote it.
I am looking to hire an independent TPA to provide plan design/administration and compliance, who will work with an agreed-upon custodian and record-keeper (record-keeper could also be the TPA)
Best,
Makes sense, though I’m still confused by the fact that you can’t find TPA/record-keeper that can handle after-tax contributions as most good ones will know what to do. Every TPA knows how to handle after-tax contributions, and major record-keepers such as Ascensus can do it as well, so it is just a matter of finding a TPA. I would concentrate on mid-size TPA firm (rather than solo TPAs), you might be talking with salespeople who are not be aware of these things, other than that, you can ask your adviser for a recommendation (any good ERISA 3(38) fiduciary should be able to recommend a TPA).
Thanks for the reply. I myself am beyond confused by the fact that I can’t find TPA/record keeper that can handle after-tax contributions. This has been an incredibly frustrating journey for something that should be so easy. To this day I have not been able to find a single one, and would love to hear from anyone on this forum who has successfully done this. Keep in mind that I am asking for nothing special here and have no unique issues, situations, or requirements. Here’s just a sample of who I have spoken to so far.:
Emparion – Said they could do it and then never responded to another communication by email or phone. It was as if they went out of business overnight.
Vanguard – Said they could not handle after-tax contributions at all.
Guideline – Said they could not handle after tax contributions at all
Fidelity – Said they could not handle after tax contributions at all
Schwab – Said they could not handle after tax contributions at all
Farmer-Betts – Said they could do it, but then said they couldn’t do it until next year
I tried several others as well, all with similar outcomes. Has anyone here had a different experience?
There’s a reason we keep a list of recommended firms: https://www.whitecoatinvestor.com/retirementaccounts/
Not sure what happened at Emparion. If you send me an email at editor (at) whitecoatinvestor.com about it we’ll get you a response or we’ll remove them from our list.
Not sure who you are talking to, but the TPA I work with (in partnership with Vanguard/Ascensus) can handle after-tax contributions. We’ve been making after-tax contributions and in-plan Roth conversions without any issues.
I’ve forgotten the name right now, but you can check with FPL.
Hi Kon,
Thanks for the reply. So far I have met with Vanguard, Guideline, Emparion, Fidelity, Schwab, Farmer-Betts, Spectrum Pension Consultants, The Retirement Plan Company, and about 2 – 3 others. Who would you recommend?
My point is that any TPA can take care of after-tax contributions, if they are a decent TPA. Hire an independent TPA, why talk with record-keepers? Or hire a good adviser who can assist you with this process.
Yup, couldn’t agree more. Can you recommend a few of these ‘independent TPA’s that you mention? Thanks
Done, thanks for following up.
Regarding the list of recommended firms, that was actually the first place I checked, I went through the whole list, and please correct me if I am wrong about anybody, but Wellington , Litovsky, iq401k, and CarsonAllaria are strictly Asset Management, no TPA services. Emparion I already tried. I need a TPA,
Hello Jesse,
I know you’ve already contacted Farmer & Betts, but I have a dedicated contact that I deal directly with at F&B. Maybe he can help you get this taken care of. Send me a message if you are interested.