It is part of human nature to avoid disturbing something that works well: “if it ain’t broke – don’t fix it”. While this can be a sound rule of thumb, when applied to retirement plans, it is exactly the opposite: if you haven’t had your plan reviewed by an independent fiduciary (that is, someone who is working in your best interest, and not for the company who sold you the plan), chances are that something in your plan can be improved that can result in significant savings, whether by lowering plan costs, decreasing your taxes by redesigning your plan to allow for higher contributions, or improving plan investment quality and services. Most small startup plans have high asset based fees, inadequate plan design and low quality investment lineup, and very few plans get the benefit of professional investment management advice that can significantly improve investment performance for plan participants. Because most plan providers are not fiduciaries (so they are not obligated to provide you with the best advice), having your plan reviewed by an independent fiduciary is always a good idea.
Even if your retirement plan is working well for you right now, there are five potential opportunities to upgrade your plan to allow you to make higher contributions.
1. SIMPLE to cross-tested 401k
Many dentists open a SIMPLE IRA because it is a great option for a start-up practice. While the 401k plan will have added administrative and investment expenses as well as higher employee matching contribution, higher contribution for the owners more than makes up for the added cost of the 401k plan. Thus, if you are capable of contributing $53k for yourself and $20k for your spouse (who can contribute roughly $20k, depending on the salary), a 401k plan might be a better solution for your practice. Please note that simply comparing the cost of 401k vs. SIMPLE misses the point – to make an adequate comparison, you’d have to include both your total contribution and your total expense, and extra tax deduction you get will more than offset any added plan cost.
2. SEP to solo 401k
If you still have a SEP that your accountant told you to open years ago, chances are you are ready for an upgrade to a Solo 401k. For one thing, it will take a much higher salary to max out your SEP ($270,000 vs. $180,000 for a sole proprietor/LLC and $212,000 vs. $140,000 for an S-corporation), so that alone allows for significantly better tax planning opportunities. If you also have a spouse on the payroll, having a Solo 401k is a no-brainer as this will allow you to contribute dollar for dollar of your spouse’s first $23k and $30k for a spouse who is 50 or older.
3. Solo 401k to Defined Benefit
If you have a solo practice (with a spouse as your only employee) and are currently maxing out a Solo 401k plan, you might want to consider a Defined Benefit plan, especially if you are 40 or older. A Solo 401k plan is a very flexible and versatile tool, so you can put away as much as $106k together with your spouse ($53k each, depending on your spouse’s salary, though usually contributions max out at about $72k). With the addition of a Defined Benefit option, you can still participate in your Solo 401k, but your profit-sharing contribution will be capped at 6% (vs. 20%). Your total contribution for you and your spouse (if you are 45) will be around $130k into the Solo 401k/Defined Benefit plan combination (assuming a $20k salary for the spouse), and will grow significantly as you get older.
4. 401k to a cross-tested 401k
If you happen to have a Safe Harbor 401k plan with a maximum of $18,000 contribution and a 4% Safe Harbor match, you will definitely want to upgrade your plan to a cross-tested version that allows you to contribute $53k. The price for that is higher contributions to your employees, but given the higher tax deduction you will be much better off with this upgrade, and if your spouse is also an employee, the numbers will most likely work out in your favor. You can also use a 6-year vesting schedule, and any unvested profit sharing employer contributions can be recycled to make contributions to other employees.
5. 401k to Cash Balance
Cash Balance plan is a Defined Benefit plan that is typically used when you have non-spouse employees, and just like Defined Benefit plan above, a Cash Balance plan can be added to an existing 401k. Your practice demographics will dictate whether this plan will work for you, since it matters greatly whether you have older employees, so simply being older than 45 will not be enough to decide whether this plan will work. However, this is the type of plan that can help you contribute significantly more than $53k into your retirement plan, so it is always a good idea to run the numbers to see if you can benefit from a Cash Balance plan.