At first glance, the only difference between small practice and large company retirement plans is the number of participants. Everything else would seem to be identical – both plans have a Third Party Administrator, a record-keeper, a custodian, an investment adviser, mutual funds, contributions to employees and individual participant accounts. Despite the apparent similarities, small practice and large company plans cannot be more different from one another. Understanding how small practice plans are different from large plans is important for small practice owners because most plan providers specialize in working with large companies and they are not capable of addressing the full scope of issues that small practice plans will encounter. In this article, we’ll explain how small practice retirement plans are different from those of large corporations, and discuss a number of important issues, including the types of services a small practice plan needs and the criteria that can be used by practice owners to select the best small practice plan providers.
Practice demographics
Small practice demographics can have a significant impact on plan design, and any changes in practice demographics can require changes to the plan design, which is not true for large company plans.
1) A practice with a younger owner and older employees or an older owner and younger employees might require two very different plan designs, and if a younger owner hires an older employee the plan might need to be redesigned.
2) Adding family members to the payroll can have a significant impact on small practice plan design and has to be taken into account, especially if this happens after a plan has already been adopted.
3) Bringing in a partner might require a plan redesign if both partners want to participate. Even if a partner does not want to participate in the plan, they will still have to share in paying the plan’s administrative expenses and employer contributions.
4) Employees working for small practices, particularly younger, lower paid employees do not typically make 401(k) salary deferrals. For this reason small practice plans (but not large company plans) have to be Safe Harbor, and provide either a 3% non-elective or a 4% elective match to employees. If the practice owner wants to maximize their 401k contribution by adding Profit Sharing, this will not be possible without the Safe Harbor. Often, low participation will require a plan to have a 3% non-elective contribution vs. a 4% elective match.
5) Small practices might have high turnover, and this, too will have an effect on plan design. Practice owners can limit the expenses associated with high turnover by adding a 6-year graded vesting schedule. Any money forfeited in this way can be used to make employer contributions to all of the remaining employees.
For a small practice, failure to update plan design might result in the plan failing testing which can lead to significant IRS penalties if the matter is not addressed promptly.
Plan design and architecture
When selecting the best plan design and architecture, small practices will require a much more comprehensive approach than do large companies. Because practice owners will get the most benefit out of the plan, small practice plans will need significantly more customization and support to find and implement the best solution.
1) Owners might want to maximize their contribution ($54k in 2017) while minimizing their expenses. Most large companies will end up with a basic 401k with just the salary deferral ($18k in 2017) and possibly a small elective match, while small practices can benefit from having a customized 401k with Profit Sharing or a Triple Match design.
2) Small practices don’t have the resources to overspend on their 401k plan. To get the best design, a design study has to be performed to take into account practice specifics and to estimate the potential cost of the plan in terms of employer contributions and administrative expenses.
3) Many small practices might benefit from a pooled plan vs. a participant-directed plan, which is more appropriate for large companies. A pooled plan eliminates the need for a record-keeper, and you can open a single pooled account directly at Vanguard to get access to low cost Admiral Shares. A pooled plan is often a better choice for a small practice because of significantly lower complexity and lower cost than a participant-directed plan.
4) When practice owners start the process of adopting a plan later in the year, they might miss the October 1st deadline for a Safe Harbor plan. However, it may still be possible to get a plan and make a full contribution for the year via a design called QNEC (Qualified Non-Elective Contributions). This is something that large companies will not be doing, but small practice owners can benefit from this option if the plan providers are able to move quickly.
5) Adding a spouse to the payroll (and having them perform services for the practice) can be another way in which practice owners can increase their plan contributions. If done correctly, this is not only legal but a great way to save money on taxes.
6) Many small practices will want to add a Defined Benefit or a Cash Balance plan in addition to a 401k plan to maximize the owners’ contributions. These types of plans are very complex, so before adopting this plan, a thorough analysis needs to be done to select the best plan design.
Large plans have different issues and concerns than do the small practice plans, and these issues are often addressed differently. Small practices have a wide array of tools available at their disposal, but the added complexity will require a much higher quality and scope of advice than is necessary for larger plans.
Investment management
Most of the assets in small practice plans belong to the practice owner and most of the practice owner’s assets will be invested in the plan, so it is important for the owner(s) to receive good investment advice.
1) If your practice has a participant-directed plan, the plan sponsor should provide employees with adequate information to make good investment decisions. Small practice employees are generally not sophisticated investors, so to get the best results (for as low as $15 per employee per year) employees can be provided with personalized advice though one of a number of companies that offer access to live financial planners who can talk directly with each of the plan participants. Large companies rarely offer this level of service, opting for electronic communications and re-enrollment.
An even better solution for a small practice is using a pooled plan. Because investments are managed by an ERISA 3(38) fiduciary (‘investment manager’), not only will you eliminate your fiduciary liability with respect to providing education to plan participants, but by taking responsibility for the investment management process, an ERISA 3(38) fiduciary will also eliminate your fiduciary liability as far as investment selection and management for the plan.
2) Most large and small plans alike pay asset-based fees for plan services. In a small practice plan, the cost of asset based fees is borne mostly by the owners, since most of the plan assets belong to them. While small plans often pay some of the highest asset-based fees, there is no need to have any asset-based fees in your plan. There are plan service providers (including investment advisers and TPAs) who specialize in working with small plans and who charge a flat fee for their services. Asset-based fees are a bad deal for any retirement plan, and you can and should eliminate all asset based fees (aside from the fees charged by low cost index funds) from your plan.
3) Many record-keepers are now offering fiduciary services that are known as ERIA 3(38) and ERISA 3(21). Do you really need these services? DOL has very specific instructions for plan sponsors, including this one: “lacking that expertise, a fiduciary will need to hire someone with that professional knowledge to carry out the investment and other functions.”
A 3(21) fiduciary is a co-fiduciary (with the plan sponsor retaining full fiduciary liability) and their role should be limited to providing participant advice. An ERISA 3(38) “investment manager” is a person who would be managing your plan’s investments on a discretionary basis (if you have a pooled plan) or selecting plan investments and managing model portfolios (if you have a participant-directed plan). While some would argue that ERISA 3(38) fiduciary is nothing more than a gimmick and that small practice owners should have no fear of lawsuits for fiduciary breaches, the role of a good adviser for a small practice plan cannot be overstated.
Services essential for small practice plans
When a typical small company wants to start a retirement plan, they usually do the following:
- Find the biggest and most well-known record-keeper, many of which also offer TPA services including plan design and administration.
- Provide a census to the record-keeper and get a single plan design illustration.
- Sign the contract, set up accounts with the record-keeper, enroll the employees and consider everything done.
It would be great if every plan was this easy to set up, but for a small practices this is rarely the case. There are many missing steps in this approach, some of which can make a big difference for a small practice. Here are some of the critical services that are rarely offered to small practice plans:
1) An analysis showing whether the 401k plan is better for your practice vs. a SIMPLE IRA, including an estimate of how cost-effective the proposed 401k plan design is given your tax bracket and employee contributions as compared to SIMPLE IRA and/or other plan designs.
2) Access to the TPA (a person) who actually designed your plan so that you can ask questions about your plan design and plan options and get a speedy response. When working with large record-keepers you will talk with a salesperson who might know something about plan design, but they will not work in your best interest to find the best solution for you.
3) Address ‘controlled group’ and ‘affiliated group’ concerns. IRS wants all eligible employees to be covered by a retirement plan, and if you own or co-own multiple practices with employees or have multiple entities within a single practice that separate employees from the owners, you have to make sure that the retirement plan does not exclude eligible employees. This can be a complex issue so your TPA and adviser will have to help you make this determination.
4) Design study. A small practice owner will need to know for sure which design will work best under various types of assumptions about the future. You don’t want to end up with an expensive plan that you will end up dropping later. You also need to consider whether a participant-directed or a pooled plan will work best for your practice will work best for your practice. A design study is a key step before you can make a decision to adopt a plan.
5) Include plan features with practice owners’ personal needs in mind. For example, if you want to make ‘backdoor’ Roth contributions, your plan document has to allow incoming rollovers, and if you want to do in-plan Roth conversions, outgoing rollovers must also be allowed.
6) Have your plan design re-evaluated if there are changes in practice demographics. This is something a good TPA should do periodically and proactively. Any plan design inefficiencies and problems should be addressed quickly.
7) Consider whether a Cash Balance plan might work for your practice. Many practices will eventually open a Cash Balance plan, but one has to be very careful because the providers who sell these plans might not have your best interest in mind, and you might not get the best design that addresses your personal needs. Even younger owners (38-40) with employees might benefit from a Cash Balance plan despite what you read elsewhere, but you will need to work with an independent actuary/TPA as well as an adviser who understands plan design and how to put it all together.
What actually matters for a small practice plan?
Record-keepers can be better or worse, but the choice of a record-keeper is not as important for a small practice plan as it is for a large plan. Here’s what really matters for small practice retirement plans:
1) Hire the right retirement plan adviser who would act in a fiduciary capacity (that is affirmed in writing), provide you with ongoing advisory and support services and charge you a flat (and not an asset-based) fee. Your record-keeper and your Third Party Administrator are not fiduciaries. You need to always make sure that your adviser and plan providers do not have any conflicts of interest and that they are acting in your best interest – otherwise you can end up with a plan that might not be a good fit for your practice.
2) Hire the right Third Party Administrator. Record-keepers come and go, but a good TPA stays. Your TPA (together with your adviser) will make sure that you have the best design and that your plan stays compliant with all of the rules and regulations. A good TPA who has experience working with small practices also knows how to design plans for small practices in such a way as to avoid any potential future issues. Your TPA will also stay on top of any changes to your practice demographics and will tell you when a new plan design is warranted. Record-keepers often make mistakes, and you will be responsible and potentially penalized (as a plan fiduciary) for any mistakes they make. Having a standalone, independent TPA is important to make sure that your plan is operating smoothly and that any mistakes are caught early.
3) Educate yourself as much as possible on retirement plans. For example, any asset-based fees can be a significant cost for your plan, so you will need to understand the value of paying flat fees and replacing any asset-based fee providers, even though at first glance it might seem that the asset based fee is not significant because your plan does not have much assets. Also, open architecture providers who are specialists in working with small practice plans can provide better value especially if you want extra oversight and personalized services for you.