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By ignoring your office retirement plan, are you making a seven-figure mistake? On this Dentist Money™ Show, Reese and Ryan talk about qualified retirement plans and why a yearly review makes such a huge difference. You’ll hear why the cheapest 401(k) provider may not really be the least expensive. And, you’ll find out how to avoid getting surprised by employee plan fiduciary responsibilities and liabilities from falling on you, which occurs more often than you think.
Reese: Welcome to the Dentist Money™ Show, where we help dentists make smart financial decisions. I’m your host, Reese Harper, here with my trusty old co-host, Sir Ryan Isaac.
Ryan: Okay, so I have a question this morning, and everyone listening can think about it: picture the last time you were laying in bed at night, almost falling asleep, and the little beep of a distant smoke alarm started chirping somewhere in your house. Can you think about that? What did you do when you heard that chirping? What was your first instinct?
Reese: I put on my headphones and turned on the white noise app.
Ryan: So you ignored it. I usually just try to pull a pillow over head and try to ignore it too. If you can’t ignore it, what do you do? What’s the default?
Reese: Just go pull the battery out! Or you hit it with a small hammer. I do have one of those small– it’s not a sledge…
Ryan: (laughs) You hit it with a small hammer? You have one of those ball hammers?
Reese: It’s a mallet! A rubber mallet that you use for a variety of household chores doesn’t damage the furniture–
Ryan: Raise your hand if you’ve used a mallet for a variety of household chores. I’ve used a mallet once before…
Reese: There are six people in the studio, and five raised their hand; you’re the only one that didn’t.
Ryan: I’ve used a mallet once when laying some brick, because you’ve gotta, like, cut the brick…
Reese: I don’t believe you were laying brick; not yourself. You were supervising it.
Ryan: No, I did! The patio! I really did it. I laid a brick paver patio once.
Reese: And then you retired from manual labor (laughs).
Ryan: (laughs) Yeah, I did. Anyway, back to the smoke alarm, most people go and they take the battery out, and then they are kind of like “I don’t know,” and then they replace it at some point. I have some statistics, but today we are going to talk about how ignoring your smoke alarm and taking your battery out it like your retirement plan. Obvious connection, I know, but check this out. This story also brings up a really emotional point for me which is the show This is Us. You’ve seen it, right? Are you caught up?
Reese: I’m a little behind, but I think I was the one that originally told you to start watching it, and what did you say? You said, “I hate crying.”
Ryan: I don’t want to cry, I know it’s going to be emotional… I don’t want to go through that. I just want to watch something funny at the end of my day. But I watched it all, and it was hard.
Reese: Since you cried during the entire day you didn’t want to cry at night (laughs).
Ryan: Yeah! Basically. It was such a good show. For anyone that’s listening who hasn’t caught up on This is Us, I’m just going to say push pause or skip ahead thirty seconds, because this has something to do with it. Let me read you some stats here: three out of every five home fire deaths occured in homes with no smoke alarms, or they had smoke alarms that did not work. The death rate per hundred in home fires was doubled in residences with no working smoke alarm compared to ones that did have it. They also found that in 46% of the fires, when a smoke alarm didn’t work, it was due to a missing or a disconnected battery, and dead batteries entirely caused 24% of the smoke alarm failures. Dead batteries cause a quarter of smoke alarm failures. So, this month is our qualified term month. It’s part of our Elements®, it’s in the bottom row. Maybe you can explain about the bottom row–
Reese: Well I’m still stuck on this fire alarm business. Are you saying fire alarms– they work, but we don’t take care of them?
Ryan: The point is, fire alarms represent something that we should pay attention to, or have some kind of maintenance on–
Reese: So they matter?
Ryan: They matter! That is the point of the stats, that a non-working smoke alarm is responsible for a higher percentage of deaths in house fires. It’s something we should pay attention to, though normally we don’t, because it’s annoying, because it doesn’t feel like an emergency or a priority, and because it never chirps in the day. Has it ever chirped in the day?
Reese: Never. It knows better!
Ryan: It knows it’s night time. It chirps at night, we remove batteries, and we don’t put them back in. Hence the show This is Us: they were supposed to buy the batteries. If they had bought the batteries, we would still have Jack with us, and I wouldn’t have cried so much.
Reese: Spoiler alert! You could have also said Jack worked a smoke alarm manufacturing plant and not given away the analogy.
Ryan: But this is the month– it’s on the bottom row of our Elements®, and you can go to our website, dentistadvisors.com, hover over services, click on Elements®, and in the middle of the page you’ll see a big Elements® table. The bottom row is where we talk about somebody’s net worth: where are they accumulating assets and wealth? Is it liquid? Is it retirement plans? Is it private businesses and practices? Is it real estate? And what we are measuring in this month is how long someone could survive if they took the money in their qualified retirement plan, which is IRA’s 401k, paid the taxes, and then kept spending how they are used to. What we found when we went through this data, we have some cool statistics from our own client base, is that, and we find this when we meet dentists we haven’t worked before, retirement plans are often like smoke alarms: they are things that you kind of just put in place once, and often ignore for years at a time. And sometimes we pull the batteries out, and it kills us. It’s a pretty direct correlation, I think. So, how about you just explained a little bit on why we measure this. Do you want to go through some statistics first? Because I have some cools stats from our clients.
Reese: I’d actually be interested in hearing those.
Ryan: Okay, let me tell you these. What percentage of someone’s overall net worth is tied up in retirement plans? Here are the averages for the age groups. This was kind of interesting: up to age 35, 12.5% of someone’s net worth is tied up in like an IRA. Then it drops to 8.9% between 36 and 40. So I think you see that what happens when someone comes out of dental school… usually, the only thing they have is an IRA that they put some money into, or maybe they had an associate job, or the spouse had a job where there was a 401k plan. And there is no other liquidity; they don’t own a practice, they don’t own any real estate, so it’s a fair amount. But then it drops from ages 36 to 40, and the it starts building back up. From in your 40s at around 11%, into your 50s at almost 12%, and then it jumps at age 56 and above to 19% of someone’s overall net worth. So, the average person over 56 years old has about 20% of their net worth in retirement plans.
Reese: And just a clarification: you are saying that that many percent of people… you’re talking about dentists, and more specifically you’re thinking about the dentists we work with?
Ryan: Yeah, I’m saying the dentists we work with up to age 55 have up to 11.6% of their net worth tied up in retirement plans, and then 56 and above, it’s almost 20%. So I think this goes to the point that we talked about where people have the best opportunities later in their career to add more money to bigger retirement plans. At some point of your 50s is when big profit-sharing plans, and pension plans, and cash balance– that’s when it makes the most sense. Usually someone has the highest cash flow, their debts are gone, or mostly gone, and they just have a bigger opportunity to pile a lot of money. So it was just kind of cool to see the data confirm what we’d like to happen in someone’s life, where they spend the early part of their career building the practice, building liquidity, and then taking advantage in that last decade of piling a lot of money into qualified plans to save on tax rate.
Reese: And that data is confirming the advice that we’re giving people. Probably not the general population, maybe. I mean we don’t have average data across all of our listeners, but in my experience in the past couple of days, I have had conversations with people in their mid 40s to 46, 47, or 48 where their retirement plan contributions have shifted dramatically as early as 45 years old.
Ryan: What do you mean, shifted dramatically?
Reese: They’ve gone from putting $5,000 to $16,000 a year away in 401k to where they are putting $160,000- $170,000+ away. Now, if they waited until their late 50s, they could even do a little bit more, but I think you want to start maximizing– the only reason that you wouldn’t want to delay your larger retirement plan contributions is if you had also delayed all of the early saving from 35-45; if you didn’t save after-tax money early in your career, and you didn’t have a lot of liquidity outside of retirement plans, then you kind of have to play catch up. And what I’d say is I’m hoping that more people start to shift more of their net worth towards qualified plans. In our reporting it was saying late 50s, and I’m hoping to get that to more of the early 50s for high-income individuals, and for the average income earner, it would probably still be the mid 50s, just because the more you earn the more you can accumulate in your early years in after-tax moneys. And really the goal here is to find a nice balance between the two: not accumulate too much in qualified plans, and not accumulate too much exclusively in after-tax assets. But man, the last few days, I’m just getting texts, and emails, and phone calls of people who are like, “man, that really made a difference in my taxes!” Right now, we’re doing these contributions for 2017 in big DV plans, like finalizing our contributions after we’ve extended taxes, and it reduces taxes by tens of thousands of dollars, and it some cases, it’s been as high as $85,000 dollars. It’s just significant! And I’m not saying that will happen with everyone, but the higher your income is, the more impactful it is, and this analysis of retirement plans is crucial.
Ryan: Yeah I thought it was interesting just to see kind of where averages end up, and towards the end of someone’s career how much they can expect, how much of their net worth is going to be sitting in one of these plans, because part of this equation too is about what happens after this. The other 30 years that you live after working when you access this money, you have to pay tax on it, and so the balance of when you take that money and how you do it in combination with other things… that matters a lot to your planning, and it matters a lot to your investment returns, and to your investment plan, right? Another thing I thought was interesting too from the data was what percentage out of all the investable money someone had was in qualified plans, and for most age groups, it was like ⅓, except at the end again, the above 56, where they are kind of just loading these big plans at the end of their career. Now this changes, though, when someone sells a practice for a million bucks and then dumps that back into after-tax liquid accounts; that will kind of balance things back out, but… kind of interesting. Okay, so here is what we’d like to get into today; I have a list of questions. So, as we ran these reports, and as we reached out to all of our clients, and we talked to them about the plans they have, and all of the adjustments they could make, and we got questions back, today is kind of a list of some of the some common questions we were asking and the clients were asking us when we were going through these plans. And again, this is kind of like how the smoke alarm is like a retirement plan, you know? And you just said it: it makes a big difference. I’ve been telling people that the retirement plan is so important, because it’s one of the most proactive, consistent things that someone can do for their taxes on an annual basis. There will always be a one-off purchase, you know? Or like a tax code thing that you can take advantage of, or maybe there is a bookkeeping thing that you do in one year, or some kind of depreciation thing, but the retirement plan is the most consistent, proactive thing that you’ll be able to do for your taxes every year, and the largest. Would you agree with me? Is there something bigger and as consistent for a tax reduction that you can do?
Reese: Well the advantage of it over everything else is it still ends up being in your net worth; it’s not money that leaves your net worth. The thing with a lot of other tax planning tools or deductions or expenses is that the money leaves your net worth, so your net worth is reduced. Even though you saved taxes, your net worth goes down, because the cost of the expense exceeds the tax deduction, so the 401k, the retirement plan, the cash balance plan, the profit sharing plan, any retirement planning contribution you make, not only does it increase your net worth by the amount of the contribution that you are making, but you are also getting an additional net worth increase by having taxes deferred and you keeping more cash in your pocket, because you didn’t have to pay those taxes, and you can defer it out into the future to hopefully a point of time where your income is lower, and to where that same tax burden doesn’t exist at the same rate. Which is likely, so…
Ryan: Alright, so let’s go through some of these questions that we’ve been asking clients and that they’ve been asking us. The first one is kind of more of a general question: what can actually change in a year? Why look at this on an annual basis? If I put a 401k in my practice, what’s going to change in a year? Thoughts?
Reese: Well I think that your taxes change quite a bit in one year, meaning you might not have the same tax rate that you had, and so there are reasons for people in the early phases of their career to look and make sure that they still want to being doing tax deductible contributions instead of Roth contributions into your 401k. If your income shifts a lot because you have a bunch of appreciation, buy a building, do a cost segregation study, and advertise things aggressively for a few years, you might want to shift your contribution strategy, because your taxes are already super low… why not take money in those years and put it towards Roth contributions instead of deductible contributions if your taxes are already super low?
Ryan: Sure. Another thing that is a big deal is that staffing can change so much year over year that you could have entirely new options year over year. Do you want to explain that a little bit?
Reese: So every time that you do a retirement plan analysis, you have to look at the ages of your staff, what they make, and the hire dates that they’ve had, and a new formula can be determined to decide how much money you can put away, and the demographics of your practice affect how much money you can put away for yourself versus how much you have to share with your team, or how much you get to share with your team, depending on you you look at it. So as you age, and as your staff ages, the contribution formula is very different than it was the previous year. And it might be as little as that you can get an extra $5,000- $8,000 away by relooking at it year after year, or it could be, like in the case of one of my clients this year, it shifted from where it was making sense to put away $32,000 the previous year to where this year we’re putting away $188,000.
Ryan: That’s crazy! $150,000 difference at a 35-40% top-bracket rate.
Reese: Yeah, well at almost 50% in this guy’s case, you know, with state, and medicare surcharge, and so it’s hugely significant. And if I’m not there testing that every year, and looking at it every year, what ends up happening is that it just doesn’t get re-evaluated.
Ryan: It’s the smoke alarm. And then you’re going to die.
Reese: Yeah, and most 401k administrators, and most 401k platforms, there is not like a built-in incentive for them to go through and do this painful testing every year, because it costs a lot of money–
Ryan: Well and you have to do it twice, because at some point during the year, before it’s too late– so any changes you have to make to your plan officially, the deadlines are in the fall. They happen in September and October. So, you have to run it early enough in the year to go “yeah, we’re probably going to want some kind of change,” and that might actually require some sort of plan structure change that is due by the fall, then you have to do it again at the end of the year to get the official end of year number when payroll is done, and everyone’s hours are finally done, and all the new hires… yeah, so it costs money, and it’s a pain to do.
Reese: So, our clients that are in our Elements® process, they are paying us to do this analysis once a year proactively in June– well we are doing it in May, and then we are reporting on it in June. Maybe it’s because all of my personal clients aren’t responding to me until then; that’s why I’m thinking it’s June. So ultimately, I think if you are not analyzing this mid year, you can’t really prepare for– like right now, in the middle of the year, if you’re in defined benefit plan mode, you’ve had to wait until all your census filings were complete, you’re still filing for 2017, and you’re preparing for 2018. And so usually what happens is that people don’t talk to you about this until it’s too late for you to plan this from a cash flow perspective, because no one wants to be told in December that they’ve got a $100,000 deduction that they need to make to fund a plan. I had a question that came in yesterday from one of our clients who is doing a large defined benefit plan contribution, and he’s like “man, cash flow is a little bit tight right now, but I definitely still want to take advantage of this deduction. What can I do?” And we figured out a plan to where we could take some of his after-tax money, because he had been saving really well for the past seven years in after-tax assets, and I was able to take some of the money out of that account, liquidate it in a tax-efficient way so he wouldn’t pay a lot of capital gains taxes, and then transfer it back to him personally, and then he was able to put that money into his practice, and then the practice made the contribution into the defined benefit plan. So because he had been consistent as a saver, and we had had a high savings rate, even though he didn’t want to take this whole contribution from the practice to fund the defined benefit plan, we still had ample amounts of liquidity in his after-tax account that we just transferred from after-tax to pre-tax, and ended up getting the same tax deduction!
Ryan: Well that’s a good point, man, I mean, I can think of quite a few clients that are doing either profit sharing, or defined benefit or cash balance, and if you know ahead of time, if you have enough time that you are going to fund $100,000 into a plan, you don’t want to wait until December, or next March to do that. Now, you don’t want to over-fund the thing, because you don’t know how it will grow, and you don’t know the exact end of your funding, but if you can say “on average, I need to put in $8,000 a month through this whole year to fund my profit sharing, so I’ll put it $5,000 just to under-do it a little bit, and then I’ll just catch up at the end,” that’s way better if you can plan ahead for that stuff.
Reese: It takes a lot of planning. I mean, it takes a really proactive financial advisor to understand how to invest the money properly, it takes a good actuary who can get numbers to you in a timely manner, and then it takes a good platform to be able to execute the trades, give you good investment options… I mean, a lot of times, people end up going with what I’d like to call the cheap 401k option…
Ryan: Okay, this is the next question: what is the difference between 401k providers? There are thousands of them out there! Does it matter where I set up my 401k?
Reese: (laughs) I just got a spreadsheet from someone the other day, and it had columns in it. Shout out to 401k column guy! And I’m sure there’s a few of you listening who are like, “I’m column guy.” But in these columns, there was investment fees, annual fees– they were trying to compare ten different 401k providers, and the cost was all within probably $500 of each other. There are ten platforms. And you could tell from his analysis and spreadsheet that he was just trying to find the most optimally low-cost option. Now the challenge with that is that for a platform to be the optimally low cost, it also has to have to optimally low amount of staffing, the optimally low amount of service, and the optimally low amount of customization (laughs).
Ryan: And only the youngest employees.
Reese: Yeah, I mean what I’m saying is that the platform you use… if it’s cheap, it’s because there is very little service, and why do you care about service? You care about service because you’re not just going to have a straight 401k plan your whole career: there are many variations between IRA 401k, profit sharing, and defined benefit plan. There are dozens of variations, different matching outcomes that you want to test, and if you don’t have a good service provider there who is getting paid enough to do testing with you, and to be around when you want that testing done, you could sit for six months waiting for data to come back, and that’s happened to us many times with the wrong providers, and the wrong platforms. So if you’re trying to just say, “what is the optimally low-cost 401k plan” because you know that you’re never going to do anything but a 401k, that’s very different than if you’re saying, “you know, I’m going to be on a glide path, a variety of plan options, from Roth 401k clear to cash balance pension and straight DB, and there’s five different plan times, and I just always want to have the most optimally tax-deductible option for myself throughout my entire career,” well that’s going to require a very different platform, because most 401k platforms don’t even have any integration, or any communication with defined benefit providers. They’re like completely separate, and so it’s difficult to pick the right platform. For us, it’s not perfect; it’s still a challenge, and we feel like we have really really excellent platforms on both end of the spectrum, but it’s still challenging, and it’s not the cheapest option that gives you the most customization, and that means that every plan has to get tested independently every year, and no plan looks the same. No plan has the exact same investment lineup, and no plan has the exact same matching formula, or the exact same census, or the exact same requirements; you don’t even have the same payroll providers; it makes it harder to integrate properly. So, if you conform to the lowest cost 401k plan, you’re conforming to the most– I don’t want to say it’s the least restrictive, but it has to be restrictive in order for the platform to charge so little, which means that you are not going to be able to get the level of customization that you want. That’s why I guess we just want to encourage people to understand that not all qualified plans are created equal, and not all qualified plans take on the same level of responsibility, which is a whole different topic.
Ryan: So you hit costs, which I think is great, and investment platform, your ability to choose between investments will vary quite a bit, you know, tech, and ease of use–
Reese: Yeah, by investments, I mean some plans have a straight mutual fund lineup, some have a mutual fund plus ETF lineup, some have an unlimited investment flexibility where each participant can have their own personal account, and trade any stalk, any bond, any option, I mean, you can have a lot of flexibility within a 401k platform, or you can have a lot of restriction, and you just want to know what your plan allows, and what rules you’re setting up for your plan.
Ryan: Well and on the cost thing, here’s what’s interesting though, is that it’s not usually as straightforward as people think it is. There are four or five costs, some of them are small costs in a 401k, but the big ones are that you have an annual fee that you have to pay, and usually, if that annual fee is on the smaller end, it’s because the other fee that is being charged in a 401k plan, not from your advisor, but just from the 401k platform, is the percentage fee inside of the account. And usually, it’s kind of a game in the industry, right? Because usually a 401k company would say, “we know we’re going to be on the smaller end of the market for a long time, so we’re going to maybe charge a higher annual fee up front, like out of pocket, and then smaller percentage fees. Or it might be the reverse. They might know, “our market is going to be large plans, so we’ll lead with a smaller annual fee, but a higher percentage.” There is kind of a game between them; it changes. Here is what I was curious about, though, too, if you want to take about it: there’s a whole side, what you were just saying, to responsibility back on the doctor’s shoulders of, if it’s really cheap, the service, and the responsibility, but then also the fiduciary responsibility. So, if there are any problems, or a lawsuit or something in a plan, you want to know where the responsibility lies, you know? Who’s it with? Is it the provider that will take everything on? Will they answer all of your employees questions? If an employee wants a loan out of their account, if they just want to take all the money and cash it out, who’s going to handle all that stuff? Who’s going to file the paperwork? But ultimately, who’s responsible for if there are errors, or any legal problems or anything? And you’ll pay more to offload the responsibility and the fiduciary liability, you’ll pay for that.
Reese: Yeah, the fancy words for this are– you have three or four different formal responsibilities that have to be handled in a plan: there’s a 316 fiduciary, there’s a 321 fiduciary, and a 338 fiduciary. And each of those roles, in most cases, the doctor unknowingly is assumed all responsibility for each of those roles, so you are ultimately responsible for the investments that are in the plan, the proper filing of the plan, and then the compliance of the plan.
Ryan: And then notices to employees, and the proper training to employees–
Reese: Yeah, and usually, you just don’t know that. So usually, the 401k plan you’re going with… they’re just holding the money for you, but you’re responsible for all the liability, and if you don’t do it right, it doesn’t matter– the plan’s not responsible for you not doing it right. Some plans will say, “we are the 316, and we’re the 321, and we’re the 338,” and that allows you just to have no legal liability to the department of labor regarding your 401k plan, and that’s worth paying for in some cases. Everyone has a 401k, but some of these 401k platforms and plans do the thing you want it to do. What you want to do, and I might just be the lazy one here, but if you’re like me, you just want it to work really well, and do its thing, and you want them to tell you when to do something, but you just want to have to like, click a button; you don’t want to have to do a lot; you want to tell someone else to click a button, like “this thing runs itself and I’m not worried about it. I’m getting the maximum out of tax deduction every year, people are telling me what to do, where to put the money, I literally just tell them to draft my money…” it’s more autopilot, and if it’s not that, then to me, you’re not getting the same thing that I’m getting, because I’m getting the autopilot version that gets my maximum amount of tax deduction, someone else is proactively monitoring it, taking all the risk in responsibility, and that does cost a little more, but I don’t care, because I just want my time back, and I just want to dedicate my time to more productive activity. There’s just a cost to doing it the right way, and I want it done the right way. You want the outcome of a maximally-reduced tax rate, personally, and putting the most money you can away at the best ratio between you and your staff based on that exact year, and all these factors, and so, there is a cost to doing that.
Ryan: What about—this is kind of along the same lines, but we hear this frequently: should I just use the 401k that comes with my payroll company?
Reese: Yeah! (laughs)
Ryan: You get that a lot! Like, “it would be easier, Reese, if I just used the payroll company’s 401k. How many clients have we had that used the payroll company’s 401k and then didn’t, like, a year later?
Reese: Yeah. How many of you have built a house, and then the builder said, “just use our x y z. Use our lender.” And you’re like, “okay…” It looks like a good deal, and it might literally be, but there is something going on there that at least you want to know about and figure out a little bit more.
Ryan: You’ll trade something for that convenience; there’s a cost.
Reese: And it’s usually a poor construction job on your house. Just kidding, (laughs) because they only make money on the loan, and they don’t care about the house construction? I don’t know. We’ll see; it’s hard to know. But ultimately, something has to give when you’re getting a
“two-fer.” When I was in Santiago, Chile for a few years in 2003, I always bought myself a “two-fer”. Now a “two-fer” was literally what they called it in Spanish: it literally said “2-F-E-R” on it, and they took pieces of yellow tape, and they wrapped it around two objects, and they would call it a “two-fer,” and you’d get anything you wanted that was a “two-fer”: there was Oreos, there was any number of food objects, but the thing I thought was most interesting is that there was stereos, boomboxes for your shoulder, wrapped up in yellow tape with a “two-fer” around it. One for each shoulder (laughs). And so, you’d get a “two-fer.” Now, there was always a catch, though, and you never knew until you got it out of there. A lot of the time, the “two-fer” cost more than the “one-fer”, but you just thought it was a good deal. So, I don’t know. I just don’t like bundles.
Ryan: Well that’s fine. So, the short answer—and it’s a common question, should I just use, out of convenience the 401k that comes with my payroll, the short answer is no, probably not—
Reese: The short answer is probably not? For sure not! But, I don’t know.
Ryan: Talk to us. Call us!
Reese: Actually, there are a couple of platforms where I’m like, “that one is actually pretty decent.”
Ryan: Based on the things that we’ve already talked about, yeah. So, if you want to know if your platform is good, you can text us. The 800 number is cool, because not only can you call it, but you can text is. 833-DDSPLAN. Shoot a text! We’d love to text you.
Reese: I’m going to tell you in thirty seconds the philosophical reason that the “two-fer” is actually a bad deal, okay? Why your 401k in your platform is probably not a good idea. Every business has to make choices about where to put its resources, okay, and if it makes money on one thing, and subsidizes or gauges in another area, then one of those two products is going to suffer. So, if you’ve got a “two-fer”, and you’ve got a boombox wrapped up with a shovel, which I did see (laughs), then one of those two things is probably subsidizing the other. Either the boombox is mediocre and you’re getting a high-quality shovel, or the shovel is mediocre and you’re getting a high-quality boombox, but you don’t know. And I’m just saying, in the 401k, it’s classic: you’ve got the payroll, and you’ve got the 401k platform, and one of those is going to win over time. Whichever one is ultimately the biggest money-maker for the company, they’re going to reinvest profits in that one, and not in the other one. So, the service you thought you were going to get that was a good option will eventually get less profits resources reinvested back into it, because it’s just not the thing. And eventually it will just disappear, and that’s usually what happens. You’ve got this 401k platform by the payroll company, they make all their money on payroll, and they’re just trying to get more margins, so they try to add a 401k platform, and then they realize that they can’t run it as properly, and it requires another set of infrastructure, so they just quit offering it, or quit supporting it.
Ryan: You’ve talked about this in some of the live events that you’ve done in speaking recently, but, the question is: how do you built the right mix of assets between qualified and non-qualified? So, one of the measures in our report during QT month is this little bar, and it’s got two colors on it: one of them is grey, and one of them is purple. The purple represents how much of your money is qualified, and the grey is all of the rest of it. What we’re trying to do every year is we’re looking at someone and saying, “basically, out of all the money you have, here is the mix between after-tax and pre-tax, and there are consequences on either side of that.” So, the question is, how do you know what is the right mix? We kind of have a general rule, or philosophy, when someone is setting up their first savings draft. Someone’s got $10K a month to save. As a general rule, or a starting point, let’s try to keep things balanced, you know 50/50 balanced. If we go one or the other a little bit more, that’s okay. How would you explain trying to keep the right mix of assets between those two, or a good balance?
Reese: I think a simple way of thinking about it would be that early in your career, you should be focused on building money outside of the retirement plan, except at maybe a minimal level. Most people listening to this are going to be able to afford to put money into a 401k, and then save some more, and as long as you’ve got more left over than what you’re putting into the 401k, or at least as much, then I think you’re probably fine doing the 401k. If you don’t even have enough to do that and save extra money comfortably, then I don’t know if you should be doing the 401k yet, unless you have ample reserves already, like if you’ve got maybe two months’ worth of overhead in your practice plus six months of living expenses personally, then maybe if your taxes are going to be high, and your income is going to be growing, then you could break the rule for a short period of time, because your income is going to be growing soon. But I think ultimately, you just want to focus on the liquidity early, and don’t get obsessed about the 401k, to the point where even if you passed on it for a year or two, and paid down some high-interest debt that was very truly high interest, and that was small balances—not big balances: don’t just take a chip at debt—but if you have some small high-balanced loans, I think that that is more important than some tax savings initially, just because your tax rates are probably not that high early in your career. The right mix, though, later on… I mean, like you were saying, it is pretty hard statistically to get to where people have more than a third of their investable assets in 401k anyway—
Ryan: Even that last push at the end of career…
Reese: Yeah, now if you push really hard there in your mid 40s, and you go for ten, twelve, fifteen years putting money into one of these larger plans we’re talking about, you might be able to get up to a 50/50 mix, but if you’re just the average person not planning, I see the only amount—these are our clients we’re talking about who have a third, because we are pushing after-tax savings like crazy as a priority. But most people, the only thing they have at the end of their career is a 401k, and for the average American, that’s normal. I mean, that’s a normal thing for the average person at what we’ll call the medium-income spectrum: you should probably only have money in a 401k, because you didn’t really have enough after-tax discretionary money to start building up money outside of the 401k, and your income is not going to be dramatically higher in retirement than it was during your career, and so it probably—the reason that it’s so important for a dentist to build after-tax assets is because your standard of living… everyone’s standard of living is based on their income, and you’re used to spending a lot more, and you have to accumulate a lot more in after-tax assets to support the standard of living that you’re going to want to have. And that’s why we see dentists retiring so late: they just don’t accumulate enough in order to keep the same standard of living, so they’ll just keep working, and let that social security benefit defer and kick up to its maximum, and then, really, the average person will then retire.
Ryan: Well I think that’s a lot of it, though, too; a lot of it’s based on income. The average dentist should have more money than can fit in a 401k plan, even if you put a spouse on payroll. And that’s just where it has somewhere else, and you want to maintain a good balance over the course of your career.
Reese: I think the optimal balance is to never miss any possible tax deduction that you can get ever, as long as you’re saving at least that much outside, until you are at the point where—it’s okay at some point, probably in your mid 40s to late 40s, and in some cases early 40s, but I’d say it is more likely to be late 40s—where the demographics of your practice is shifted, and you already have a lot of after-tax assets, then shifting to a straight DV contribution where your contributions go really high into there, then I’m fine with that, because you’ll never really be able to catch up to that total mix on assets anyway.
Ryan: So I was just going to say, I was just checking this out on our website, we did a podcast not too long ago on… the title is like “Everything You’d Want to Know About Retirement Plans…” what we did on that episode is we broke down how to know which retirement plan is probably most appropriate for you, or at least where to start looking based on the amount of money you have left over every month, because that is really what we’re saying, like, for example, it costs about $1,500-$2,000 a month to fund one person’s 401k including match for a whole year. So, if you want to have balance, if you’re trying to maintain an approximate 50/50 balance, that means you’d need $3,000- $4,000 a month to be able to do a 401k, maxfund it, and then have some money outside of it too. It doesn’t do much good to like, do a little bit there, and to pay the cost of having a 401k, when you’re not even going to maxfund it, or take advantage of it fully, or put everything you have and not get anything else out of it. So, I think it was called “Everything You Need to Know About Retirement Plans”—
Reese: Yeah, so that’s Episode 53 for those who want to check that out. To kind of pose an opposite example for our listeners who are at the extreme other end, in a lot of cases, you’ll have people who are saving, like in this case of the person a few days ago, it’s north of $20,000 per month going into after-tax savings that then is shifted, almost entirely, to pre-tax at the latter part of their career.
Ryan: But, how old is he and what is his situation like?
Reese: Now we’re in our late 40s—
Ryan: He’s seven figures liquid, after-tax money—
Reese: Yeah, in after-tax money, and we’re probably 25% in pre-tax, which is super healthy, and now we’re going to shift to where we go all pre-tax, and probably end up at more of a 70/30 to 60/40 mix of pre-tax to after-tax, at the point to where work is optional in the next few years.
Ryan: But that’s totally healthy, because he’s got a large amount in after-tax, and he’ll sell a business that will be debt-free or almost debt-free when he sells it, which will translate into after-tax anyway—
Reese: But it’s just interesting to see how to him it wasn’t a big deal to make this transition. It was just like, “we’ve started early in our career with a high savings rate, we’ve got in the habit of saving a certain amount of money automated every month,” and then all we’re doing is, periodically every year, I’m just shifting some of that savings that used to be after-tax, I’m just saying, “okay, this year, instead of having x amount of after-tax, you know, $18,000 of after-tax, and $4,000 of pre-tax, we’re going to go $15,000 and $7,000, and now we’re going to go $10,000 and $12,000.
Ryan: That’s totally balanced because of the way he did it in the beginning of career. And now, I mean, the tax savings on that, then what does he do, then there’s liquidity left over sitting around that would have gone to taxes—
Reese: And we can either use that new tax savings for debt reduction on his second residence that he bought that’s finally his family vacation property, or you can use it on additional after-tax savings to build up your retirement liquidity as well.
Ryan: Okay, so to recap this: Reese, are there any main takeaways, as you went through with your clients this month and gave them feedback, any takeaways for someone who is maybe not monitoring it this closely? Any advice?
Reese: I would just say that retirement plans are a 7 figure decision, easily, in net worth, that you’re making by avoidance—like if you’re not proactively doing this, we’re talking easily that this is a 7 figure mistake that you’re making by just saying, “you know what, I’ve got my 401k, it’s good, and I’m fine.” By not being proactive in letting your 401k plan advance and getting more complex to allow you to put more contributions away… for the average person. There are some of you who own a multi-practice DSO, and you have way too many employees, and way too many locations—
Ryan: I was just going to say, there is a segment of this that it just doesn’t apply; you can’t participate in it in the same way.
Reese: And the only reason you’re doing a 401k plan in those situations is to provide benefit to your team. And in our business– that’s more of the case in our own company. I don’t have the ability with the way our company is growing, and the way our demographics are, it just doesn’t make sense for me to use my qualified plan as a place where I’m going to be able to take advantage of it like most of our listeners will.
Ryan: So, there’s some people listening with multiple locations, and 30+, 50+ employees—
Reese: Well you can do it on even as many as two to three locations, depending on the staff mix, and I mean, I’m doing it right now with a multi-location practice with several associates, it’s just, you have to get the associates on board, and they have to be willing to take a reduction in their associate comp in order for them to get the higher retirement plan contribution, which is not fun, but they want to do it because they are paying taxes anyway, so it still can be a win-win, but the bigger you get, and the more employees you get, then all the stuff we are talking about… it still applies, but it applies at more of a minimal level, right? You’re just going to do the minimal referrals rather than trying to maximize your plan contributions.
Ryan: Okay. On our website, this is one of many discussions we’ve had about retirement plans. We’ve had guests, retirement plan experts, and CPAs come on the show where we’ve talked about this. If you go to our website, dentistadvisors.com, and click on “Education Library,” you can scroll down and then filter for retirement plans, and there are probably like a dozen plus episodes in there, and if you would like to talk to us about your situation specifically, you can call us at 833-DDSPLAN, or text us, because that’s cool, or you can go to our website and book a free consultation, so go to dentistadvisors.com, and click on “Book Free Consultations”, it’s a big button right on the front, so it should be pretty easy, and you can pick a time on our calendar, and we would love to hear from you. So, thanks for joining us today, and we will see you soon!
Reese: Carry on.Retirement Plans