Is a profit share 401k the best option for a solo Office?

[Annabelle]

Hi: I’ve been in solo practice for 4 years and recently started to read about finances and I read the White Coat Investor and For doctors eyes and I decided I need a retirement account. Now the question is which one. I contacted a financial person at Wells Fargo and she gave me a quote for a 401 k profit sharing. I have 15 employees and 3 of them have high salary $120k (nurse practitioners). The quote would allow me to contribute 54k to myself (65%) and $29k to employees. I asked my CPA and he said that I would be reducing my tax liability for the year by $29k ( $10k for employee contribution and $18k for me). The company will also charge me $1000 set up fee and $2000 yearly for maintance.
In addition, Wells Fargo is proposing me to use a platform with Lincoln Director and they charge investment fees to range from 2.20%-2.36%, 0.50% Advisor compensation: deposit based year 1 & years 2+ asset based, $750 annual charge, and $25 per participant.
After all these, I don’t think is beneficial for me. I would have to contribute $29k to my employees in order to save $29k in taxes and I would have all those fees mentioned above. I practice in an area where employees don’t value retirement that much (they prefer an increase in salaries). However, I do want to start working on a retirement plan. What do you guys think?

[Peds]

Yes 401k, no Wells Fargo.

[spiritrider]

Peds has responded with a 100% correct concise reply.

Unfortunately, as many forum members have no doubt diagnosed, I am seriously afflicted with verbosity (aka diarrhea of the mouth). So let's separate whether and how you should do a 401k and where to do it.

A good rule to follow when it comes to investments. Banks are for banking and should never be used for investments. The are maybe the second most expensive place to invest behind full-service brokers. These are some of the highest expense ratios and ancillary charges I have ever seen.

You should be able to find a local or national Third Party Administrator (TPA) with setup/yearly administrative fees <= the $1K/$2K you were quoted. Then you should be able to use Vanguard, Fidelity, Schwab index funds with maybe 1/20th of the expense ratios you and your employees would be paying for Lincoln Director funds. It would be bad enough for you, but I would suggest that it is almost criminal to subject your employees to 2.7% - 2.86% expense ratios + AUM fees.

The final question is how is the 401k plan constructed. The fact that the plan allows you to contribute $54K ($55K in 2018), leads me to believe it is a 401k using the New Comparability Method for profit sharing. This requires a higher level of non-elective employer contributions.

If your employees as you say are not that interested in retirement, you may be better of with a standard Safe Harbor 401k match. This would require 100% match on the 1st 3% of compensation and 50% match on the next 2% of compensation for a maximum match of 4% of compensation. Yes, this would limit your contributions to about 1/2 of the $54K depending on your compensation, but would probably reduce your employer contributions < $15K. If your employees are reluctant to contribute as you say, maybe far less.

[Annabelle]

Thank you soooo much for the reply. Like I said, I’m barely starting my learning process as far as finances: reading books, following the blog and still feel pretty lost. However, common sense was telling me that with those rates, the benefits were almost gone.
I’ll keep looking into independent 401k providers instead of bank
Thanks

[DMFA]

Annabelle wrote:

Thank you soooo much for the reply. Like I said, I’m barely starting my learning process as far as finances: reading books, following the blog and still feel pretty lost. However, common sense was telling me that with those rates, the benefits were almost gone.
I’ll keep looking into independent 401k providers instead of bank
Thanks

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Fidelity and Schwab, maybe Vanguard if you don't need to make incoming rollovers.

[White.Beard.Doc]

The betterment 401k is about 35 basis points (0.35% per year).  Vanguard is about 22 basis points (0.22% per year).  If you don’t have a lot of investment knowledge, betterment could work very well for you.  They use the best research to optimize your investment allocations and they guide you through the entire process.  Vanguard let’s you figure out your own investment plan.

[litovskyassetmanagement]

Annabelle wrote:

Hi: I’ve been in solo practice for 4 years and recently started to read about finances and I read the White Coat Investor and For doctors eyes and I decided I need a retirement account. Now the question is which one. I contacted a financial person at Wells Fargo and she gave me a quote for a 401 k profit sharing. I have 15 employees and 3 of them have high salary $120k (nurse practitioners). The quote would allow me to contribute 54k to myself (65%) and $29k to employees. I asked my CPA and he said that I would be reducing my tax liability for the year by $29k ( $10k for employee contribution and $18k for me). The company will also charge me $1000 set up fee and $2000 yearly for maintance.
In addition, Wells Fargo is proposing me to use a platform with Lincoln Director and they charge investment fees to range from 2.20%-2.36%, 0.50% Advisor compensation: deposit based year 1 & years 2+ asset based, $750 annual charge, and $25 per participant.
After all these, I don’t think is beneficial for me. I would have to contribute $29k to my employees in order to save $29k in taxes and I would have all those fees mentioned above. I practice in an area where employees don’t value retirement that much (they prefer an increase in salaries). However, I do want to start working on a retirement plan. What do you guys think?

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There are several steps to getting the best 401k plan possible, and the first step is getting a design illustration/study done for the practice where the design is optimized.  Not all TPAs would do that, and in your case there are different considerations involved, such as whether the HCEs will get any profit sharing contributions, or just a match.

I've written several articles on the topic of setting up 401k plans for small practice owners:

http://www.dentaltown.com/blog/post/3376/small-practice-retirement-plans-how-they-are-different

http://whitecoatinvestor.com/how-to-run-a-successful-retirement-plan-for-a-medical-or-dental-practice

http://whitecoatinvestor.com/how-to-reduce-your-practice-retirement-plan-cost

There are basically 3 criteria to getting the best possible plan:

1) An independent TPA

2) Fixed/flat fee providers, no asset-based fees of any type, and low cost index funds as investments

3) An ERISA 3(38) fiduciary to assist you in selecting the TPA, the record-keeper and to set up your plan's investment menu and model portfolios, as well as to provide enrollment support for the staff, and advice to the owner regarding the best use of the plan.  Your plan adviser has to work exclusively in your best interest, and assist you in making important plan level decisions as well as to interface with your TPA to make sure that you always have the best plan design possible.

I've also developed a retirement cost calculator to assist in evaluating various retirement plan proposals:

http://retirementplanhub.com/retirement-plan-cost-calculator/

When considering different proposals, always look at the whole picture.  There are many different platforms out there that provide only bare-bones services.  A medical/dental practice would typically use a profit sharing 401k plan and potentially a Cash Balance plan down the road, so the services provided to such a plan have to be a lot more sophisticated than for a simple Safe Harbor 401k plan.

 

 

[litovskyassetmanagement]

White.Beard.Doc wrote:

The betterment 401k is about 35 basis points (0.35% per year).  Vanguard is about 22 basis points (0.22% per year).  If you don’t have a lot of investment knowledge, betterment could work very well for you.  They use the best research to optimize your investment allocations and they guide you through the entire process.  Vanguard let’s you figure out your own investment plan.

Click to expand...

Betterment has been a total disaster of a platform. I've had TPAs tell me all about it, and I would never recommend anyone to go there without your own TPA at the very least. Not only would they not do cross-tested profit sharing plans, but they won't do much of anything as far as plan design and compliance.  Setting up a 401k is not just about investments. These 'automated' platforms are completely ineffective if you have complex retirement plan needs. Not to mention that 35 bps is a lot of money over time vs. a fixed fee.  It is always better to have independent components to your retirement plan - a TPA, a record-keeper and an ERISA 3(38) fiduciary adviser all of whom are independent and working directly for the plan sponsor (vs. everything provided by a single platform).  This not only provides checks and balances, but you can get significantly better service quality at the same or lower cost vs. a one-size-fits-all platform where everyone gets exactly the same service and does not get access to top TPAs/advisers who can make  big difference as far as lowering your plan cost and getting you the best investments and the best plan design, as well as ongoing advice on compliance and other retirement plan aspects such as adding a Cash Balance plan or changing your plan design based on potential changes in practice demographics.  Good luck getting any of this with Betterment and other bundled platforms.  Everything is fine if you have a stable practice with a Safe Harbor 401k - try some turnover, cross-tested profit sharing and a Cash Balance plan, and you'll quickly see that without quality advice it would become a big mess fast.

[ambesima]

Stay away from Wells Fargo....seriously. Agree with DMFA.

[White.Beard.Doc]

Kon Litovsky wrote:

White.Beard.Doc wrote:

The betterment 401k is about 35 basis points (0.35% per year).  Vanguard is about 22 basis points (0.22% per year).  If you don’t have a lot of investment knowledge, betterment could work very well for you.  They use the best research to optimize your investment allocations and they guide you through the entire process.  Vanguard let’s you figure out your own investment plan.

Click to expand…

Betterment has been a total disaster of a platform. I’ve had TPAs tell me all about it, and I would never recommend anyone to go there without your own TPA at the very least. Not only would they not do cross-tested profit sharing plans, but they won’t do much of anything as far as plan design and compliance.  Setting up a 401k is not just about investments. These ‘automated’ platforms are completely ineffective if you have complex retirement plan needs. Not to mention that 35 bps is a lot of money over time vs. a fixed fee.  It is always better to have independent components to your retirement plan – a TPA, a record-keeper and an ERISA 3(38) fiduciary adviser all of whom are independent and working directly for the plan sponsor (vs. everything provided by a single platform).  This not only provides checks and balances, but you can get significantly better service quality at the same or lower cost vs. a one-size-fits-all platform where everyone gets exactly the same service and does not get access to top TPAs/advisers who can make  big difference as far as lowering your plan cost and getting you the best investments and the best plan design, as well as ongoing advice on compliance and other retirement plan aspects such as adding a Cash Balance plan or changing your plan design based on potential changes in practice demographics.  Good luck getting any of this with Betterment and other bundled platforms.  Everything is fine if you have a stable practice with a Safe Harbor 401k – try some turnover, cross-tested profit sharing and a Cash Balance plan, and you’ll quickly see that without quality advice it would become a big mess fast.

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Thanks for sharing your thoughts.  We would keep our TPA if we were to go with Betterment.  Betterment actually recommended that we keep our TPA.  Our TPA is quite inexpensive now that our plan assets have become larger.  Our TPA does the plan design and fairness testing.  At the moment we are leaning towards Vanguard as even some of the millennials have stated that they like the very low cost of Vanguard.

[litovskyassetmanagement]

White.Beard.Doc wrote:

Kon Litovsky wrote:

White.Beard.Doc wrote:

The betterment 401k is about 35 basis points (0.35% per year).  Vanguard is about 22 basis points (0.22% per year).  If you don’t have a lot of investment knowledge, betterment could work very well for you.  They use the best research to optimize your investment allocations and they guide you through the entire process.  Vanguard let’s you figure out your own investment plan.

Click to expand…

Betterment has been a total disaster of a platform. I’ve had TPAs tell me all about it, and I would never recommend anyone to go there without your own TPA at the very least. Not only would they not do cross-tested profit sharing plans, but they won’t do much of anything as far as plan design and compliance.  Setting up a 401k is not just about investments. These ‘automated’ platforms are completely ineffective if you have complex retirement plan needs. Not to mention that 35 bps is a lot of money over time vs. a fixed fee.  It is always better to have independent components to your retirement plan – a TPA, a record-keeper and an ERISA 3(38) fiduciary adviser all of whom are independent and working directly for the plan sponsor (vs. everything provided by a single platform).  This not only provides checks and balances, but you can get significantly better service quality at the same or lower cost vs. a one-size-fits-all platform where everyone gets exactly the same service and does not get access to top TPAs/advisers who can make  big difference as far as lowering your plan cost and getting you the best investments and the best plan design, as well as ongoing advice on compliance and other retirement plan aspects such as adding a Cash Balance plan or changing your plan design based on potential changes in practice demographics.  Good luck getting any of this with Betterment and other bundled platforms.  Everything is fine if you have a stable practice with a Safe Harbor 401k – try some turnover, cross-tested profit sharing and a Cash Balance plan, and you’ll quickly see that without quality advice it would become a big mess fast.

Click to expand…

Thanks for sharing your thoughts.  We would keep our TPA if we were to go with Betterment.  Betterment actually recommended that we keep our TPA.  Our TPA is quite inexpensive now that our plan assets have become larger.  Our TPA does the plan design and fairness testing.  At the moment we are leaning towards Vanguard as even some of the millennials have stated that they like the very low cost of Vanguard.

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I would still not recommend Betterment in any capacity.  The cost is not the only driver.  Betterment at that point is just a record-keeper that is totally incompetent at being a retirement plan record-keeper, from what I've been told, even if you have your own TPA.  For the type of money you'll pay, you can actually hire your own ERISA 3(38) and still have money left over the long term.  I've developed a calculator specifically to compare different types of fees side by side:

http://retirementplanhub.com/retirement-plan-cost-calculator/

And in most cases fixed fees beat asset-based fees especially with retirement plans. There are plenty of low cost record-keepers out there with an asset-based component that is at most 5 bps (which is just the custodial fee).  The whole idea is to avoid paying any asset-based fees.  Those don't seem high, but they do catch up fairly quickly as your assets grow.  Also, there is a lot of valuable advice that your own adviser should be able to provide to you that Betterment and other record-keepers won't provide. Your adviser should also be able to evaluate the type of record-keeper that would be best for your plan based on the needs of the practice and the amount of assets in the plan.

You can get low cost Vanguard funds on any open architecture record-keeping platform, and there is no need to go to Vanguard/Ascensus for that (though we do have plans with Vanguard/Ascensus, and this can be a good choice for a mid-to-large size plan).  So depending on your needs and sophistication of the staff you can get a custom-designed plan vs. a one-size-fits-all at Betterment, and with a higher quality of service and lower cost (or at least comparable cost but simply a better plan).  Always compare various proposals side by side, and avoid going into bundled arrangements that make money via AUM fees, especially those that are designed to get a lot of clients in quickly without providing adequate services.  Using independent standalone providers you can get personalized advice often for the same or lower cost.

[White.Beard.Doc]

At this point it looks like we are probably going to switch to Vanguard/Acensus from T. Rowe Price to get away from their relatively high mutual fund fees.  We will keep our current cost effective TPA and our own plan design professional.  Our plan is a safe harbor 401k with profit sharing that is fairness tested by our TPA.  I am not sure if it is considered a small plan or not, but ours is a relatively new practice and we have about 8MM in assets, currently increasing by 1 or 2MM per year but the growth may accelerate as the practice is growing.

The only remaining question is how we get the fiduciary services.  Do we get that from the provider that Acensus is offering, with the option of two different levels of fiduciary services for either 2 or 4 basis points.  I am still trying to learn more about these fiduciary options, and I also have to discuss all of this with our TPA and plan designer.

[litovskyassetmanagement]

White.Beard.Doc wrote:

At this point it looks like we are probably going to switch to Vanguard/Acensus from T. Rowe Price to get away from their relatively high mutual fund fees.  We will keep our current cost effective TPA and our own plan design professional.  Our plan is a safe harbor 401k with profit sharing that is fairness tested by our TPA.  I am not sure if it is considered a small plan or not, but ours is a relatively new practice and we have about 8MM in assets, currently increasing by 1 or 2MM per year but the growth may accelerate as the practice is growing.

The only remaining question is how we get the fiduciary services.  Do we get that from the provider that Acensus is offering, with the option of two different levels of fiduciary services for either 2 or 4 basis points.  I am still trying to learn more about these fiduciary options, and I also have to discuss all of this with our TPA and plan designer.

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Vanguard/Ascensus would work fine if you already have a TPA.

I wouldn't take Vanguard's advice on an ERISA 3(38) fiduciary for a number of reasons.  Your TPA and Ascensus are not fiduciaries, so they are not versed in the details of investment selection and management.  Selection of plan fiduciaries is done by the plan sponsor, not by the TPA. Whoever they offer is a bundled provider for their plans, and they have a deal with them.  That in and of itself is not an issue, the issue is that this would be an entity that does one thing only: they select plan investments and that's it.  You nave no control over their investment selection process (if they are a 3(38)) and there is no guarantee that they will pick the best investments for your plan.  That is, a 3(38) fiduciary is not obligated to only pick index funds that are low cost.  That's nowhere in the laws.  That's the first issue.

Next, you should pick a 3(38) not a 3(21), and to make the right choice the plan sponsor has to understand the differences, as well as advantages and disadvantages:

http://litovskymanagement.com/2014/01/hiring-fiduciary-adviser/

A 3(21) might be cheaper, but they are co-fiduciary, and in no way are obligated to give you the best possible advice.  Neither is a 3(38) by the way, so you have to make sure that their philosophy matches what you are trying to achieve with the plan investments and participant education.

Next, it is always better to have an independent ERISA 3(38) fiduciary, not the one affiliated with a record-keeper.  This affords for better checks and balances.

Another issue is that 4 bps can get quite expensive for a plan your size.  A fixed fee would be a better deal going forward.  This is easily demonstrated using the above calculator.

And of course, there is the issue of the services provided. It does not matter if the services are low cost if they are low quality.  I prefer customized services for plans like yours.  So investment selection is only one part.  The next part is model portfolio set up and management (for an all-in-one solution that many participants would appreciate vs. just plain TDFs which might not be appropriate for all participants).  Another function that a 3(38) can provide is to assist with such things as Cash Balance plan analysis, and addressing various types of brokerage account issues (if any).  So an adviser that adds value should be an actual person who can help with a multitude of plan issues, rather than some entity that you never hear from that provides no advice other than a selection of your fund lineup.  While investment selection is important, many other aspects of the plan have to be taken care of (such as ensuring that the design is optimal, and that all of the right plan options are enabled such as in-plan Roth conversions, etc, and this is done in consultation with the plan's TPA). Also, sometimes a 3(21) is needed to provide individualized participant advice and education.  Most plans serviced by Vanguard/Ascensus are quite plain in comparison to yours, and so you might need (and can definitely afford, especially if it is a fixed/flat fee) a larger array of services than provided by a bundled 3(21) or a 3(38).

For those reasons it is better to select an ERISA 3(38) based on all of the above criteria, rather than use a bundled one that comes with the record-keeper.

 

[White.Beard.Doc]

Kon, as an example, how much does your firm charge for 3(38) fiduciary services?

[litovskyassetmanagement]

White.Beard.Doc wrote:

Kon, as an example, how much does your firm charge for 3(38) fiduciary services?

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There is no set fee schedule - everything is provided on a case by case basis.  I can say the following though:

1) We believe in low cost indexing, and primarily we use Vanguard and DFA funds.  My specialty is investment management, so we actually pick all of the best asset classes and build a number of risk-managed model portfolios, as well as make sure that the investment menu is streamlined vs. bloated. A typical model portfolio has an expense ratio of ~0.15%. Also, we make sure that every investment is the lowest cost available on the market - every basis point counts once your assets are large enough.

2) We assist in the selection of an ERISA 3(21) to provide participant education as well as to offer individualized financial planning (so the 3(21) has to be thoroughly vetted to be an hourly/fixed fee fiduciary who can potentially come in person or provide advice virtually - this is is not just some random employee of a big firm, but an actual CFP who is a wealth manager).

3) All of the fees charged are fixed/flat, and are extremely competitive vs. asset-based fees.  I always put together a proposal comparing fees side by side to see the cumulative effect vs. time, and it is really easy to see with compounding that every basis point indeed counts against you.