401k or SIMPLE

[triad]

Hi, I'm an owner of a small dental practice and was trying to decide what type of retirement plan I should start now that continuing a SEP is going to be cost prohibitive.  When researching 401ks I'm having a hard time justifying the cost.  I've been told that a SEP is "worth it" if 80% of the contributions go to the owner, but running some calculations I'm not seeing how it pays off...

So if you put away 53k for yourself into the 401k and that is 80% of the contribution you contribute 13.25 k for the staff (lets assume that includes all fees as well).

The other option of a SIMPLE you put away 18.5k and zero contribution for staff. (3% match but guessing most staff wouldn't bother with this)

so by doing the 401k you're paying 13.25k to put away an extra 34.5k, right?  13.25/34.5 =38%.  Wouldn't I be better off paying the taxes now (I'm in the 33% marginal bracket and no state income tax) and putting the money in a taxable account?

In my example I'd be paying a 38% fee for the right to defer taxes.  lets say I take out 200k/yr at retirement.  that would be an avg tax rate of about 25%.

If I pay a 33% tax now then I have to pay longterm cap gains tax of 15% when I withdraw at retirement.  And if I invest in a tax efficient way (like all VTI) dividends would be very low, about 2%/yr which is also taxed at 15%

I must be missing something, right?  Why would anyone start a 401k if my assumptions are accurate?

[East coast]

Just my 2 cents, but most good employers provide a match as a valuable benefit for their employees - sounds like you would only do it if it meant more $$ in your pocket, which seems disappointing.

[scott]

The SIMPLE will be much more cost effective for you if you have a small dental practice. It costs next to nothing, and you can match 3% of what your employees put in. If they don't contribute...you don't match. Those who see value in it will participate. I had a SIMPLE in place for many years and just switched to a 401K safe harbor profit sharing plan this year. The reason I waited was due to the expenses involved. I am now in a position where my wife and I will put away ~$72,000 with this plan, so it makes sense for us. That being said, many dental offices go the SIMPLE rout early in practice ownership because of the low fees and minimal employee contribution. I set mine up at Fidelity without difficulty. Hope this helps.

[triad]

East coast wrote:

Just my 2 cents, but most good employers provide a match as a valuable benefit for their employees – sounds like you would only do it if it meant more $$ in your pocket, which seems disappointing.

Click to expand...

You must be unfamiliar with SIMPLE's.  There is a 3% match.  I'm definitely going to offer a retirement plan, just trying to figure out which one would work best for me and my office.  You should be really disappointed I'm moving away from my SEP which is incredibly generous to employees...

[triad]

scott wrote:

The SIMPLE will be much more cost effective for you if you have a small dental practice. It costs next to nothing, and you can match 3% of what your employees put in. If they don’t contribute…you don’t match. Those who see value in it will participate. I had a SIMPLE in place for many years and just switched to a 401K safe harbor profit sharing plan this year. The reason I waited was due to the expenses involved. I am now in a position where my wife and I will put away ~$72,000 with this plan, so it makes sense for us. That being said, many dental offices go the SIMPLE rout early in practice ownership because of the low fees and minimal employee contribution. I set mine up at Fidelity without difficulty. Hope this helps.

Click to expand...

would you mind telling me your total costs (employee contributions + 401k annual fees).  did you do a similar analyses when you made the switch?  If you can do a SIMPLE with your wife and deduct 34k/yr are you coming out ahead going with the 401k?

[jfoxcpacfp]

triad wrote:

Hi, I’m an owner of a small dental practice and was trying to decide what type of retirement plan I should start now that continuing a SEP is going to be cost prohibitive.  When researching 401ks I’m having a hard time justifying the cost.  I’ve been told that a SEP is “worth it” if 80% of the contributions go to the owner, but running some calculations I’m not seeing how it pays off…

So if you put away 53k for yourself into the 401k and that is 80% of the contribution you contribute 13.25 k for the staff (lets assume that includes all fees as well).

The other option of a SIMPLE you put away 18.5k and zero contribution for staff. (3% match but guessing most staff wouldn’t bother with this)

so by doing the 401k you’re paying 13.25k to put away an extra 34.5k, right?  13.25/34.5 =38%.  Wouldn’t I be better off paying the taxes now (I’m in the 33% marginal bracket and no state income tax) and putting the money in a taxable account?

In my example I’d be paying a 38% fee for the right to defer taxes.  lets say I take out 200k/yr at retirement.  that would be an avg tax rate of about 25%.

If I pay a 33% tax now then I have to pay longterm cap gains tax of 15% when I withdraw at retirement.  And if I invest in a tax efficient way (like all VTI) dividends would be very low, about 2%/yr which is also taxed at 15%

I must be missing something, right?  Why would anyone start a 401k if my assumptions are accurate?

Click to expand...

The maximum you can contribute to a SIMPLE in 2016 is $12,500 or $15,500 if you are age 50+. So if both you and your wife are on the payroll and age 50+, you can contribute a total of $31k per year + the 3% employer match. As an employer, you can choose to contribute 2% to the plan for every employee with no match or up to 3% on a matching system. If you choose to match less than 3%, you can choose 1% for up to 2 Of every 5 years.

SIMPLES are very easy to set up and monitor. No government reporting is involved. And, as you have discovered, a 401k can be very expensive for a small business.

At the same time, you should weigh the cost of paying taxes at your marginal bracket TODAY on the difference between what you can contribute to a SIMPLE and a 401k. BUT you also will pay taxes at ordinary income tax rates at withdrawal instead of preferred LTCG and dividend rates (beyond basis) on a taxable account. For a small practice where you are not at top marginal rates, I suspect the SIMPLE will come out ahead.

I have always used a SIMPLE for my own businesses.

[scott]

As Johanna said, with the SIMPLE you and your wife can put away $25,000 + 3% match in 2016. When I had my SIMPLE in place, I matched 3% for those employees who participated.

With my Safe Harbor 401K + Profit sharing plan, my wife and I will put away $36,000 + 4% match. Employee  costs are based on what the employees contribute. Basically I match 4% of what they put in - THAT IS THE SAFE HARBOR MATCH.

For the profit sharing portion - I will determine that before I pay taxes next year. If I want to lower my tax bill, I will contribute more to the profit sharing portion - but you contribute to the profit sharing portion for all employees whether they participate or not. Based on my office census, if my wife and I max out the profit sharing portion (which we plan to do), we will be able to contribute ~$72,000 combined. If I do that, I will need to contribute around $23,000 for the rest of my employees - those who participate and those who do not.

So my total costs with the 401K look like this:

4% employee match = ~$5000

Profit Sharing = ~$23,000

Annual Fee to administer plan = $1500

So it will be close to $30,000 to fully maximize this particular plan, however I can save $72,000 vs. $32,000 (25k + 7k in match) in a SIMPLE. And the additional 30K it costs are business expenses to lower my tax bill - not to mention an employee benefit.

That all being said, unless you know you can maximize the 401K features, it is my opinion to start a SIMPLE due to the cost savings and ease of administration.

[litovskyassetmanagement]

triad wrote:

Hi, I’m an owner of a small dental practice and was trying to decide what type of retirement plan I should start now that continuing a SEP is going to be cost prohibitive.  When researching 401ks I’m having a hard time justifying the cost.  I’ve been told that a SEP is “worth it” if 80% of the contributions go to the owner, but running some calculations I’m not seeing how it pays off…

So if you put away 53k for yourself into the 401k and that is 80% of the contribution you contribute 13.25 k for the staff (lets assume that includes all fees as well).

The other option of a SIMPLE you put away 18.5k and zero contribution for staff. (3% match but guessing most staff wouldn’t bother with this)

so by doing the 401k you’re paying 13.25k to put away an extra 34.5k, right?  13.25/34.5 =38%.  Wouldn’t I be better off paying the taxes now (I’m in the 33% marginal bracket and no state income tax) and putting the money in a taxable account?

In my example I’d be paying a 38% fee for the right to defer taxes.  lets say I take out 200k/yr at retirement.  that would be an avg tax rate of about 25%.

If I pay a 33% tax now then I have to pay longterm cap gains tax of 15% when I withdraw at retirement.  And if I invest in a tax efficient way (like all VTI) dividends would be very low, about 2%/yr which is also taxed at 15%

I must be missing something, right?  Why would anyone start a 401k if my assumptions are accurate?

Click to expand...

Here is an article I wrote for Dentaltown Magazine specifically addressing the 401k vs. the SIMPLE dilemma:

http://www.dentaltown.com//Dentaltown/Article.aspx?i=403&aid=5625

The problem is that without doing an accurate side by side analysis for your specific situation there is no way to tell which plan is better.  There are simple rules of thumb in the article above, but that's not good enough if you don't fall neatly into one of the extremes (low contribution or maximum contribution). So the first step is to get a good illustration for the best design possible for your specific demographics.  Then the analysis has to be done using your specific numbers to figure out which plan would be better.  The above link shows you how we typically do this type of analysis.

When doing the analysis you have to include all of the costs (including plan costs, employer contribution, as well as the cost of keeping your money after-tax).

 

[triad]

Sounds like the 401k becomes more favorable as your tax bracket increases and if you get married...

Kon, does your scenario take into account the different tax rates of withdrawing money from taxable account vs deferred tax accounts?

[litovskyassetmanagement]

triad wrote:

Sounds like the 401k becomes more favorable as your tax bracket increases and if you get married…

Kon, does your scenario take into account the different tax rates of withdrawing money from taxable account vs deferred tax accounts?

Click to expand...

Yes, however, if you are single, you are in a higher tax bracket unless your wife also works.  For a startup practice, those in CA would really want a 401k while someone in TX might be fine with a SIMPLE, though if you are in the highest brackets, a SIMPLE does not make a lot of sense given the cost of keeping the money after-tax.

For withdrawals I have another spreadsheet.  Withdrawals are complex because you also have the ability to do in-plan Roth conversions, and that alone can bring your tax liability down, almost to the level of the after-tax portfolio!  With that in mind, I believe that the accumulation phase calculation in the article is a good approximation, however, I would still have to take all of this math and run the numbers for each individual because differences in assumptions can produce a huge difference in results.  After all, this is trying to look at aggregate numbers over many decades without getting carried away.  Our assumptions might be wrong, but as long as we are comparing two scenarios side by side, at least we would know which one is better.

[KarenPhD]

It depends on what your objectives are, how old you are, and how many employees you have.  If you want to maximize your tax deferrals now and make larger contributions than you could make with a SIMPLE, SEP or 401(k) alone now, you might want to consider a cash balance plus safe harbor 401(k).  Assuming you have the income to support it, you might be able to contribute over $150,000 for yourself now tax deferred, and keep employee contributions below 10% of total.  We are a TPA specializing in defined benefit and cash balance plans and can run an illustration for you -- no obligation, just want to inform you to make the best decision -- so you can see for yourself.