The Doctor’s 401(k) Solution

Doctor's 401(k)I saw a post on Facebook from an Orthodontist asking his community about retirement plans.  I was compelled to respond since my partners and I have The Doctor’s 401(k) Solution, a Pension Plan Administration firm (Third Party Administrator or TPA) in addition to the CPA and Financial Planning firms.

The question was about SIMPLE IRA’s versus 401(k) plans and I ended up posting a rather lengthy response.  Here it is:

There are SIMPLE IRA’s and there are 401(k) Profit Sharing Plans. SIMPLE IRA’s have a 3% match that applies to everyone equally including the doctor. If an employee defers 3% or more of their wages, up to a limit of $12,000, the maximum contribution by the practice owner is 3% of that employee’s wages. If an employee does not defer, they do not get a match. One does not need the services of a Pension Plan Administrator for a SIMPLE IRA or a SEP IRA because they are not “Qualified Plans.” 401(k) Profit Sharing Plans are qualified plans and do require a pension plan administrator. Do not use an insurance company or payroll service to set up a 401(k) plan as they are very expensive. They are sold as free or inexpensive, but the truth is that they are not. Do not use a brokerage firm either because they lack the necessary skills to properly construct a plan for a professional practice and they will only offer products or funds upon which they are paid. There are innumerable nuances, like those that exist in moving teeth, that only a reputable administrator can work to your benefit. As for administrators, most accept revenue sharing from brokers or mutual fund companies. Ask prospective administrators if they do this. If they do, you will be saddled with mutual funds that have high internal fees (expense ratios) or “loads” to cover commissions and other costs that you need not pay. Pension plan administration will cost $2,500 – $3,000 annually for a practice with 5-7 participants in a “pooled trust.” This means that there will be one account for everyone in the plan as opposed to separate accounts for everyone. You will be told by many that segregated accounts protect you from being liable for dumb mistakes your employees make with their investments. In fact, the opposite is true. As the owner of the practice you have a fiduciary responsibility to your employees to do what is right for them. By allowing them to make their own investment decisions, you open yourself up to being liable for poor performance in their accounts. In other words, if they lose their money in a segregated account, they can hold you responsible. Think, “you didn’t tell me the coffee was hot before I drank it.” The “Prudent Investor Rule” states that if you invest in a portfolio of low-cost, diversified mutual funds designed to capture market returns (Modern Portfolio Theory), you will have met your fiduciary obligation to your employees. And, when using an independent, registered investment advisor to implement and manage such a portfolio, you will find that they stand beside you as a co-fiduciary. If they do not, move on until you find one that does.  There are online platforms for 401(k) plans that are pretty cost prohibitive until you have a dozen or more employees. Staff will ask about this option because they might have a spouse who works for a large employer through which everyone has online access to all their employee benefits including the 401(k) plan. The key term to focus on with all this is “Transparency.” See my previous post, Transparency in Investing.  Make sure all the costs and professional fees are clearly disclosed pursuant to the law. The disclosures for the low-cost or free plans are extremely difficult to find for obvious reasons – the costs are anything but low and they are nowhere near free. For a plan using a reputable TPA, such disclosures will be clearly and boldly stated. The administration fees of $2,000 – $3,000 are just like those for your tax returns – professional fees that should be paid with pre-tax dollars. So are the investment advisory fees even though most advisors require an automatic draft from the retirement account. Why pay tax-deductible fees from your tax deferred retirement plan account? Have them drafted from your practice operating account or make other arrangements to pay them automatically on a pre-tax basis. These advisory fees will run in the neighborhood of 1% of the assets being managed. Lastly, there are costs built into a mutual fund called the “Expense Ratio.” The SEC requires mutual fund managers to express their operating costs, including commissions and marketing fees, as an annual percentage like the rate of return on your investment. The average expense ratio for a domestic mutual fund is 1.4%. Thus, if the rate of return on that fund is 10.4%, the amount earned by the investor is 9% (10.4% minus 1.4%). A low-cost, well diversified portfolio of passively managed mutual funds should have a weighted average expense ratio of about .30%. One may easily find a mutual fund’s expense ratio on the mutual fund’s website or by searching online. See my prior posts, An Index by Any Other Name and Choosing an Investment Advisor.  A final word… A retirement plan is a great employee benefit. The manner in which the investments are managed can be a real gift from you to the staff or an expensive nightmare. Do your homework. Ask your Dental CPA. Don’t be sold. Be prudent. You and your employees will have a much more satisfying investment experience as a result.

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