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Everything You Need to Know About Retirement Plans – Episode 53

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IRA? 401(k)? Profit sharing plan? Pension? Mosts dentists know that choosing the right plan will put them on a faster track to retirement. But deciding which plan is best isn’t always straightforward. In this episode of Dentist Money™, Reese & Ryan discuss the most important factors to consider when choosing a retirement plan for you and your employees. They also describe how TPAs, advisors, fiduciaries, and custodians can help you optimize your plan and protect you from compliance violations.


Podcast Transcript:

Reese Harper: Welcome to the Dentist Money™ Show. I’m your host Reese Harper, and this is the place where we help dentists make smart financial decisions. Today, I have a special ghost coming back to program.

Ryan Isaac: A ghost from the past.

Reese Harper: Sir Ryan Isaac! It’s a ghost from Christmas past, coming back to the show during a special time of year. Ryan, you have been traveling the country for the last few months, beating the streets, talking to dentists everywhere, and we thought we would bring you back in for a special “what’s the biggest question you keep getting over the last few months” show. What do you think about that?

Ryan Isaac: Well, what we are going to talk about today, one of the most popular and common questions, is “how do I figure out what type of retirement plan to put together my office? What do I do?”

Reese Harper: Yeah, it’s kind of like a multi-pronged question, right? It’s, “what type of retirement plan do I put together?” or, “is there a type of retirement plan that I have the right plan for my situation?”

Ryan Isaac: “How do I figure it out?” Yeah, there are a lot of prongs on this question.

Reese Harper: Can I– maybe a question for people who are a little more further along in their careers: “what can I do to my plan to make my plan get better?” or, “how can I enhance my plan? How can I improve my plan? How can I put more money away? Save more taxes? Retire sooner?”

Ryan Isaac: Yeah, we will probably tackle these in a few parts, I would assume, but there are a lot of angles to this question, like you said. Later on in their career, people want to know, “can I reduce my taxes further? Can I make this plan more cost efficient? Can I put more money away?” And in the beginning of the career, we hear a lot of questions about, you know, “I bought a practice and it has a 401k. Do I keep it? Do I scrap it? Do I start another one? I just bought the practice, and my employees are asking for some type of retirement plan… where do I begin? Who is involved in setting these things up? What do I need to know, and where do I start?” Let’s tackle some of those questions today!

Reese Harper: We also get the, “the world is ending, so why do I need a plan?” That question comes up occasionally (laughs). Do we want to address it?

Ryan Isaac: Well, or, “I don’t really trust the government; I think they’re going to come back and steal all 401k assets to pay for the national debt at some point, so I don’t want to put money in my 401k (laughs).

Reese Harper: I don’t mean to laugh; I know that these are real issue for a lot of you out there.

Ryan Isaac: I don’t argue with that question; I’m just like, “fine, then don’t do it. Pay the tax now.” There are a lot of questions here to start with. This would be the most basic one: how do I figure out what type of retirement plan is most appropriate for my office and for me personally with where I’m at financially?

Reese Harper: Well, you and me always tackle this in our conversations, usually by talking about income, you know, where people start out, and I think that’s kind of one of the big problems is that people assume that everyone should have a retirement plan, and that it’s kind of all the same thing, and that there’s not a difference between why you might want to pick one or the other, and I think it starts by narrowing down the variables that you need to know in order to pick which plan corresponds best to your income. If you’re making, you know, $200,000 a year of taxable income, you’re going to have a very different retirement plan than the person making $120,000, and very different than the person making $400,000, or very different than a seven-figure income practice. So, I don’t know, that’s probably a starting point. What would you say about that?

Ryan Isaac: Yeah, income makes a big difference, because that’s where your tax rate is derived from is how much income you’re paying taxes on. Part of that equation is, how much money is even left over? Another thing we talk about in terms of cash flow is that you could have more savings left over at 200 of income than some people do at 500 of income, you know? And it depends on how much money you are putting towards debt, and how much you are spending at home. So, one of the first places is– if we could maybe talk about that and hit that for a minute– are there some guidelines of, you know, if I can save two grand a month, for example, is a 401k appropriate, or should I do something smaller, or something bigger? At what point do I do a SIMPLE IRA, or a 401k, or a profit sharing? I mean, we don’t want to go into too much detail there, but are there some general guidelines to know, based on how much money I have got left over every month, what type of plan would be most appropriate?

Reese Harper: Yeah, I think you’re right. So first, I would say you would want to look at income, and not just how much you make, but what your taxable income is, because if you have a lot of money left over, but your taxable income is very low– not very low, I don’t want to say that, but let’s say your taxable income is south of $200,000 a year. If your taxable income is up to maybe 200,000, your total effective tax rate is not going to be super high, and so it might not make sense at that income level to do a deductible retirement plan, one where it reduces your taxes.

Ryan Isaac: Yeah, and so maybe a good place to start then, Reese, is to have a conversation with your tax advisor about where income is going to land, and what your taxable income is going to be… this is a discussion for another day, but there are two ways to think of your taxable income, right? There is the bracket system, and that’s the marginal rate, and then you have the effective rate. So you kind of just want to have an understanding of, at the highest level, what your income is being taxed, and like you’re saying, Reese, if it’s not very high, maybe consider doing something after tax for this year.

Reese Harper: Yeah, I don’t think this is a bad thing to hit initially. In your taxes, everyone’s income is divided up into brackets, and every level of income– maybe you could pull up a chart of that Ryan, if you have your laptop open, there.

Ryan Isaac: Yeah.

Reese Harper: There’s a marginal rate, meaning that if anything is above a certain income level, you pay a certain percentage on it. So, as your income rises, you pay a higher and higher percentage, and what you want to know is how much money you have in a particular marginal rate so that you can know what your savings is going to be if you do a retirement plan. Do you have those bracket levels brought up here?

Ryan Isaac: Yeah. What do you want to know? I could tell you anything about these brackets.

Reese Harper: If my income is $250,000 a year, what marginal rate am I paying?

Ryan Isaac: We’re going to assume that you’re married. Are you married?

Reese Harper: Yes. I’m married with seventeen children.

Ryan Isaac: Of course you are, and you filed jointly. You don’t file separately on that (laughs).

Reese Harper: (laughs) you are claiming all those deductions.

Ryan Isaac: Okay, so if you have $250,000 of taxable income, that will put about $17,000 of that income at a 33% bracket. So, the minimal– where the 33% bracket begins is 233 grand. So anything above 233, you’re paying 33% tax on that money. So at 250, you have seventeen grand at 33%. In that scenario, if you can say, “it would be nice to have a retirement plan where I could wipe out at least $17,000 of my taxable income, because that $17,000 is at the highest federal bracket at 33–” you might live in a state, too, where there is also a state tax on top of that, so…

Reese Harper: Yeah, you want to remember– if you’re trying to say, “well how much taxes do I save by putting money into a retirement plan?” you first find what your marginal rate is, and your CPA can tell you that, and then you have to add the state taxes to that that you will be owing in the state you live in, and that could be anywhere from 0% for some people, up to as much as 12% or 13% for some people. And so you could be—between your federal and your state taxes, you could be in the high 40s to even almost as much as 50% for some people, depending on their income level. The highest marginal rate this year, Ryan, or in 2016, was 39.6, correct?

Ryan Isaac: Yeah, 39.6, as far as we know it. That might change.

Reese Harper: And so what happens is that—yeah, I mean I guess that’s possible… it would have to change in the next few weeks. But what we’ll see is that next year, there is probably going to be some changes to the marginal tax rates, and you might see that change slightly, so just go online, google “marginal tax brackets for 2017,” and you can see it. But I think it’s fair to assume that most people probably don’t realize how much they can save by putting money into a deductible retirement plan, you know? Of some kind. We’ll go into types later, but I don’t think people realize that it’s such a significant savings over a 20 to 25-year career.

Ryan Isaac: Well, even in that example of $250,000 of taxable income, if you live in a state with a state tax rate, I mean you could be pushing upwards of 40 cents on the dollar for every dollar you put into that thing. So, that’s significant.

Reese Harper: Yeah, if I put in $30,000 to my retirement plan, I could save $12,000, right? And every year that that happens, not only am I saving that tax along the way, but the money I put into the plan, I’m not paying taxes on any of the growth, and once I get out to a later point in life, generally what we see– and I know people say, “taxes are always going up,” and sometimes that scares people from wanting to put money into a retirement plan. Do you ever get that question?

Ryan Isaac: Well yeah, that’s the hard game to play: what’s the tax rate going to be 30 years from now when I retire, and I need this money? I mean, that is a hard guessing game to play. But that’s the general consensus: it will be more expensive. That’s the general understanding.

Reese Harper: It will be more expensive for the different income levels, or most likely, but you might not be at the same income level; that’s kind of what we’re hoping for, right? So, if I’m making $300,000 to $400,000 today, or if I’m making—whatever I’m making today, hopefully I’m going to be making less money in the future when I’m not working, and I don’t have a practice, and I’m done, you know?

Ryan Isaac: By making less, you just mean… you don’t spend 300 grand a year, you only spend a hundred, so you’re taking out only a hundred in retirement; that’s your income, and it’s a smaller income.

Reese Harper: Yeah, because what you will be taxed on is just what you withdraw out of that 401k plan. And one thing we talk about sometimes is that we encourage people to have other monies to draw from as well; if they are not depending entirely on the 401k, and they are drawing on both the after-tax monies that they have—so let’s say that they have another investment account that they have already paid taxes on, and they can withdraw money from that plus money from the 401k, it can bring their overall tax rate down quite a bit.

Ryan Isaac: Yes, so I would say first, we covered “know your marginal rate, know your taxable income,” and number two, you’re talking about achieving some balance between taxable and yet-to-be-taxed money when you get to retirement, and having liquidity, and kind of achieving a balance of your savings as you go along; that would kind of be the second point. The third thing that I want to get some feedback is—you know, when I set up a retirement plan, I want to know how much money is even left over every month for me to save. I guess the principle here is that you don’t want to set up a retirement plan that you can’t fill up, you know? You don’t want to pay for an expensive plan to be put in place as a really high limit and you can’t really even get close to that limit. You might as well keep you expenses lower and put a smaller plan in place where the limits are lower that match really what you can save. Maybe we can chat for a second about how much is even left over, and how that dictates what type of plan you would even put in place.

Reese Harper: Yeah, I think we have a good foundation going here to now jump into that specific question, and I think that you are touching on something called a savings rate, and internally, we look at– the average person in our practice can save somewhere between 20% to 25% of their gross income, that’s our average, depending on the year; this year will probably be a little higher, because it seems like people have done a little bit better in 2016. But ultimately, I feel like that is the kind of main starting point as you say, “okay, off my gross income, if I’m going to be able to save somewhere between 20% and 25%,” which is reasonable—some people save 40%, some people save zero, but the average that we see is somewhere between 20% and 25%. So, once you know what that number is, you can kind of determine which retirement plan makes sense for how much money you have left over. And like Ryan said, you don’t want to have a plan that has the ability to put away more than maybe what you could even afford to do with your income. So, let’s start with the smallest types of retirement plans, and work our way up and describe each plan as it goes along. If I have a thousand buck a month left over, or two thousand bucks a month left over, and that’s all I had, what kind of plans fit that kind of income level, Ryan?

Ryan Isaac: Yeah, so going back to your point, number two, of having some kind of balance between the money that goes into these retirement plans that are yet to be taxed and have a penalty if you want the money… you know, you can think of this as a general rule. If you have two grand a month, think of a fifty/ fifty rule. And there are a lot of exceptions to this, but this is just a general rule. You could say, “I have two grand a month; it’s appropriate to put half of this into a retirement plan that will be locked up for a while, and I won’t pay taxes on it, and the other half, I’d want to probably have outside of this plan to build some liquidity and achieve some balance.” If you have two grand a month, that means you have a thousand bucks a month to put in some kind of retirement plan, and at that rate, a personal IRA is totally appropriate for that. And you know—again, point number one. Depending on your tax rate, your taxable income, and how much you’re even paying in taxes, you might choose between a traditional IRA that will reduce your tax burden, or you might find that your taxable income is low enough, and your tax brackets are low enough, and you fit under the income limits, that you might want to put that money into a Roth IRA, where you pay the tax today and let it grow.

Reese Harper: Totally! So, if I have a thousand bucks or less, I’m only doing IRAs, and it could be traditional or Roth, depending on how high my income was. If I have a really high income, I would probably choose traditional; if it’s a lower income, I’m going to use a Roth. And if I have two thousand bucks, probably the same thing? You would still say that?

Ryan Isaac: Yeah, probably close. The next step up from personal IRAs—and I mean, there are a lot of variations to this; I guess that we would have to make the assumption that this is a practice owner taking a W-2 at some level, or just not an associate. If you’re an associate, and you don’t have employees, and you have more money, there are different retirement plans that are really appropriate for an associate with no employees, you know, versus a practice owner with ten people on payroll.

Reese Harper: Yeah, let’s talk about that in a second. How about you start talking about the people who own a practice, and then we will hit the associate thought?

Ryan Isaac: Okay, so next step up, for those who own a practice and have employees, if you have the personal traditional and Roth IRAs, the next step would be to put a plan at the office level, which would be a SIMPLE IRA, and SIMPLE IRAs are—I mean, they are what they sound like: they are very easy to administer and set up; there are no other third parties that have to be involved to file tax returns, or do any kind of client testing, they are just IRA accounts for you and your employees, and the maximum for this year is $12,500 for each person. So, you know, that is about a thousand bucks a month that you could put in to max out a SIMPLE IRA, so again, going back to our fifty/ fifty rule, if you have two grand a month to save, half of that could go into a SIMPLE IRA. That’s kind of a starting point; you might want to start thinking about that.

Reese Harper: I like that. So ultimately, I’ve got IRAs, and then my IRAs can allow me to put away, you know, up to—I don’t know, we might want to say up to $3,000 a month, even. I would say if you’re at $3,000 a month or less, I would probably look at a regular IRA, a traditional IRA, or a Roth IRA.

Ryan Isaac: Yeah, at the personal level. Yup.

Reese Harper: If you’re an associate, you could also, at that level, probably consider something called a SEP IRA, and a SEP IRA is an account that generally, if you have employees, doesn’t make sense, because you have to match them at a very high percentage. You have to match them at the same percentage as you put away for yourself, but that SEP IRA could allow you, as an associate, to put up to $53,000 a year away. Is that right, Ryan?

Ryan Isaac: Uh huh. Yeah, so for example, I was just on the phone this week with a client of ours who is an associate working at a couple of practices, and he takes an income into his own corporate structure, and doesn’t have any employees in that corporate structure, and so he has about—I think he had 4,500 bucks a month to save. And so, a SEP IRA for him was really appropriate, because it allowed him to put—I think his goal was to put about $2,500 of that money every month into this SEP IRA, which would allow him to put a lot more than if it was just a traditional IRA with a limit of 5,500 bucks, you know, he can go all the way up to the $53,000 limit. He won’t hit it, but he could go that high. So yeah, for an associate, that was great. If he had employees, though, he would have to match them at the same percentage that he is giving to himself, and that just becomes really expensive. So most of the time, as soon as you buy into the practice, the SEP IRA is usually off the table.

Reese Harper: So, what about if I’ve got—I’m starting to get to three, four, five, six, seven thousand a month. Let’s talk about what my options are kind of in that structure. You talked about a SIMPLE IRA, and that SIMPLE IRA, you can do $12,500 this year per person, so that would let you put about a thousand bucks a month away. But if I’m hitting 4,00 or 5,000 a month, like you said, 50% of that savings, if I want to put that away into a qualified retirement plan, I have more than enough to do a SIMPLE IRA. So, now I’m looking at a 401k plan; a 401k plan lets me put away $18,500 this year, instead of the $12,500, so that’s the reason I might pick a 401k plan over a SIMPLE IRA. But, there’s also some downsides with a 401k that you may not want to start considering one for a while, and those are the costs that come with it, right?

Ryan Isaac: Yeah, I would say that is probably the next common question. When we start putting these retirement plans together, people want to know, “who is involved? Who do I gotta pay? Who do I have to get involved?” Before we jump into that, there is a caveat to consider here, and this is a tax question to ask your tax advisor, but there are circumstances where the owner/ doctor can put a spouse on payroll. And again, tax question for your tax advisor, but that’s something to consider too, because if you have a thousand bucks a month for yourself going into a SIMPLE IRA, but you have the ability to add a spouse to payroll, I mean you double that, and then it’s 2,000 a month.

Reese Harper: In some circumstances, people have spouses who are doing work, and who are not receiving any wages or any compensation for that either, you know? And if you have a spouse that is involved at some level in the business, then there are potentially some big advantages to having them contribute as well to the retirement plan instead of taking that income home. I met someone yesterday, actually, whose spouse was receiving a wage from the company, and they had a 401k plan in place (laughs)–

Ryan Isaac: And she wasn’t putting money in it.

Reese Harper: Yeah! She was taking it home, and they were like, “yeah, we just bring it home and get paid,” and I’m like, “really? That’s interesting.”

Ryan Isaac: (laughs) well she prefers that, probably.

Reese Harper: And this someone had a really high taxable income, so they had plenty of money left over to be able to take home more money if they needed to through distributions, but the spouse that was working for the practice and taking a wage was not putting any money into the retirement plan, and that was costing them a fair amount in tax every year to not take advantage of that, so…

Ryan Isaac: Definitely. Okay, so back to your other question then: who is involved when they set up a retirement plan?

Reese Harper: That was actually your question… not mine. (laughs) just kidding.

Ryan Isaac: Yeah, that was my question; good call (laughs).

Reese Harper: So, let’s talk about how many hands are in the kiddie jar here, when we start setting up a 401k plan.

Ryan Isaac: Well, we can back up. With your IRAs, personal IRAs, there is no one else involved. I mean, you can go directly to a custodian, you can go somewhere online and set up an account, you can do that directly. A SIMPLE IRA is pretty much the same thing; there is a three-page form that you have to file, and keep on file at your practice, but nobody has to be involved. I mean, you can certainly self-direct a fair amount of that. The first retirement plan that comes in to play where– I mean, technically, you could do this all yourself, but I don’t know one dentist that does every part of a 401k by themselves, and I wouldn’t recommend it ever, obviously… but the 401k is the first plan where other people are involved, and you should involve them, and there is a handful of them.

Reese Harper: Yeah, and it starts to get more complicated, because you have to fall under new guidelines. There are what is called fiduciaries, and if you don’t outsource, or have someone else become the fiduciary over some of these areas in the retirement plan, then you end up assuming the liability as the employer, the dentist. In most people, that is what ends up happening. But let’s just describe generally the jobs that need to be done when I set up a 401k plan, and then we’ll talk about maybe different people that you can hire to do those jobs, and what they cost, and stuff like that.

Ryan Isaac: Okay. I’ll list a few; tell me if I miss any. One of them would be a third-party administrator, often referred to as a TPA. Do you want to go through the jobs of each one of these first, or just list them?

Reese Harper: Yeah, let’s just list them first. So you’ve got a TPA–

Ryan Isaac: Yeah, a third-party administrator… you have a record keeper– a lot of times that is the same person as the TPA, but technically, it’s a separate job– you have a fiduciary that mentioned, you have a custodian, and then you have the advisor.

Reese Harper: Yeah, the investment advisor. And I think technically, there are three fiduciary responsibilities in the ERISA code… they list out one called a 338 fiduciary, one is a 316, and one is a 321. So, these different fiduciary responsibilities require these people to do things for the plan. Let’s take the first one, though.

Ryan Isaac: The first one: TPA, third-party administrator. Who are they? What do they typically cost? Why do they have to be involved?

Reese Harper: I mean, the third-party administrator takes all of the information, everything that is happening, and they prepare reports for the Department of Labor so that you can have your retirement plan be above board, and be considered compliant. So you have to file forms– kind of like a tax return every year– called a 5500 form, and that sheet has a lot of information on it, like, how many people were eligible, you have to keep track of Social Security numbers for each employee, and report how many hows they work, and you have to report what they get paid, and you have to report the plan assets, and whether there is insurance on the plan, and bonding, and all that stuff, and so you have to do that job. That is generally what the third-party administrator does, and they are working with the record keeper, who is the person who keeps track of the money, kind of like an accountant for the 401k plan. And so, maybe let’s talk about that; I’ll let you clarify anything about that that you want to.

Ryan Isaac: I think that’s good. I would just say, the third-party administrator job, it’s just a really really big job, and the bigger the plan gets– you know, if you go from a 401k plan, to adding profit sharing, for example, the compliance factor that has to be adhered to becomes so much more complicated and more strict. All of the sudden, there is new testing rules that you have to stay in all these different bounds based on different scenarios in the plan, and so it’s just a really big job. Do you want to talk about costs?

Reese Harper: Well, let’s finish going through the people. So we had the record keeper, we had the TPA, then we have a custodian. The custodian is the bank that actually holds the money; the physical bank where your money is being held. They are going to be the ones who buy the securities, and who buy the mutual funds inside of your plan, and these roles that we are listing right now, you can set them up where each one of these people is completely an independent person, or in some cases, they are going to be all the same person. And when we talk about costs, it will help make sense of this a little bit, but the custodian is basically the bank, or the place where your money is being held. The investments inside of these plans are maybe one thing that we need to clarify, too. If you are hiring an investment advisor, sometimes that investment advisor will work for the bank, or the custodian, or sometimes that investment person is the TPA, or the record keeper who will give investment advice on the plan as well. And so, I think the most important question here is, is there someone whose expertise is really investments? Who knows the difference between expense ratios and fund performance? Who is really an expert on selecting investments for your plan, both for you as a doctor, and for your participants? Because the investments themselves– I mean, that drives the performance of the plan, and without a good investment lineup, it really devalues the plan in general, and your employees won’t value it if it’s not performing well, and if they don’t have a high-quality investment menu to pick from. That’s a big issue.

Ryan Isaac: That’s on the top of my mind; I just got an email last night from a client who bought into a very large practice with a 401k plan that has been going for a long time that is set up, administered, and advised from the bank– they are all the same person– and you would be very disappointed in these funds, Reese. You would be very angry right now. All the funds are expense ratios of like– some of them are 2%, man! And there is only like, twelve to choose from… it’s frustrating. You need someone who is going to have some accountability to keeping that down. The last job here that you touched on is the fiduciary. Sometime, that is confused with the investment advisor, but in a 401k plan, the role of a fiduciary is slightly different. And it sometimes feels like, “I don’t care. I’ll save some money. I’m not going to pay for someone to be the fiduciary. Nothing will ever happen.” But that one time that something ever happens– I mean, there is a huge amount of responsibility that comes along with that.

Reese Harper: Totally. And I think that dentists don’t realize that depending on who you hire, these fiduciary duties that we are talking about– they are primarily, like… picking the investments is one, and the other fiduciary duty is making sure that all the matching, and all the accounting is done properly, and that everyone who is eligible gets money, and there is good education done on the plan. You have to make sure that the main fiduciary, like the primary fiduciary in the plan, is responsible for picking the investment advisor, and they are responsible for making sure that the plan is run properly. And what you’ll see is a lot of the third-party administrators– and this isn’t necessarily a bad thing– a lot of them aren’t taking any fiduciary responsibility off your plate.

Ryan Isaac: Which keeps cost down. I mean, that is kind of some of the purpose to it.

Reese Harper: Yes, that will keep your cost down. So, if you don’t want to spend hardly anything to set up a 401k plan, then you can go online, find a document that you can buy that kind of sets up all the rules of your plan, you can pick a few options, and then you can go open investment accounts, and then you can have your payroll person run checks, and match employees correctly, and get the money into these accounts, and in that scenario, you would probably have an almost free 401k plan, I mean, pretty close to free, right? But you would assume the responsibility of the investment fiduciary; you would also assume the responsibility of making sure the accounting was done properly, that your employees got the right education, and that all of the matching was done, and that people who were hired in the practice knew what the plan was, and when they could enroll… so, if anyone has any beef in that scenario where you DIYed the whole thing, you are on the hook for it.

Ryan Isaac: Yeah, it comes back to you. I was asking a third-party administrator a couple of weeks ago what the most common lawsuits are against fiduciaries of 401k plans. I thought the first one would be lack of education, you know, someone comes back and claims, “I had no idea, and I picked something, and my accounts went down, and I’m suing you for it.” It turns out that the number one lawsuit, the most common one, is just having too expensive of funds in the account. So people, employees, are coming back later and suing the employer or whoever is responsible for it and saying, “hey! You only gave me options of really expensive funds, and that hurt my retirement,” and those lawsuits are being won and settled a lot. That’s the number one reason.

Reese Harper: Wow. I have heard that too, and I wasn’t sure if that was still the top one. I know that was number one or number two, but there are a few that are kind of really important; you would think they were happening like that, you know? And I feel like the thing that is probably important to clarify is that if you don’t want to take on some of those responsibilities, the plan will get inherently more expensive for you as an employer. You’re going to have to pay some flat fees, or some hourly rates, or–

Ryan Isaac: Let’s talk about that, maybe. If I set up a 401k, what are my expectations?

Reese Harper: You can do one for free if you want to just do all the work yourself.

Ryan Isaac: So we have a free plan; it’s all on you.

Reese Harper: (laughs) and I have seen people try to do it, okay? And then you have plans, you know, where you don’t want to pick the investments, you don’t want to file that 5500 form, and you want to completely offload all the fiduciary responsibility onto other people. So you, as an employer, don’t want to assume any of those fiduciary roles. You can do that, and there are third-party administrators, and record keepers, and investment advisors who will assume those liabilities for you so that if the Department of Labor comes back to you, and you are having an employee dispute, you are not on the hook, and these people can kind of step in and handle that. I think you should– in those kind of scenarios, a good expectation for a fixed amount that you should be paying for a really well-done 401k plan… if you can do it all for $2,500 a year, I kind of feel like that is probably pretty reasonable. If you are at $1,500 a year, you found yourself a deal, but if you are less than that, what is probably happening is you probably have some of the fiduciary responsibilities that you have signed off on, and you just might not know about it. Like, you probably are the fiduciary (laughs), and you probably just don’t know.

Ryan Isaac: You don’t know until the lawsuit happens.

Reese Harper: Yeah, and so what will happen is, everyone listening to this is probably like, “oh, I’ve got a TPA, I’ve got an investment guy, I’m all good! Like, I’m not the fiduciary.” What you will probably find out is that if you will look (laughs), you are the investment fiduciary, you are the 316 plan administrator, and you are the 321; you are all three of the fiduciary responsibilities; they are one your plate, but you think you have offloaded them all to other people. And all those people are doing is getting paid to provide a service to you, rather than assume the liability. And that’s not necessarily important–

Ryan Isaac: Like, impossible, or like someone couldn’t navigate that.

Reese Harper: And I don’t know. For a small small plan, it’s not like the liability there is going to be super severe. If you wanted to save a little bit of money, and assume some of the responsibility… but you just need to know! Ask the people you are working with, “am I the fiduciary on this plan? Am I the plan administrator?” Those are two kind of separate questions; you are going to have the administrator, and then you are going to have the main fiduciary, and then you are going to have an investment fiduciary. Find out from your investment person, “are you the fiduciary, or am I the fiduciary?” We recommend the 401k plans and platforms that we implement: we use a lot of different TPA’s, we have a lot of different record keepers, and the ones that we prefer working with are the ones who assume most or all of the fiduciary responsibilities from the client so that, you know… I mean, I don’t know how you feel about the people you work with, Ryan, but my clients generally don’t have a really good understanding of what is going on; they don’t want that liability.

Ryan Isaac: Yeah, and the thing I was going to do in addition to that: sometimes, it’s not all about scary liability, or, “someone might sue me.” Some of this is just about, how much time do you feel like you want to take? Or, how much expertise or interest do you even have in holding a plan meeting twice a year to satisfy the requirements in teaching your employees? Or, every time you hire or fire somebody that has to fill out applications and ask questions about, “what box do I check? Where do I sign?” Like, do you want to deal with that? Or do you want to just say, “here’s an 800 number; here’s a website; they’ll walk you through it.” How much do you want to offload, and how much do you want to take on to your own plate?

Reese Harper: A lot of this is just about time; it will burn up a lot of your time if you don’t have the right service providers in place. Okay, we talked about those roles a little bit, and picking the 401k plan… let’s talk about steps above the 401k plan, because that is a really really important segment. The 401k plan is going to allow me to put $18,500 per year. Is there anything else I can do? Let’s talk about profit sharing plans and how those work, Ryan; I’ll let you take it from there.

Ryan Isaac: Yeah, so like you said, the next step up– and what we mean by that is just the amount of money you can put into a retirement plan from a 401k– would be profit sharing. Now, profit sharing is usually just in addition to the 401k. So usually, you are still putting away your $18,500; if you have a spouse on payroll, your spouse is also doing that. But in addition to that, you can do profit sharing. Now profit sharing shares the same limit as the SEP IRA does that we talked about earlier; it is still around that $53,000 limit. It changes; it gets indexed and changes every couple of years, but it is right around there this year. And so, what it allows you to do is that if you put in $18,000 or $18,500 or whatever your limit is for the 401k for that year, it allows you to put in an additional amount up to the 53. So, that’s where the profit sharing comes in. Now, profit sharing then becomes a lot more complicated. The way that they determine– well, let’s back up. How do you determine how your employees get a match in a 401k? Usually, it is pretty easy; it’s like a flat 4%, or some people are really generous and are giving a 5% or a 6%. Usually, it’s a flat 4%; if they contribute that much, it’s a match; a lot of employees don’t participate, so not much match gets paid. In a profit–

Reese Harper: So, just backing up really quickly, because I am getting lost with all your knowledge, here. So, if I am setting up a 401k plan, I have two options: I can either give people money without them having to contribute, or I can match them, right?

Ryan Isaac: You can do either one, yeah. And the most common is a match.

Reese Harper: The simplest scenarios are the match, right? I mean, that is the one that is most common.

Ryan Isaac: Yep.

Reese Harper: Because you just said most people don’t take advantage of– a lot of employees, even if they are educated on it, they may not take advantage of that match, so it limits the employer’s out-of-pocket cost for the plan. But if you want to do a profit sharing plan, generally, you are going to have to switch that mindset around in order for it to test well, correct?

Ryan Isaac: Yep. So, in a profit sharing plan, now you go from maybe you are just matching people who put in money, to you are giving money to everyone no matter what they do. So they might not put in a dime of their own money, but you are giving them a certain percentage every year. And that is where it becomes more complicated, because now, we have introduced to this equation a series of tests that have to be satisfied that determine, you know, if I, as the owner, contribute x amount, what is the percentage that goes to all the employees? And there are a quite a few of those that happen, so do you want to talk about how that is determined, Reese? What kind of information you have to figure out?

Reese Harper: Like, I think it is important to just clarify that there is that safe harbor rule– some of you might have a safe harbor plan. That is a provision that is an ERISA provision that has a matching formula that Ryan just talked about that makes it to where you don’t have to do testing every year to make sure the plan is fair. Testing is what is required every year to make sure that the plan stays fair for everybody.

Ryan Isaac: That owners are not putting in too much for themselves, and skimping on the employees; that is what the testing is for.

Reese Harper: Exactly. So if I am going to switch, and I want to put in as much as $53,000 a year for myself, then I am going to start doing what we call nonelective contributions, where I have to give employees money. Typically, you see that starting at right around 3% as kind of the minimum non-elective contribution. So, if you look at your entire payroll and you say, “hmm. If I could put away $53,000 a year, and I had to give everyone of their annual salaries,” then you add up all your payroll, you could say, “okay. Well I’ve got $200,000 a year in payroll across my staff,” or “I’ve got $300,000,” or “I’ve got $400,000…” you know, the bigger your staff payroll on an annual basis, the more you are going to have to give away. 1% of $200,000 would be two grand, so 3% would be $6,000. So on $200,000 of annual payroll, you might have to put away $6,000 a year or more; you may have to do a little bit more depending on ages; the older that people are, and the more that they make, the more that you will have to contribute on their behalf in many cases. But this is very much an art; the testing, and the “how much you can put away for each person,” it’s not brainless work, here. This isn’t just like a formula that is one size fits all, and there is no flexibility. I mean, the more competent your third-party administrator, and the more competent your record keeper… the more beneficial the formula and testing usually is on the doctor’s behalf. At least, that is what we have seen. People who spend time on this regularly come back with different outputs than people who don’t (laughs). It’s funny, I will send out two censuses, right, to two different third-party administrators, like, “I want to have testing done on this plan. Can you tell me– here’s the payroll amounts, here’s ages, here’s hired dates…” You give these two different censuses, and they come back with these totally different solutions for the plan. Has that been your experience too?

Ryan Isaac: Yeah (laughs). It is kind of an art; like you said, it is a little bit of an art. This lends itself well to the question we wanted to ask today: how often should I look at my retirement plan? How often should I consider making changes to my retirement plan? We haven’t covered… I mean it goes up– maybe you want to stick on that for a for a minute, Reese– above a profit sharing plan. Now, we start introducing what is called the defined benefit plan; those are also referred to as pensions sometimes. And then, there are mixes of plans where you mix pensions and profit sharing… there are just a lot of different ways that you can mix them. When you start getting into the pension world, that is when you can get above that $53,000 limit per person, and you can get into the multiple six figures of pre-tax money.

Reese Harper: Yeah, I mean to answer a couple of your questions… one, I would definitely do this testing at least once a year; I would make sure that, on an annual basis, I was giving– like, in our firm, on an annual basis, we collect a census from clients who want us to do this. If we have a comprehensive financial planning client, we will reach out to their office manager, gather the census, and then take that to the third-party administrators, and have them run another test to see if there is any additional contributions that we can make during that year. Every employer has a different staff ratio– ages are all very different– and those change throughout a twelve-month period! And you would be amazed how one hire or one age change– you know, you used to have a 27-year-old, and now you have a 41-year-old, or you had a 46-year-old, and now you have a 33-year-old, or your hygienist just got swapped, or whatever. Those changes that happen every year totally change the matching and the testing, and so you need to do it once a year, because most of the time, you are already paying a flat amount per year to have these third-party administrators do your filing for you, and as a service, they usually just add on the testing so you can, if you have a financial advisor, or an office manager, or someone who is willing once a year to kind of get that census to the third-party administrator and have them run their testing, then you can make big adjustments that add up to be a lot of money. And you talked about this cash balance plan, or the pension world… I mean, we are talking now– like, it’s a very very important world, and it is kind of the one where we spend a lot of our time, which is people who can save more than $15,000 a month. It is people who have way more than they can put into a profit sharing plan, and they have tens of thousands of dollars every month that they want to defer. In this kind of scenario, you combine pension plans with profit sharing plans; you combine these two worlds together, where a pension is kind of the old school retirement plan that GM or Delta used to have, you know? Where you start working there, and you work for 30 years, and when you retire, you get six grand a month forever.

Ryan Isaac: The company pension. We have one of those.

Reese Harper: We just started one never (laughs).

Ryan Isaac: (laughs) the ol’ company pension.

Reese Harper: It is going away, because they have been replaced a lot with self-directed, independent plans, or defined contribution plans like the 401k, or the profit sharing plan, because they are just really really hard to keep in force once a company grows and becomes really large. It just becomes a huge financial commitment, and one that is really hard to project. And so, in a small business, it is a little bit easier where you will have– just this week, I have wrapped up three different cash balance plans that I feel good about; one is a high-income specialist who has twelve people on staff, and they have had twelve people for nine years, and they know it isn’t changing, and they can really kind of see what the next ten years are going to look like, and they are able to put away a lot of money. I mean, this particular plan, I think, is a 39-year-old or a 40-year-old specialist, and it is in the high hundreds, you know? Probably $169,000 in deferral, and 90% of the total contribution, or 92% of the total contribution is going to the practicing doctor, and that is a big big deal, you know? And it makes a huge difference. Those kind of plans, though, have different– they have even another person who comes into the mix which is an actuary, and an actuary is someone who has to run the defined benefit plan calculations to see how much you can put in each calendar year. They have to look at the rate of return that the pension plan gets, and all these pension assets get held in a different account. So, this is a different thing from the profit sharing plan, but the combination of the profit sharing and the defined benefit plan result in these large deposits. Is that enough for you to chew on, Ryan?

Ryan Isaac: That’s enough for me. (laughs) I’m done! I mean, that was really good. Okay, there were two other questions that we wanted to here, which are: do all retirements have the same investments inside of them? And if I buy a practice that already has a plan in place, what do I do? Those would be the two last questions that I think we get a lot. The first one is, do all retirement plans have the same investment plans in them? And I would add this, because you hear this a lot: sometimes, there is a mistake in assumption that the plan in itself is an investment. Like, you will hear people say, “I don’t want to invest in a 401k; that’s a bad investment.” You know? Or, “I don’t want to buy the 401k; it hasn’t performed well.” So, I think that it’s important to make the distinction that all these things we’re talking about, whether it’s an IRA, a Roth, a 401k, a SIMPLE, a pension, cash balance… those are just types of accounts that have special taxation rules mandated by the IRS and the Department of Labor that allow you to put certain amounts of money, and deduct that from your income tax, but those are independent; not the investments; separate and independent from the investments themselves, and what goes inside of those. These are just buckets that hold stuff.

Reese Harper: Yeah, so I get that quite a bit. Like, “I’m not gonna do a 401k because all that happens is that it just goes down, down down.” And I’m like, “well you could do a 401k and just not invest the money! It would just sit in the money market; you could put it in a money market account (laughs), or you could put it in a high-quality government bond portfolio that is the full faith and credit of the U.S. government, and you could make 2% a year, or 3% a year. Or yeah, you could put it in tech stocks, like you did, and lose it all (laughs).” I think it is confusing to people. And here’s the truth: if you don’t pick the right custodian, the right bank, you are going to be really limited in your investment options. There are independent custodians who give you unlimited investment options: you can have ETFs; you can have individual securities; you can have a self-directed brokerage account that lets you buy anything under the sun. Or, you could have like three investment options, or five investment options; they could all be proprietary mutual funds offered by the custodian, because the custodian owns those mutual funds, and they want to promote them. I mean, you want to pick an independent custodian who allows you to have an unlimited investment selection. And the investment decision is completely separate from the plan decision. The investments should be the same across any of the plans you pick; you should pick the same high-quality, best-of-class investments, no matter if it is an IRA, a SIMPLE IRA, a defined benefit plan, or a profit sharing plan. The investments that you can put in those plans should be identical.

Ryan Isaac: Based on the same philosophy and same allocation that you would do in any type of plan, or any type of investment account.

Reese Harper: Yeah. But that is an investment discussion, and if you are feeling like you don’t have an investment-focused person involved in this, then that is where you need to make some adjustments, because you won’t get a high-quality investment suggestion unless someone is always looking at it, and updating it, and understanding that they need to make adjustments to the plan. No one investment is good enough for 40 years, you know? I mean, you do need to look at this periodically, and there are changes that a good investment advisor will want to make, to either add investments to the plan, or to make adjustments to the percentages that you might have in a particular portfolio. In our situation, we build investment models that kind of have recommended targets, and we have the ability for participants to say, “I want to pick fund,” or “I want to build my own percentages, or my own mix,” or “I want to use one of these models,” or “I want to use something that is completely self-directed, and I want to buy stuff that I just want to buy on my own,” and so a good plan design allows for people to have that kind of flexibility.

Ryan Isaac: Okay, I think that is a pretty good description of investments in there. Like you said, I think that is another discussion for another day, but a good distinction to make: investments are independent from the type of account you set up. So last question: I buy a practice; the doctor has had this 401k plan in there for fifteen, twenty years… do I just keep it? Do I look at something different? Should I start my own thing? I will add in here, out of all the clients we have had who have purchased practices with a previous retirement plan, even if they have decided to continue the same type of retirement plan, the exact same type, they have always closed the old plan and started a new one. I have always understood that to be kind of a liability issue; you don’t want to take on liability from old clients. We have seen in situations, Reese, where someone is closing out a plan after twenty years of participation, and then found out that they didn’t fund it right fifteen years ago, and they still owe money back to employees, and it wasn’t calculated the right way… I mean, we have seen that happen, so I think as a general rule, if you are buying a practice that has a plan in place, you want to know– some of this decision of what type of plan that we didn’t really talk about has to do with the demographics of your practice, and, you know, is this a retention tool? Is this something people really value highly at the office? And that might sway you from a SIMPLE IRA to a 401k because you have some key employees that really want that higher limit, and that matters to you to make them happy and keep them happy, but I would say–

Reese Harper: Or, you might have a crazy profit sharing plan in place that you are getting no benefit from, you know?

Ryan Isaac: They are getting like a flat 5% giveaway every year–

Reese Harper: And you have a big staff, and you’re drowning in funding…

Ryan Isaac: We have seen that too. General rule of thumb, I would say, close the old one and start a new one.

Reese Harper: And you know, the plan assets can be moved into the new plan, right? If your employees want to have them. I don’t want to say this as an every case, but in many cases, you will want to do that. I have seen a lot of situations where there is just liability that comes up because of the way a plan was funded… or, I had a situation that I am thinking of right now in my head where there was an unfunded liability, like a huge unfunded employee liability, meaning there was a profit sharing balance that needed to be put into a plan, but the old doctor didn’t ever put the money into the plan, and so–

Ryan Isaac: It wasn’t malicious, right? (laughs)

Reese Harper: It wasn’t malicious, he just kind of spaced it. And it was like 40,000 or something that never got funded for employees in a given calendar year from like four years back, and the new owners having to deal with that reality, and just like, “crap. That’s my money out of my pocket now that I have to put in there, and I can’t go back to the old seller and reclaim that money from him because he’s done, and I can’t reach him. He didn’t even give me a cell phone number.”

Ryan Isaac: (laughs) he’s gone! He gave me the keys, and he’s gone. So, I would say a good rule of thumb is to have someone with whom you can discuss the dynamics of this plan. Just because you bought the practice with a 401k doesn’t mean, even if you’re going to put a plan back in place, it doesn’t mean it has to be a 401k; I have seen two practices in the last few months that were purchases, and they had a 401k, and they actually ended up putting a SIMPLE IRA in place, because that matched the owner’s investment goals, the owner’s tax rate, and the employees didn’t even care. I mean, it didn’t matter to them. It didn’t really change too much; the match is slightly different between a 401k and a SIMPLE IRA, but he made that up in an after-tax bonus, and they were happier anyway, because they could go spend the money today. But you know, have someone you can look this with and say, “what type of plan should I start with now? What’s most appropriate for my business and retention? What’s most appropriate for my tax rate and how much money I even have to put into this thing, and what is my cash flow?” Just kind of start with a clean slate on that; I think that is the best way to look at it.

Reese Harper: I like it. Just as a closing thought here, think about your retirement plan decision as maybe one of four major types. If you have less than 4,000 a month– actually, let’s say associates first– associates, if you have 2,000 or less per month, I would probably just go with personal IRAs. If you are above 2,000, I would go with a SEP IRA. If you don’t have any employees, I probably wouldn’t be doing a solo 401k plan, because even a solo 401k plan is going to cost more than a SEP IRA. As long as those rules are in place, I would be looking at a SEP or just an IRA if I’m an independent contractor or an associate. If I am an owner/ doctor and I’m 3,000 a month or less, I’m still looking at an IRA as my primary retirement savings tools. If I have somewhere between 3,000 and 7,000 a month in savings, I am looking at a SIMPLE IRA to a 401k plan. The low end of that, I would probably still be sticking with a SIMPLE, and the higher I get, I would probably be looking at a 401k plan. And whether I use a Roth or a traditional 401k is again a function of my income. Again, lower income, I would probably tilt Roth, and higher income, I would probably tilt traditional, unless I had so much savings, and I was just really anti-government and whatever, then you can go a Roth, and that is fine too, if you just don’t trust government and their taxes. I am personally a traditional IRA saver, so…

Ryan Isaac: That’s now a qualification on an application: are you anti-government? Yes or no. Okay, yes, now here’s your option.

Reese (laughs) okay, now if you are above 7,000, let’s say 8,000-15,000. Somewhere in that range, I’m probably going only profit sharing; I’m not bringing defined benefit plan into the mix unless I’m a– let’s say a 15,000-a-month saver or greater. Maybe 14,000, maybe 13,000, but generally I would say about $15,000 a month or greater, I would be considering myself a cash balance, pension, or a defined benefit plan, combined with a pension plan, that kind of a save, right? I think it is just important for people to have those ranges down, because you see the wrong plans being used in the wrong circumstances a lot.

Ryan Isaac: Thanks for taking time Reese, this was good to do. We’ll stop there, that’s good. Thanks, Reese!

Reese Harper: Carry on!

Retirement Plans

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