Target Date Funds: A Public Service Announcement
Before getting into the main objective of this article, let me briefly explain a Target Date Fund. Investopedia defines a target date fund as “a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal”. The specified period of time is typically the period until the date you “target” for retirement
Target Date Funds: A Public Service Announcement
Before getting into the main objective of this article, let me briefly explain a Target Date Fund. Investopedia defines a target date fund as “a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal”. The specified period of time is typically the period until the date you “target” for retirement or to start withdrawing assets. For this article, I will refer to the target date as the “retirement date” because that is how Target Date Funds are typically used.
Target Date Funds are continuing to grow in popularity as Defined Contribution Plans (i.e. 401(k)’s) become the primary savings vehicle for retirement. Per the Investment Company Institute, as of March 31, 2018, there was $1.1 trillion invested in Target Date Mutual Funds. Defined Contribution Plans made up 67 percent of that total.
Target Date Funds are often coined as the “set it and forget it” of investments for participants in retirement plans. Target Date Funds that are farther from the retirement date will be invested more aggressively than target date funds closer to the retirement date. Below is a chart showing the “Glide Path” of the Vanguard Target Date Funds. The horizontal access shows how far someone is from retirement and the vertical access shows the percentage of stocks in the investment. In general, more stock means more aggressive. The “40” in the bottom left indicates someone that is 40 years from their retirement date. A common investment strategy in retirement accounts is to be more aggressive when you’re younger and become more conservative as you approach your retirement age. Following this strategy, someone with 40 years until retirement is more aggressive which is why at this point the Glide Path shows an allocation of approximately 90% stocks and 10% fixed income. When the fund is at “0”, this is the retirement date and the fund is more conservative with an allocation of approximately 50% stocks and 50% fixed income. Using a Target Date Fund, a person can become more conservative over time without manually making any changes.
Note: Not every fund family (i.e. Vanguard, American Funds, T. Rowe Price, etc.) has the same strategy on how they manage the investments inside the Target Date Funds, but each of them follows a Glide Path like the one shown below.
The Public Service Announcement
The public service announcement is to remind investors they should take both time horizon and risk tolerance into consideration when creating a portfolio for themselves. The Target Date Fund solution focuses on time horizon but how does it factor in risk tolerance?Target Date Funds combine time horizon and risk tolerance as if they are the same for each investor with the same amount of time before retirement. In other words, each person 30 years from retirement that is using the Target Date strategy as it was intended will have the same stock to bond allocation.This is one of the ways the Target Date Fund solution can fall short as it is likely not possible to truly know somebody’s risk tolerance without knowing them. In my experience, not every investor 30 years from retirement is comfortable with their biggest retirement asset being allocated to 90% stock. For various reasons, some people are more conservative, and the Target Date Fund solution may not be appropriate for their risk tolerance.The “set it and forget it” phrase is often used because Target Date Funds automatically become more conservative for investors as they approach their Target Date. This is a strategy that does work and is appropriate for a lot of investors which is why the strategy is continuing to increase in popularity. The takeaway from this article is to think about your risk tolerance and to be educated on the way Target Date Funds work as it is important to make sure both are in line with each other.For a more information on Target Date Funds please visit https://www.greenbushfinancial.com/target-date-funds-and-their-role-in-the-401k-space/
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.
Big Changes For 401(k) Hardship Distributions
While it probably seems odd that there is a connection between the government passing a budget and your 401(k) plan, this year there was. On February 9, 2018, the Bipartisan Budget Act of 2018 was passed into law which ended the government shutdown by raising the debt ceiling for the next two years. However, also buried in the new law were
While it probably seems odd that there is a connection between the government passing a budget and your 401(k) plan, this year there was. On February 9, 2018, the Bipartisan Budget Act of 2018 was passed into law which ended the government shutdown by raising the debt ceiling for the next two years. However, also buried in the new law were changes to rules that govern hardship distributions in 401(k) plans.
What Is A Hardship Distribution?
A hardship distribution is an optional distribution feature within a 401(k) plan. In other words, your 401(k) plan may or may not allow them. To answer that question, you will have to reference the plan’s Summary Plan Description (SPD) which should be readily available to plan participants.
If your plan allows hardship distributions, they are one of the few in-service distribution options available to employees that are still working for the company. There are traditional in-service distributions which allow employees to take all or a portion of their account balance after reaching the age 59½. By contrast, hardship distributions are for employees that have experienced a “financial hardship”, are still employed by the company, and they are typically under the age of 59½.
Meeting The "Hardship" Requirement
First, you have to determine if your financial need qualifies as a "hardship". They typically include:
Unreimbursed medical expenses for you, your spouse, or dependents
Purchase of an employee's principal residence
Payment of college tuition and relative education costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
Payment necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your primary residence
For funeral expenses
Certain expenses for the repair of damage to the employee's principal residence
Second, there are rules that govern how much you can take out of the plan in the form of a hardship distribution and restrictions that are put in place after the hardship distribution is taken. Below is a list of the rules under the current law:
The withdrawal must not exceed the amount needed by you
You must first obtain all other distribution and loan options available in the plan
You cannot contribute to the 401(k) plan for six months following the withdrawal
Growth and investment gains are not eligible for distribution from specific sources
Changes To The Rules Starting In 2019
Plan sponsors need to be aware that starting in 2019 some of the rules surrounding hardship distributions are going to change in conjunction with the passing of the Budget Act of 2018. The reasons for taking a hardship distribution did not change. However, there were changes made to the rules associated with taking a hardship distribution starting in 2019. More specifically, of the four rules listed above, only one will remain.
No More "6 Month Rule"
The Bipartisan Budget Act of 2018 eliminated the rule that prevents employees from making 401(k) contributions until 6 months after the date the hardship distribution was issued. The purpose of the 6 month wait was to deter employees from taking a hardship distribution. In addition, for employees that had to take a hardship it was a silent way of implying that “if things are bad enough financially that you have to take a distribution from your retirement account, you probably should not be making contributions to your 401(k) plan for the next few months.”
However, for employees that are covered by a 401(k) plan that offers an employer matching contribution, not being able to defer in the plan for 6 months also meant no employer matching contribution during that 6 month probationary period. Starting in 2019, employees will no longer have to worry about that limitation.
Loan First Rule Eliminated
Under the current 401(k) rules, if loans are available in the 401(k) plan, the plan participant was required to take the maximum loan amount before qualifying for a hardship distribution. That is no longer a requirement under the new law.
We are actually happy to see this requirement go away. It never really made sense to us. If you have an employee, who’s primary residence is going into foreclosure, why would you make them take a loan which then requires loan payments to be made via deductions from their paycheck? Doesn’t that put them in a worse financial position? Most of the time when a plan participant qualifies for a hardship, they need the money as soon as possible and having to go through the loan process first can delay the receipt of the money needed to remedy their financial hardship.
Earnings Are Now On The Table
Under the current 401(k) rules, if an employee requests a hardship distribution, the portion of their elective deferral source attributed to investment earnings was not eligible for withdrawal. Effective 2019, that rule has also changed. Both contributions and earnings will be eligible for a hardship withdrawal.
Still A Last Resort
We often refer to hardship distributions as the “option of last resort”. This is due to the taxes and penalties that are incurred in conjunction with hardship distributions. Unlike a 401(k) loan which does not trigger immediate taxation, hardship distributions are a taxable event. To make matters worse, if you are under the age of 59½, you are also subject to the 10% early withdrawal penalty.
For example, if you are under the age of 59½ and you take a $20,000 hardship distribution to make the down payment on a house, you will incur taxes and the 10% penalty on the $20,000 withdrawal. Let’s assume you are in the 24% federal tax bracket and 7% state tax bracket. That $20,000 distribution just cost you $8,200 in taxes.
Gross Distribution: $20,000
Fed Tax (24%): ($4,800)
State Tax (7%): ($1,400)
10% Penalty: ($2,000)
Net Amount: $11,800
There is also an opportunity cost for taking that money out of your retirement account. For example, let’s assume you are 30 years old and plan to retire at age 65. If you assume an 8% annual rate of return on your 401(K) investment that $20,000 really cost you $295,707. That’s what the $20,000 would have been worth, 35 years from now, compounded at 8% per year.
Plan Amendment Required
These changes to the hardship distribution rule will not be automatic. The plan sponsor of the 401(k) will need to amend the plan document to adopt these new rules otherwise the old hardship distribution rules will still apply. We recommend that companies reach out to their 401(k) providers to determine whether or not amending the plan to adopt the new hardship distribution rules makes sense for the company and your employees.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
403(b) Lawsuits Continue To Spread To More Colleges
In the last 3 years, the number of lawsuits filed against colleges for excessive fees and compliance issues related to their 403(b) plans has increased exponentially. Here is a list of just some of the colleges that have had lawsuit brought against them by their 403(b) plan participants:
In the last 3 years, the number of lawsuits filed against colleges for excessive fees and compliance issues related to their 403(b) plans has increased exponentially. Here is a list of just some of the colleges that have had lawsuit brought against them by their 403(b) plan participants:
Yale
NYU
Duke
John Hopkins
MIT
Columbia
Emory
Cornell
Vanderbilt
Northeastern
USC
The fiduciary landscape has completely changed for organizations, like colleges, that sponsor ERISA 403(b) plans. In 2009, new regulations were passed that brought 403(b) plans up to the compliance standards historically found in the 401(k) market. Instead of slowly phasing in the new regulations, the 403(b) market basically went from zero to 60 mph in a blink of an eye. While some of the basic elements of the new rules were taken care of by the current service providers such as the required written plan documents, contract exchange provisions, and new participant disclosures, we have found that colleges, due to a lack of understanding of what is required to fulfill their fiduciary role to the plan, have fallen very short of putting the policies and procedures in place to protect the college from liabilities that can arise from the 403(b) plan.
Top Violations
Based on the lawsuits that have been filled against the various colleges, here is a list of the most common claims that have been included in these lawsuits:
Excessive fees
Fees associated with multiple recordkeepers
Too many investment options
Improper mutual fund share class
Variable annuity products
Excessive Fees
This is by far number one on the list. As you look at these lawsuits, most of them include a claim that the university breached their fiduciary duty under ERISA by allowing excessive fees to be charged to plan participants.
Here is the most common situation that we see when consulting with colleges that leads to this issue. A college had been with the same 403(b) provider for 60 years. Without naming names, they assume that their 403(b) plan has reasonable fees because all of the other colleges that they know of also use this same provider. So their fees must be reasonable right? Wrong!!
If you are member of the committee that oversees that 403(b) plan at your college, how do you answer this question? How do you know that the fees for your plan are reasonable? Can you show documented proof that you made a reasonable effort to determine whether or not the plan fees are reasonable versus other 403(b) providers?
The only way to answer this question is by going through an RFP process. For colleges that we consult with we typically recommend that they put an RFP out every 3 to 5 years. That is really the only way to be able to adequately answer the question: “Are the plan fees reasonable?” Now if you go through the RFP process and you find that another reputable provider is less expensive than your current provider, you are not required to change to that less expensive provider. However, from a fiduciary standpoint, you should acknowledge at the end of the RFP process that there were lower fee alternatives but the current provider was selected because of reasons X, Y, and Z. Document, document, document!!
Investment Fees / Underperformance / Investment Options
Liability is arising in these 403(b) plans due to
Revenue sharing fees buried in the mutual fund expense rations
Underperformance of the plan investments versus the benchmark / peer group
Too many investment options
Investment options concentrated all in one fund family
Restrictions associate with the plan investment
Investment Policy Statement violations or No IPS
Failure to document quarterly and annual investment reviews
Here is the issue. Typically members of these committees that oversee the 403(b) plan are not investment experts and you need to basically be an investment expert to understand mutual fund share classes, investment revenue sharing, peer group comparisons, asset classes represented within the fund menu, etc. To fill the void, colleges are beginning to hire investment firms to serve as third party consultants to the 403(b) committee. In most cases these firms charge a flat dollar fee to:
Prepare quarterly investment reports
Investment benchmarking
Draft a custom Investment Policy Statement
Coordinate the RFP process
Negotiation plan fees with the current provider
Conduct quarterly and annual reviews with the 403(b) committee
Compliance guidance
Multiple Recordkeepers
While multiple recordkeepers is becoming more common for college 403(b) plans, it requires additional due diligence on the part of the college to verify that it’s in the best interest of the plan participants. Multiple recordkeepers means that your 403(b) plan assets are split between two or more custodians. For example, a college may use both TIAA CREF and Principal for their 403(b) platform. Why two recordkeepers? Most of the older 403(b) accounts are setup as individual annuity contracts. As such, if the college decides to charge their 403(b) provider, unlike the 401(k) industry where all of the plan assets automatically move over to the new platform, each plan participant is required to voluntarily sign forms to move their account balance from the old 403(b) provider to the new 403(b) provider. It’s almost impossible to get all of the employee to make the switch so you end up with two separate recordkeepers.
Why does this create additional liability for the college? Even through the limitation set forth by these individual annuity contracts is out of the control of the college, by splitting the plan assets into two pieces you may be limiting the economies of scale of the total plan assets. In most cases the asset based fees for a 403(b) plan decreases as the plan assets become larger with that 403(b) provider. By splitting the assets between two 403(b) platforms, you are now creating two smaller plans which could result in larger all-in fees for the plan participants.
Now, it may very well be in the best interest of the plan participants to have two separate platforms but the college has to make sure that they have the appropriate documentation to verify that this due diligence is being conducts. This usually happens as a result of an RFP process. Here is an example. A college has been using the same 403(b) provider for the last 50 years but to satisfy their fiduciary obligation to the plan they going through the RFP process to verify that their plan fees are reasonable. Going into the RFP process they had no intention of change provides but as a result of the RFP process they realize that there are other 403(b) providers that offer better technology, more support for the plan sponsor, and lower fees than their current platform. While they are handcuffed by the individual contracts in the current 403(b) plan, they still have control over where the future contributions of the plan will be allocated so they decide that it’s in both the plan participants and the college’s best interest to direct the future contributions to the new 403(b) platform.
Too Many Investment Options
More is not always better in the retirement plan world. The 403(b) oversite committee, as a fiduciary, is responsible for selecting the investments that will be offered in accordance with the plan’s investment menu. Some colleges unfortunately take that approach that if we offer 80+ different mutual funds for the investment that should “cover all of their bases” since plan participants have access to every asset class, mutual fund family, and ten different small cap funds. The plaintiffs in these 403(b) lawsuits alleged that many of the plan’s investment options were duplicates, performed poorly, and featured high fees that are inappropriate for large 403(b) plans.
To make matters worse, if you have 80+ mutual funds on your 403(b) investment menu, you have to conduct regular and on-going due diligence on all 80+ mutual funds in your plan to make sure that they still meet the investment criteria set out in the plan’s IPS. If you have mutual funds in your plan that fall outside of the IPS criteria and those issues have not been addressed and/or documented, if a lawsuit is brought against the college it will be very difficult to defend that the college was fulfilling its fiduciary obligation to the investment menu.
Improper Mutual Fund Share Classes
To piggyback on this issue, what many plan sponsors don’t realize is that by selecting a more limited menu of mutual funds it can lower the overall plan fees. Mutual funds have different share classes and some share classes require a minimum initial investment to gain asset to that share class. For example you may have Mutual Fund A retail share class with a 0.80% internal expense ratio but there is also a Mutual Fund A institutional share class with a 0.30% internal expense ratio. However, the institutional share class requires an initial investment of $100,000 to gain access. If Mutual Fund A is a U.S. Large Cap Stock Fund and your plan offers 10 other U.S. Large Cap Stock Funds, your plan may not meet the institutional share requirement because the assets are spread between 10 different mutual funds within the same asset class. If instead, the committee decided that it was prudent to offer just Mutual Fund A to represent the U.S. Large Cap Stock holding on the investment menu, the plan may be able to meet that $100,000 minimum initial investment and gain access to the lower cost institutional share class.
Variable Annuity Products
While variable annuity products have historically been a common investment option for 403(b) plans, they typically charge fees that are higher than the fees that are charged by most standard mutual funds. In addition, variable annuities can place distribution restrictions on select investment investments which may not be in the plan participants best interest.
The most common issue we come across is with the TIAA Traditional investment. While TIAA touts the investment for its 3% guarantee, we have found that very few plan participants are aware that there is a 10 year distribution restriction associated with that investment. When you go to remove money from the TIAA Traditional fund, TIAA will inform you that you can only move 1/10th of your balance out of that investment each year over the course of the next ten years. You can see how this could be a problem for a plan participant that may have 100% of their balance in the TIAA Traditional investment as they approach retirement. Their intention may have been to retire at age 65 and rollover the balance to their own personal IRA. If they have money in the TIAA Traditional investment that is no longer an option. They would be limited to process a rollover equal to 1/10th of their balance in the TIAA Tradition investment between the age of 65 and 74. Only after age 74 would they completely free from this TIAA withdrawal restriction.
Consider Hiring A Consultant
While this may sound self-serving, colleges are really going to need help with the initial and on-going due diligence associate with keeping their 403(b) plan in compliance. For a reasonable cost, colleges should be able to engage an investment firm that specialized in this type of work to serve as a third party consultant for the 403(b) investment committee. Just make sure the fee is reasonable. The consulting fee should be expressed as a flat dollar amount fee, not an asset based fee, because they are fulfilling that role as a “consultant”, not the “investment advisor” to the 403(b) plan assets.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Does A Simple IRA Plan Work?
Not every company with employees should have a 401(k) plan. In many cases, a Simple IRA plan may be the best fit for a small business. These plans carry the following benefits
Not every company with employees should have a 401(k) plan. In many cases, a Simple IRA plan may be the best fit for a small business. These plans carry the following benefits
No TPA fees
Easy to setup & operate
Employee attraction and retention tool
Pre-tax contributions for the owners to lower their tax liability
Your company
To be eligible to sponsor a Simple IRA, your company must have less than 100 employees. The contribution limits to these plans are about half that of a 401(k) plan but it still may be the right fit for you company. Here are some of the most common statements that we hear from the owners of the business that would lead you to considering a Simple IRA plan over a 401(k) plan:
"I want to put a retirement plans in place for my employees that has very low fees and is easy to operate."
"We are a start-up, we don't have a lot of money to contribute to the plan as the owners, but we want to put a plan in place to attract and retain employees."
"I plan on contributing $15,000 per year to the plan, even if I sponsored a plan that allowed me to contribute more I wouldn't because I'm socking all of the profits back into the business"
"I have a SEP IRA now but I just hired my first employee. I need to setup a different type of plan since SEP IRA's are 100% employer funded"
Establishment Deadline
The deadline to establish a Simple IRA plan is October 1st. Once you have cross over that date, you would have to wait until the following calendar year to set the plan.
Eligibility
The eligibility requirements for a Simple IRA are different than a SEP IRA or 401(k) plans. Unlike these other plan "1 Year of Service" = $5,000 of compensation earned in a calendar year. If you want to only cover "full-time" employees with your retirement plan, you may need to consider a 401(k) plan which has the 1 year and 1000 hours requirement to obtain a year of service. The most restrictive "wait time" that you can put into place is 2 years. Meaning an employee must obtain 2 years of service before they are eligible to start contributing to the plan. You can also be more lenient that 2 years, such as immediate entry or a 1-year wait, but 2 years is the most restrictive it can be.
Types of Contributions
Like a 401(k) plan, Simple IRA have both employee deferral contributions and employer contributions.
Employee Deferrals
Eligible employees are allowed to make pre-tax contributions to their Simple IRA accounts. The contribution limits are less than a traditional 401(k). Below is a tale comparing the 2021 contribution limits of a Simple IRA vs a 401(k) Plan:
There are not Roth deferrals allows in Simple IRA plans.
Employer Contributions
Unlike other employer sponsored retirement plans, employer contributions are mandatory each year to a Simple IRA plan. The company must choose between two pre-set employer contribution formulas:
2% Non-elective
3$ Matching contribution
With the 2% non-elective contribution, the company must contribute 2% of each eligible employee’s compensation to the plan whether they contribute to the plan or not.
For the 3% matching contribution, it’s a dollar for dollar match up to 3% of compensation that they employee contributes to the plan. The match formula is more popular than the 2% non-elective contribution because the company only must contribute if the employee contributes.
Special 1% Rule
With the employer matching contribution there is also a special rule. In 2 out of any 5 consecutive years, the company can lower the employer match to as low as 1% of pay. We will often see start-up company's take advantage of this rule by putting a 1% employer match in place for the first 2 years of the plan to minimize costs and then they are committed to making the 3% match for years 3, 4, and 5.
100% Vesting
All employer contributions to Simple IRA plans are 100% vested. The company is not allowed to attach a "vesting schedule" to the contributions.
Important Compliance Requirements
Make sure you have a 5304 Simple Form in your files for each year you sponsor the Simple IRA plan. If you are audited by the IRS or DOL, they will ask for these forms. You need to distribute this form to all of your employee each year between Nov 1st and Dec 1st for the upcoming plan year. The documents notifies your employees that:
A retirement plan exists
Plan eligibility requirement
Employer contribution formula
Who they submit their deferral elections to within the company
If you do not have this form on file, the IRS will assume that you have immediate eligibility for your Simple IRA plan, meaning that all of your employees are due employer contributions since day one of employment. Even employee that used to work for you and have since terminated employment. It’s an ugly situation.
Make sure the company is timely when submitting the employee deferrals to the Simple IRA plan. Since you are withholding money from employees pay for the salary deferrals the IRS want you to send that money to their Simple IRA accounts “as soon as administratively feasible”. The suggested time phrase is within a week of the deduction in payroll. But you must be consistent with the timing of your remittances to your Simple IRA plan. If you typically submit contributions to your Simple IRA provider 5 days after a payroll run but one week you randomly submit it 2 days after the payroll run, 2 days just became the rule and all of the other deferral remittances are “late”. The company will be assessed penalties for all of the late deferral remittances. So be consistent.
Cannot Terminate Mid-Year
Unlike other retirement plans, you cannot terminate a Simple IRA plan mid-year. Simple IRA plan termination are most common when a company started with a Simple IRA, has grown in employee head count, and now wishes to put a 401(k) plan in place. You must wait until after December 31st to terminate the Simple IRA plan and implement the new 401(k) plan.
Special 2 Year Rule
If you replace your Simple IRA with a 401(k) plan, the balances in the Simple IRA can usually be rolled over into the new 401(k) if the employee elects to do so. However, be very careful of the special Simple IRA 2 Year Distribution Rule. If you process any type of distribution from a Simple IRA, within a two-year period of the employee depositing their first dollar to the account, and the employee is under 59½, they are hit with a 25% IRS penalty. THIS ALSO APPLIES TO DIRECT ROLLOVERS. Normally when you process a direct rollover from one retirement plan to another, no taxes or penalties are assessed. That is not the case in Simple IRA plan so be care of this rule. If you decide to switch from a Simple IRA to a 401(k), make sure you run a list of all the employees that maintain a balance in the Simple IRA plan to determine which employees are subject to the 2-year withdrawal restriction.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Does A SEP IRA Work?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
What is a SEP?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
Special Establishment Deadline
SEP are one of the few retirement plans that can be established after December 31st which make them a powerful tax tool. For example, it’s March, you are meeting with your accountant and they deliver the bad news that you have a big tax bill that is due. You can setup the SEP IRA any time to your tax filing date PLUS extension, fund it, and capture the tax deduction.
Easy to Setup & Low Plan Fees
The other advantage of SEP IRA’s is they are easy to setup and you do not have a third-party administrator to run the plan, so the costs are a lot lower than a traditional 401(k) plans. These plans can typically be setup with 24 hours.
Contributions limits
SEP IRA contributions are expressed as a percentage of compensation. The maximum contribution is either 20% of the owners “net earned income” or 25% of the owners W2 wages. It all depends on how your business is incorporated. You have the option to contribution any amount less than the maximum contribution.
100% Employer Funded
SEP IRA plans are 100% employer funded meaning there is no employee deferral piece. Which makes them expense plans to sponsor for a company that eligible employees because the employer contribution is uniform for all employees. Meaning if the owner contributes 20% of their compensation to the plan for themselves they must also make a contribution equal to 20% of compensation for each eligible employee. Typically, once employees begin becoming eligible for the plan, a company will terminate the SEP IRA and replace it with either a Simple IRA or 401(k) plans.
Employee Eligibility Requirements
An employee earns a “year of service” for each calendar year that they earn $500 in compensation. You can see how easy it is to earn a “year of service” in these types of plans. This is where a lot of companies make an error because they only look at their “full time employees” as eligible. The good news for business owners is you can keep employees out of the plan for 3 years and then they become eligible in the 4th year of employment. For example, I am a sole proprietor and I hire my first employee, if my plan document is written correctly, I can keep that employee out of the SEP IRA for 3 years and then they will not be eligible for the employer contribution until the 4th year of employment.
Read This……..Very Important…..
There is a plan document called a 5305 SEP form that is required to sponsor a SEP IRA plan. This form can be printed off the IRS website or is sometimes provide by the investment platform for your plan. Remember, SEP IRA plans are “self-administered” meaning that you as the business owner are responsible for keeping the plan in compliance. Do cannot always rely on your investment advisor or accountant to help you with your SEP IRA plan. You should have a 5305 SEP for in your employer files for each year you have sponsored the plan. This form does not get filed with the IRS or DOL but rather is just kept in your employer files in the case of an audit. You are required to give this form to all employees of the company each year. It’s a way of notifying your employees that the plan exists and it lists the eligibility requirements.
Compliance Issues
The main compliance issues to watch out for with these plan is not having that 5305 SEP Form for each year the plan has been sponsored, not accurately identifying eligible employees, and miscalculating your “net earned income” for the max SEP IRA contribution.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Do Single(k) Plans Work?
A Single(k) plan is an employer sponsored retirement plan for owner only entities, meaning you have no full-time employees. These owner only entities get the benefits of having a full fledge 401(k) plan without the large administrative costs associated with traditional 401(k) plans.
What is a Single(k) Plan?
A Single(k) plan is an employer-sponsored retirement plan for owner-only entities, meaning you have no full-time employees. These owner-only entities get the benefits of having a full-fledged 401(k) plan without the large administrative costs associated with traditional 401(k) plans.
What is the definition of a “full-time” employee?
Oftentimes, a small company will have some part-time staff. It does not matter whether you consider them “part-time”, the definition of full-time employee is defined by the IRS as working 1000 hours in a 12-month period. If you have a “full-time” employee, you would not be eligible to sponsor a Single(k) plan.
Types of Contributions
There are two types of contributions to these plans. Employee deferral contributions and employer profit sharing contributions. The employee deferral piece works like a 401(k) plan. If you are under the age of 50 you can contribute $23,500, in 2025, in employee deferrals. If you are 50-59 or 64 or older, you get the $7,500 catch up contribution so you can contribute $31,000 in employee deferrals. Beginning in 2025, if you are age 60-63, instead of the $7,500 catch-up, you can contribute an additional $11,250 for a total of $34,750 in employee deferrals.
The reason why these plans are a little different than other employer sponsored plans is the employee deferral piece allows you to put 100% of your compensation into these plans up to those dollar thresholds.
In addition to the employee deferrals, you can also contribute 20% of your net earned income in the form of a profit-sharing contribution. For example, if you make $100,000 in net earned income from self-employment and you are age 53, you could contribute $31,000 in employee deferrals and then you could contribute an additional $20,000 in the form of a profit-sharing contribution. Making your total pre-tax contribution $51,000.
Establishment Deadline
The deadline for establishing a Solo(k) plan varies based on how the business is incorporated. If the business is an S-Corp or multi-member partnership, the business owner(s) must have the Solo(k) plan setup by December 31st. If the business is a sole proprietor or single member LLC, the Solo(k) plan can be setup by the tax filing deadline plus extension.
Loans & Roth Deferrals
Single(k) plans provide all of the benefits to the owner of a full 401(k) plan at a fraction of the cost. You can set up the plan to allow 401(k) loan and Roth deferral contributions.
SEP IRA vs Single(k) Plans
A lot of small business owners find themselves in a position where they are trying to decide between setting up a SEP IRA or a Single(k) plan. One of the big factors, that is often times the deciding factor, is how much the owner intends to contribute to the plan. The SEP IRA limits the business owner to just the 20% of net earned income. Whereas the Single(k) plan allows the 20% of net earned income plus the employee deferral contribution amount. However, if 20% of your net earned income would satisfy your target amount then the SEP IRA may be the right choice.
Advanced Strategy Using A Single(k) Plan
Here is a great tax strategy if you have one spouse that is the primary breadwinner bringing in most of the income and the other has self-employment income for a side business. If the spouse with the self-employment income is over the age of 50 and makes $20,000 in net earned income, they could set up a Single(k) Plan and defer the full $20,000 into their Single(k) plan as employee deferrals. If they had a SEP IRA, the max contribution would have been $4,000.
A huge tax savings for a married couple that is looking to lower their tax liability.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
The Fiduciary Rule: Exposing Your 401(K) Advisor’s Secrets
It’s here. On June 9, 2017, the long awaited Fiduciary Rule for 401(k) plans will arrive. What secrets does your 401(k) advisor have?
It’s here. On June 9, 2017, the long awaited Fiduciary Rule for 401(k) plans will arrive. The wirehouse and broker-dealer community within the investment industry has fought this new rule every step of the way. Why? Because their secrets are about to be exposed. Fee gouging in these 401(k) plans has spiraled out of control and it has gone on for way too long. While the Fiduciary Rule was designed to better protect plan participants within these employer sponsored retirement plans, the response from the broker-dealer community, in an effort to protect themselves, may actually drive the fees in 401(k) plans higher than they are now.
If your company sponsors an employer sponsored retirement plan and your investment advisor is a broker with one of the main stream wirehouse or broker dealers then they may be approaching you within the next few months regarding a “platform change” for your 401(k) plan. Best advice, start asking questions before you sign anything!! The brokerage community is going to try to gift wrap this change and present this as a value added service to their current 401(k) clients when the reality is this change is being forced onto the brokerage community and they are at great risk at losing their 401(k) clients to independent registered investment advisory firms that have served as co-fiduciaries to their plans along.
The Fiduciary Rule requires all investment advisors that handle 401(k) plans to act in the best interest of their clients. Up until now may brokers were not held to this standard. As long as they delivered the appropriate disclosure documents to the client, the regulations did not require them to act in their client’s best interest. Crazy right? Well that’s all about to change and the response of the brokerage community will shock you.
I will preface this article by stating that there have been a variety of responses by the broker-dealer community to this new regulation. While we cannot reasonably gather information on every broker-dealers response to the Fiduciary Rule, this article will provide information on how many of the brokerage firms are responding to the new legislation given our independent research.
SECRET #1:
Many of the brokerage dealers are restricting what 401(k) platforms their brokers can use. If the broker currently has 401(k) clients that maintain a plan with a 401(k) platform outside of their new “approved list”, they are forcing them to move the plan to a pre-approved platform or the broker will be required to resign as the advisor to the plan. Even though your current 401(k) platform may be better than the new proposed platform, the broker may attempt to move your plan so they can keep the plan assets. How is this remotely in your employee’s best interest? But it’s happening. We have been told that some of these 401(k) providers end up on the “pre-approve list” because they are willing to share fees with the broker dealer. If you don’t share fees, you don’t make the list. Really ugly stuff!!
SECRET #2:
Because these wirehouses and broker-dealers know that their brokers are not “experts” in 401(k) plans, many of the brokerage firms are requiring their 401(k) plans to add a third-party fiduciary service which usually results in higher plan fees. The question to ask is “if you were so concerned about our fiduciary liability why did you wait until now to present this third party fiduciary service?” They are doing this to protect themselves, not the client. Also, many of these third party fiduciary services could standardize the investment menu and take the control of the investment menu away from the broker. Which begs the question, what are you paying the broker for?
SECRET #3:
Some broker-dealers are responding to the Fiduciary Rule by forcing their brokers to move all their 401(k) plans to a “fee based platform” versus a commission based platform. The plan participants may have paid commissions on investments when they were purchased within their 401(k) account and now could be forced out of those investments and locked into a fee based fee structure after they already paid a commission on their balance. This situation will be common for 401(k) plans that are comprised primarily of self-directed brokerage accounts. Make sure you ask the advisor about the impact of the fee structure change and any deferred sales charges that may be imposed due to the platform change.
SECRET #4:
The plan fees are often times buried. The 401(k) industry has gotten very good at hiding fees. They talk in percentages and basis points but rarely talk in hard dollars. One percent does not sound like a lot but if you have a $2 million dollar 401(k) plan that equals $20,000 in fees coming out of the plans assets every year. Most of the fees are buried in the mutual fund expense ratios and you basically have to be an investment expert to figure out how much you are paying. This has continued to go on because very rarely do companies write a check for their 401(k) fees. Most plans debit plan assets for their plan fees but the fees are real.
With all of these changes taking place, now is the perfect time to take a good hard look at your company’s employer sponsored retirement plan. If your current investment advisor approaches you with a recommended “platform change” that is a red flag. Start asking a lot of questions and it may be a good time to put your plan out to bid to see if you can negotiate a better overall solution for you and your employees.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Strategies to Save for Retirement with No Company Retirement Plan
The question, “How much do I need to retire?” has become a concern across generations rather than something that only those approaching retirement focus on. We wrote the article, How Much Money Do I Need To Save To Retire?, to help individuals answer this question. This article is meant to help create a strategy to reach that number. More
The question, “How much do I need to retire?” has become a concern across generations rather than something that only those approaching retirement focus on. But what if you, or in the case of married couples, your spouse, are not covered by an employer-sponsored retirement plan? In this article we are going to cover retirement savings strategies for individuals that may not be covered by an employer-sponsored retirement plan.
Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Not Maxing Out
A common strategy we use for clients when a covered spouse is not maxing out their deferrals is to increase the deferrals in the retirement plan and supplement income with the non-covered spouse’s salary. The limits for 401(k) deferrals in 2025 is $23,500 for individuals under 50, $31,000 for individuals 50-59 and 64+ and $34,750 for individuals 60-63. For example, if I am covered and only contribute $8,000 per year to my account and my spouse is not covered but has additional money to save for retirement, I could increase my deferrals up to the plan limits using the amount of additional money we have to save. This strategy is helpful as it allows for easier tracking of retirement accounts and the money is automatically deducted from payroll. Also, if you are contributing pre-tax dollars, this will decrease your tax liability.
Note: Payroll deferrals must be withheld from payroll by 12/31. If you owe money when you file your taxes in April, you would not be able to go back and increase your deferrals in your company plan for that tax year.
Married Filing Jointly - One Spouse Covered by Employer Sponsored Plan and is Maxing Out
If the covered spouse is maxing out at the high limits already, you may be able to save additional pre-tax dollars depending on your Adjusted Gross Income (AGI).
Below is the Traditional IRA Deductibility Table for 2025. This table shows how much individuals or married couples can earn and still deduct IRA contributions from their taxable income.
As shown in the chart, if you are married filing jointly and one spouse is covered, the couple can fully deduct IRA contributions to an account in the covered spouses name if AGI is less than $126,000 and can fully deduct IRA contributions to an account in the non-covered spouses name if AGI is less than $236,000. The Traditional IRA limits for 2025 are $7,000 if under 50 and $8,000 if 50+. These lower limits and income thresholds make contributing to company sponsor plans more attractive in most cases.
Single or Married Filing Jointly and Neither Spouse is Covered
If you (and your spouse if married filing joint) are not covered by an employer sponsored plan, you do not have an income threshold for contributing pre-tax dollars to a Traditional IRA. The only limitations you have relate to the amount you can contribute. These contribution limits for both Traditional and Roth IRA’s are $7,000 if under 50 and $8,000 if 50+. If married filing joint, each spouse can contribute up to these limits.
Unlike employer sponsored plans, your contributions to IRA’s can be made after 12/31 of that tax year as long as the contributions are in before you file your tax return.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
