Yet another individual 401k question

[Mantis Toboggan]

Apologies if this has been covered elsewhere, I searched but did not run across this issue.

I am a partner in a physician group. We organized as a pass-through LLC that fully funds a retirement account to the max allowed for each partner. We have no employees: the non-partners and bookkeeper are 1099 contractors.

I have a SEP through Vanguard but want to start funding a backdoor Roth. I reached out to Fidelity to open an individual 401k, my goal being to transfer the SEP to a Fidelity 401k. The representative was concerned with what my other partners have for retirement, SEP or 401k. He apparently was told we all needed to have the same type of account, even if they were all individually owned.

Has anyone ever of heard of anything like this before? I am wondering if somehow I misrepresented my situation...

 

[litovskyassetmanagement]

Do you have a single plan document or is each physician paid as an independent contractor?  If it is the former, it sounds like you have a brokerage only 401k plan. If you have a single plan document for the plan, you can't fund a SEP in the same year that you fund your 401k plan (unless you have side 1099 income).  You also can't have an individual 401k if you have a group plan document.  What you can open is a self-directed brokerage account and roll your SEP into that brokerage account.  Yes, the rep sounds like they are correct.  You need a single type of account under the plan.

If you are paid as a 1099, then you can do whatever you want, and open whatever account you like (including an individual 401k plan), but if the practice pays you a W2 and also does profit sharing, then you definitely have a centralized plan document that governs all of the partner's accounts, and they all have to be in compliance for your plan to retain ERISA protection.

By the way, this is how compliance issues happen.  Not only do you need a single type of account, you probably also need a Third Party Administrator. Chances are you probably have one to administer the multiple brokerage accounts, but this is a total compliance nightmare for the group.  I'm currently working with one group and brokerage windows can cause huge number of problems. For example, if your brokerage window is NOT titled in the name of the plan, then you will most certainly not be protected if you are sued, and those assets would be subject to creditors.  If the investments in that window are of the wrong type, then the plan may be in violation of ERISA. You have to provide statements to the TPA who does valuation, and if mistakes happen, plan sponsor is responsible for the fallout (and mistakes will happen because it is nearly impossible to make sure that many brokerage windows are compliant with ERISA). This is why I'm totally against brokerage-only plans, even though it might seem like a great idea to physicians.  Too many compliance headaches, and too much stuff happening right now to cause lots of compliance problems for the plan sponsor.  For one thing, I'm also seeing some advisers asking plan sponsors to sign ERISA 3(21) contracts for the brokerage windows.  That's another compliance nightmare because these contracts make the plan sponsor 100% responsible for everything that goes on in the brokerage windows (even though they have no control over it).

 

[Mantis Toboggan]

I should have written "we are organized as an LLC": I became a partner early last year but the group existed long before. Last year I earned enough to reach max SEP funding after I made partner but I just requested deposit slips from Vanguard for my pre-existing SEP IRA and then the money was deposited by our book keeper. I know my income now is K1, it was 1099 pre-partner. The group does not administer any plan at all, and the phrase single plan document is not a term I am familiar with, but I will look into it.

Thank you for your reply.

[spiritrider]

I don't believe partners can be paid on a 1099. They are considered owner-employees of the partnership and must use a partnership plan.

 

26 U.S. Code § 401 - Qualified pension, profit-sharing, and stock bonus plans, (c) Definitions and rules relating to self-employed individuals and owner-employees, (4) Employer

An individual who owns the entire interest in an unincorporated trade or business shall be treated as his own employer. A partnership shall be treated as the employer of each partner who is an employee within the meaning of paragraph (1).

[Mantis Toboggan]

Update: turns out in the stack of partnership documents I got last year there is a SEP plan. I had no idea. LOL.

Basically, it defines a "Simplified Employee Pension" as a "retirement savings vehicle chosen by a Participant (me) for deposit of contributions made hereunder by the Employer (group. Such retirement savings vehicle may only be either an approved IRA under Code Section 408(a) or approved IRA annuity under Code Section 408(b)."

So I guess the question is whether or not a 401k meets these requirements (my guess they are administered under Code 401), and if not, and we want the ability to have 401k's, we have to change the plan? Any small groups go through anything similar?

[litovskyassetmanagement]

Mantis Toboggan wrote:

Update: turns out in the stack of partnership documents I got last year there is a SEP plan. I had no idea. LOL.

Basically, it defines a “Simplified Employee Pension” as a “retirement savings vehicle chosen by a Participant (me) for deposit of contributions made hereunder by the Employer (group. Such retirement savings vehicle may only be either an approved IRA under Code Section 408(a) or approved IRA annuity under Code Section 408(b).”

So I guess the question is whether or not a 401k meets these requirements (my guess they are administered under Code 401), and if not, and we want the ability to have 401k’s, we have to change the plan? Any small groups go through anything similar?

Click to expand...

No, a SEP is a SEP, not a 401k.  Your group should adopt a 401k instead, not a SEP, for multiple reasons, but that should be decided together with whoever is advising your group.  SEP does not afford asset protection nearly as much as a 401k plan.  Also, no catch-ups for doctors over 50, no Roth contributions, no possibility of adding a Cash Balance plan, no backdoor Roth IRAs with a SEP, etc.  And you still need to comply with the rules of the plan document and rules that apply to SEP IRAs and other retirement plans.  Some of the things I mentioned above about brokerage-only plans do apply to the SEP as well. It is much better to have a 401k plan with a record-keeper and investment menu, and not deal with multiple brokerage accounts.