Solo 401K vs. Roth 401K vs. Cash Balance Plan

[csciora]

I'm still a little confused about some aspects of 401K plans, particularly with regards to funding the Roth component.

1. Does funding the Roth prohibit funding the standard 401K plan? Can you fund both in any given year subject to the $18K/$54K max contributions?

I'm picturing the two options as buckets that can filled with a total of $54,000 divided in any manner between the two, but not more than that.

2. Married couples can share in the Solo 401K plan which double the effective contribution limits (assuming there's enough distrbuted income to support it). I recently read that children and other close family members can also participate through "attribution" whereby they're magically also considered 100% owners.

Are the 401K contribution limits for additional family members the same as husband/wife?

3. Bonus question: What is a cash balance plan and when would someone use it?

Thanks!!!

~ Chris

[spiritrider]

1. The $18K employee deferral limit is shared between both traditional (pre-tax) and Roth (post-tax) contributions. So you can contribute $18K and nothing to the other or vice versa or shared between them. The $54K annual addition limit includes the employee deferral. So if you make the full $18K deferral, you will have $36K available for employer contributions which must always be pre-tax.

2. Married couples can share a single Solo 401k plan, but must have separate accounts. One participant 401k plans which is what the IRS considers Solo 401k, Individual 401k, etc... plans can only include the owner and their spouse or partners and their spouses.

While direct lineage family members (parents, children, grandchildren) would be considered 100% owners due to attribution, the employer (you) would not qualify for a one participant 401k. Keep in mind that a one-participant 401k is still just a 401k, subject to the vast majority of the laws, regulations and rules that apply to all other 401k plans.

The two major differences that allow financial institutions to offer these plans with no administrative costs is the greatly reduced compliance and testing requirements. This is because with just spouses there is no requirement to do anti-discrimination testing. Also, the plan does not have to file Form 5500 until the plan assets reach $250K (and then may use Form 5500-EZ).

The reduced compliance, administrative cost and testing would still be true with the addition of lineal family members. Form 5500 or 5500-SF would be required to be filed every year regardless of plan balance. Financial institutions could certainly could offer a spouse and lineal family member 401k. I am only aware of one 401k provider who does so. This is OppenheimerFunds Single K plan. This plan charges $30/participant and they only offer fairly expensive (average ~1.0% expense ratios) active mutual funds.

So the only way to do this is with a TPA provided document and administrative services. This would generally cost at least $1K/year. Although given the specifics that it is not really much different than a one-participant plan, you might be able to find someone to offer it cheaper.

3. A cash balance plan is a Defined Benefit plan. This could allow you to make greater retirement plan contributions, especially if you are 45+.

 

[litovskyassetmanagement]

csciora wrote:

I’m still a little confused about some aspects of 401K plans, particularly with regards to funding the Roth component.

1. Does funding the Roth prohibit funding the standard 401K plan? Can you fund both in any given year subject to the $18K/$54K max contributions?

I’m picturing the two options as buckets that can filled with a total of $54,000 divided in any manner between the two, but not more than that.

2. Married couples can share in the Solo 401K plan which double the effective contribution limits (assuming there’s enough distrbuted income to support it). I recently read that children and other close family members can also participate through “attribution” whereby they’re magically also considered 100% owners.

Are the 401K contribution limits for additional family members the same as husband/wife?

3. Bonus question: What is a cash balance plan and when would someone use it?

Thanks!!!

~ Chris

Click to expand...

spiritrider wrote:

1. The $18K employee deferral limit is shared between both traditional (pre-tax) and Roth (post-tax) contributions. So you can contribute $18K and nothing to the other or vice versa or shared between them. The $54K annual addition limit includes the employee deferral. So if you make the full $18K deferral, you will have $36K available for employer contributions which must always be pre-tax.

2. Married couples can share a single Solo 401k plan, but must have separate accounts. One participant 401k plans which is what the IRS considers Solo 401k, Individual 401k, etc… plans can only include the owner and their spouse or partners and their spouses.

While direct lineage family members (parents, children, grandchildren) would be considered 100% owners due to attribution, the employer (you) would not qualify for a one participant 401k. Keep in mind that a one-participant 401k is still just a 401k, subject to the vast majority of the laws, regulations and rules that apply to all other 401k plans.

The two major differences that allow financial institutions to offer these plans with no administrative costs is the greatly reduced compliance and testing requirements. This is because with just spouses there is no requirement to do anti-discrimination testing. Also, the plan does not have to file Form 5500 until the plan assets reach $250K (and then may use Form 5500-EZ).

The reduced compliance, administrative cost and testing would still be true with the addition of lineal family members. Form 5500 or 5500-SF would be required to be filed every year regardless of plan balance. Financial institutions could certainly could offer a spouse and lineal family member 401k. I am only aware of one 401k provider who does so. This is OppenheimerFunds Single K plan. This plan charges $30/participant and they only offer fairly expensive (average ~1.0% expense ratios) active mutual funds.

So the only way to do this is with a TPA provided document and administrative services. This would generally cost at least $1K/year. Although given the specifics that it is not really much different than a one-participant plan, you might be able to find someone to offer it cheaper.

3. A cash balance plan is a Defined Benefit plan. This could allow you to make greater retirement plan contributions, especially if you are 45+.

 

Click to expand...

You can have a single 'solo' 401k plan for married couples, even for a couple with two separate businesses.  Don't think in terms of a standard plan provider - with a custom plan document anything (that is legal) is possible.  A 'solo' 401k plan is a product, and in many cases an inappropriate product.  In most cases when you have high earning physicians and spouses I prefer to use a 'regular' 401k plan with a custom plan document that allows all of the best features. In addition, in a 'regular' 401k you can do in-plan Roth conversions, so you could potentially convert your entire contribution to Roth in various ways.  You can't do that in a 'solo' 401k product offered by big brokerages.

You can not have children participate in a solo 401k.  However, if you have a family business, you can certainly hire children (under the right circumstances) but at that point you'll have a 'regular' 401k plan (for which you'll need to hire a TPA).  They don't participate by attribution, but by earning legal earned income.  You can't just give your spouse a $200k W2 if he or she is not doing enough to justify such a salary.  I would recommend that you get advice from your CPA on that.

A Cash Balance plan is useful when you are at least 35 years old, are making probably $400k+ in net profit and would like to make significant contributions.  They are paired with a 401k plan, and you can not use a 'solo' 401k product for that, you would need a custom-designed 401k plan.  I like these plans a lot - physicians and dentists who are high earners can definitely benefit from having this type of plan.  It is rather complex, so you would definitely need a TPA for that.  In addition, managing investments in a combo plan is tricky because the CB portion should be invested conservatively, while the 401k portion can be invested more aggressively, so the entire portfolio needs to be kept in balance.

One thing to remember is that these plans can get complex, and if you mess up there can be hefty penalties and fines. Always make sure that you know exactly what you are doing and that you get the right advice.  Often, unsuitable CB plans are sold to unsuspecting doctors that are 'low cost'.  Whenever you work with someone, always make sure that they are working in your best interest, rather than in the interest of selling you a plan.

 

 

 

[SValleyMD]

Hi Kon-

Do you mind expounding on why CB plans need to be more conservatively invested vs. 401k plans??

[litovskyassetmanagement]

SValleyMD wrote:

Hi Kon-

Do you mind expounding on why CB plans need to be more conservatively invested vs. 401k plans??

Click to expand...

There are different schools of thought on that, but there are several reasons:

1) A CB plan typically has a limited time horizon (anywhere between 10 and 15 years is typical).  So you can't do the same things you would do in a 401k plan or an IRA.

2) Wild swings in return will create potential issues with under-funding and over-funding.  So if your return is high, you will be able to contribute less the following year, and if it is too low you have to contribute more.  It is much more advantageous to have a steady return (which can only be created with a portfolio that has mostly bonds), and take the risk on the 401k side.

This is not to say that you can't have a more aggressive portfolio, but I typically prefer low volatility portfolios for CB plans.  In general, when you are accumulating significant amount of money (potentially multiple millions), the best risk management approach is to de-risk with time without having to sell anything (to avoid issues with timing), and this can be done by increasing your allocation to bonds over time.  So this approach also works well by using a conservatively-managed CB plan.  Over time your CB contribution increases, we can hit both goals by keeping CB invested mostly in bonds, so as long as we can keep track of the overall allocation (and manage both 401k and CB allocation together), adding more money to the CB plan will also play the role of providing long-term risk management.

If you have a group practice CB plan, the game is somewhat different.  The plan can run for a very long time, and in that case a liability matching approach should be used.  For example, as more participants are near retirement, allocation should be come more conservative.  On the other hand, if more participants are younger, the allocation can become more aggressive.  With group practice plans, over- and under-funding is a really bad idea, so one must be even more careful with group CB plans than with solo plans.

Another consideration is what happens when CB plan is terminated and is rolled into your 401k plan.  There are ample opportunities for tax planning via in-plan Roth conversions. A combo plan is a great tool to build wealth, but it is always a good idea to look at the entire situation and to avoid costly mistakes.

 

[csciora]

Thanks, Kon.

Could you do a brief summary of what a CBP is and why someone would want one?

All I saw briefly was being able to "put away $200K" above and beyond 401K limits. If that's tax deferred, it's a huge step up from what I already know about.

Cheers,

Chris

[litovskyassetmanagement]

csciora wrote:

Thanks, Kon.

Could you do a brief summary of what a CBP is and why someone would want one?

All I saw briefly was being able to “put away $200K” above and beyond 401K limits. If that’s tax deferred, it’s a huge step up from what I already know about.

Cheers,

Chris

Click to expand...

Here's a link to an AICPA article (yes, this stuff is legal):

http://competency.aicpa.org/media_resources/208085-cash-balance-plans-for-professional-practices/detail

I also did several presentations that mentioned CB/DB plans (the first link talks about CB plans at length and the 2nd one shows some examples):

http://quantiamd.com/player/ygvmhdmbm?cid=1467

http://quantiamd.com/player/yewvnfqav?cid=1467

[csciora]

Thanks for the links! I'll take a look later this week and check them out.