Most people know that saving in a 401(k) plan is one of the primary vehicles to wealth accumulation. For a business owner—starting your own plan also offers special tax incentives to the employer.
Like any 401(k) savings plan, it gives you the opportunity to save in a tax-deferred savings account. The business owner perk? You can defer more—all while being creditor protected.
There are two types of contribution types in these plans:
1. Employee contribution: This type comes out of each employee’s paycheck and has a maximum annual funding limit of $19,000 or $25,000 if you are over 50.
2. Employer contribution: This type is funded by the employer for either themselves or for the staff. The maximum per person for the employer is $37,000.
Business owners can leverage both types of contributions for a combined tax-deferred savings of $56,000 or $62,000 for those over age 50 each year. When you also consider employed family members can participate in this program, the opportunity is even greater.
This increased owner funding opportunity does come at a cost—which is the amount funded to the staff member’s plans. This is why plan design and testing are so important.
CPA and Financial Planner Brittany Frazier says, “There are many different ways to do compliance testing. The level of sophistication is not the same in all plans or providers. It’s important to recognize that all third-party administrators are not created equal.”
This is where the details and terms and conditions of the plan can get especially complicated. Over the years, Brittany has reviewed dozens of plans for her clients and recommends that owners pay special attention to the following three items before choosing a plan administrator:
1. Pension Proposal: When you are looking at plan options, the first thing to ask for is the pension proposal. The proposal will show the associated costs and staff funding requirements based on the census of employees for the business. The third-party administrator (TPA) must be able to produce favorable testing results by maximizing the contributions for the owner.
2. Fees: It’s important to request and review administration fees, participant fees and transaction fees that may be associated with the plan. A listing of investment options and associated investment fees are also important to review. Ones to look out for—recordkeeping/plan level fees, advisor fees and investment fees by dollar amount or percentage of AUM.
3. Fiduciary Responsibility: It is important to understand that as the business owner and trustee of these plans, you will always have a fiduciary responsibility to the plan participants. Regardless of the varying fiduciary roles plan providers take on for the business owner. The owner/trustee of the plan is required to make prudent decisions tailored to their plan. This includes offering sound investment options to the plan participants, ensuring fees are kept reasonable, and meeting administration-related responsibilities. This fiduciary duty comes to all owners/trustees no matter the arrangement you choose.
“Many small-business owners find it appealing to use one provider for all aspects of the 401(k) plan, and with all the bundled plans out there, it can initially seem appealing,” says Brittany. “However, once they get into the details of the agreement, these seemingly lower cost options can actually end up costing the client more.”
With all these considerations to be made; oftentimes “low-fee” options are not as transparent as they may first seem. Be skeptical on “prototype,” or “bundled” plans—in which the document, administration and investment portions of the plan are managed by one single third-party. In many cases, testing against these types of plans will uncover that clients are unable to maximize owner contributions. Typically, what Brittany has found is that un-bundled plans provide better results for her clients.
As a business owner, you’re used to handling a lot of responsibilities outside of just practicing dentistry—everything from drawing up detailed business plans to managing your monthly budget. The thought of selecting, starting and funding a retirement plan for your entire office may sound overwhelming. It doesn’t have to be.
Just as Brittany does for her clients, it’s always a good idea to have an objective and trusted party review the plan proposal.
“Understanding the differences in the plan types is an important exercise,” Brittany says. “If you are operating a plan that doesn’t match your business needs, you could be missing out on important tax benefits, or possibly making mistakes regarding employee contributions. However, if you do it right—it can make a big impact on your long-term savings goals.”
If you have questions on this topic, or others related to tax benefits of owning your own practice, contact us for a complimentary consultation.