Why Professional Service Firms Should Sponsor a 401(k) Plan

Why Professional Service Firms Should Sponsor a 401(k) Plan

I work as a retirement plan financial advisor  to professional service organizations such as legal practices, physician groups and dentists. A big reason for these firms to sponsor a plan is that it is a huge employee benefit. More importantly for the plan sponsor, it is a key component used to recruit and retain top-level employees and highly compensated partners and talent. These organizations must constantly be evaluating recruitment and retention because it is the lifeblood of their growth.

Compared to health insurance premiums that seem to increase 20% or more annually, the costs of administering a retirement plan are far more forecastable. The value to partners and staff of building future wealth through a qualified retirement plan can far outweigh health benefits provided through a Cadillac health plan.

For this reason, the dominant plan of choice for professional service organizations is the 401(k). Despite what you may have heard otherwise, 401(k) plans are only bad if they are run poorly or administered by incompetent providers. When it comes to retirement plans, a well-designed 401(k) is the gold standard for professional service firms. This article will tell you why.

Pension Plans have become as rare as the slide projector!

Vintage Slide Projector

Prior to the broad acceptance of personal computers in the 80’s, the slide projector was the presentation tool of choice. In similar fashion, prior to the introduction of 401(k) plans in the early 80’s, the retirement plan of choice was the good old-fashioned defined benefit plan. These plans are far less popular now, primarily because 401(k) plans are far cheaper for employers to maintain. The bulk of savings in the average 401(k) is funded by the employee through salary deferrals, while pension plans, which seek to fund a future benefit at retirement, are almost entirely funded by employers. 

Pension vs 401(k)

This higher cost of pension plans to the employer, combined with soaring premiums for employer funded health insurance benefits, made it inevitable that defined benefit pension plans were going to be a casualty. Fortunately, lower cost 401(k) plans became an increasingly attractive alternative for employers who could now largely shift the cost and liabilities incurred with pension plans to the employees. 

Pension plans are still a great tool for sole proprietors and small, family businesses. For many professional service organizations, certain “hybrid” defined benefit plans such as cash balance plans have flourished in recent years as a way to allow the most highly compensated owners and partners to substantially increase their pre-tax contributions and tax savings when paired with a traditional 401(k) plan.

For many legal, physician, dental and accounting practices with highly compensated employees, these newer defined benefit plans, paired with a traditional 401(k) defined contribution plan, are still something that you should consider. But fundamental to this strategy is a well designed 401(k).

SEP’s and SIMPLE IRA plans are very efficient… unless you have employees!

Clearly there are some company sponsored retirement vehicles that are cheaper to manage and free of the compliance requirements of a 401(k) plan. These plans have virtually no administrative cost, are easy to set up and maintain, and have minimal filing requirements (no Form 5500). The two most popular are the SEP- IRA (Simplified Employee Pension) or the SIMPLE-IRA (Savings Incentive Match Plan for Employees). The limitations of these two options are flexibility and that total employer costs are directly related to headcount.

SEP-IRA plans allow only employer contributions.

The good news with the SEP is that it has virtually no administration cost  and it allows employers to make discretionary, pre-tax contributions up to 25% of compensation without administrative or compliance duties of a more complex qualified plan. Under the SEP, employers make contributions to eligible employees through a traditional retirement arrangement called a SEP-IRA. The employee owns and controls the account and the employer makes the contributions to the financial institution where the assets are maintained.

Employees cannot make contributions to a SEP meaning that 100% of the contributions are made by the employer. SEP plans get very expensive because all employer contributions are made pro-rata. This means that the same percentage of compensation is applied to all employees. In a SEP, there is no flexibility to favor certain employee groups of higher paid employees, partners or owners.

SIMPLE IRA’s have lower contribution limits and less flexibility.

The SIMPLE IRA is similar to the SEP in the sense that it is an IRA-type arrangement, but there are three major differences:

  1. A SIMPLE-IRA allows participant contributions up to $13,500 or up to $16,500 if they are older than 50. Contrast this with $19,500 and $26,000 limits for 401(k) in 2020.
  2. Certain minimum employer contributions must be made each year, regardless of whether the business is profitable. Employers must make these contributions either in the form of a dollar-for-dollar match up to 3% of the employee’s compensation or a flat 2% for each employee. Adding to this employer expense, every employee making more than $5,000 annually is eligible. In comparison, the employer match with 401(k) is discretionary and can be adjusted annually. Eligibility can be restricted to full time employees, age 21 or older, with a service requirement up to 12 months from hire date.
  3. SIMPLE plans are only available to employers with fewer than 100 employees. 

When it comes to retirement plans for legal, medical and other professional service organizations, the 401(k) plan is the “gold standard”!

Highly compensated employees cannot save enough in a SEP or SIMPLE to fund retirement.

Highly compensated individuals are severely limited by the lower contribution limits of SEP and SIMPLE plans. In contrast, annual participant deferral limits for 401(k) allow $19,500 or $26,000 if they are over age 50.  Optional employer contributions in the form of discretionary match and profit-sharing contributions allow total annual contributions up to $57,000 annually for 401(k) participants who meet the income requirements.

 When you factor that these additional investment savings compound free of tax for 30 years to retirement age, just do the math!

There is no flexibility in contributions for a SEP or a SIMPLE. 

A SIMPLE requires a contribution every year. Both SEP and SIMPLE plans require pro-rata employer contributions. This means that if you are an owner and want to give yourself a 25% contribution, under a SEP, you must give the same pro-rata contribution to all of your eligible employees. That requirement becomes expensive very quickly for a plan sponsor. With a SIMPLE, there is no profit sharing feature and simply limited to a 3% match.

The flexibility of 401(k) plan design allows the option of both a flexible match and an additional profit sharing contribution. For those employees that are eligible yet choose not to contribute to the plan, the plan may be designed so that no match from the employer is required. 

401(k) allows legal discrimination through profit sharing contributions to key employees.

In organizations where some highly compensated employees make over the Social Security Wage Base ($137,700 in 2020) or where higher compensated employees in general are older than lesser paid employees, 401(k) designs allow flexibility to make much higher allocations for these employees through profit sharing allocation features. An allocation formula arrived by cross-testing/new comparability may produce the same result.  

Employee Groups

So unlike in a SEP where you would be forced to give every eligible employee a pro-rata 25% contribution, these profit sharing allocation formulas allow certain employee groups up to 25% of compensation while only 5-7% of compensation would be required to lower paid staff. 

The after-tax benefits of a well-designed 401(k) plan often exceed the total annual costs of the plan.

In most plans, the bulk of the contributions are made by the participants. Because of this, it’s safe to say that with respect to employer contributions, the 401(k) is the most cost effective plan for organizations with more than a handful of employees. 

Thanks to competition and recent fee disclosure, 401(k) plans have seen considerable fee compression in recent years. Despite of the lack of administrative costs for SEP and SIMPLE plans, these plans lack the flexibility to achieve higher contributions for your highly compensated employees.

Law Firm

If your firm has highly compensated owners, partners and key employees and you have a SEP or SIMPLE, you have the wrong plan.

For certain professional organizations that I work with, a 401(k) can be combined with a “hybrid” cash balance plan that may allow older, more highly compensated partners to legally contribute up to $250,000 in annual tax-deferred contributions in some cases without proportionate increases to the rank and file. While this requires some additional administrative costs to the organization, there simply is no other plan design that comes anywhere close to providing this level of annual pre-tax deferral and tax savings for both the organization and these highly compensated individuals. 

An experienced 401(k) advisor is usually available to help 401(k) participants.

Employers who sponsor 401(k) plans are required to provide education to employees with regard to their investment options and decisions. This is one of many reasons that informed plan sponsors should hire a financial advisor both to select and monitor plan investment options and to provide guidance to employees

With SEP’s and Simple’s, most employees make these decisions without the help or guidance of a financial advisor. This is a serious disadvantage for most employees who are not investment savvy. In most cases, SEP or SIMPLE plans are funded with higher cost mutual fund share classes, further reducing future returns. I recently reviewed a SIMPLE IRA for a client that offered A shares with a 5% load fee in addition to annual expenses of nearly 0.75%. She thought the plan was free. 

Technology provides limited liability to employers for participant direction of investments.

The booming stock market and technology advances in the late 90’s converged to produce a boom in the creation of 401(k) plans by mutual fund companies. Online daily valuation coupled with participant direction through custom website portals simplified the administrative process for plan sponsors. 

Employers who followed the rules established in ERISA 404c could also now rely on a layer of protection against liability for participant investment decisions. As long as you did the work of selecting and monitoring investment options and educating participants, you would not be held liable for plan losses incurred by participants. Lower liability for investment returns became a significant advantage not possible with defined benefit plans..

A well designed 401(k) is not an expense. It is a valuable business asset.

The additional flexibility in 401(k) employer contributions allow both savings to the employer and significant tax saving benefits to talented employees who have started saving for retirement in their 40’s. Proper 401(k) plan design allows your key talent to build wealth much faster than other plans.

Asset vs Expense

In most cases, the after tax benefits of a well-designed 401(k) plan far exceed the additional costs. When the ability to recruit and retain talent is added to the equation, the decision to sponsor 401(k) retirement plan becomes a no-brainer for the firm’s growth.

The 401(k) market is loaded with talent.

Because 401(k) is the dominant plan in the marketplace, it is loaded with talented providers that can assist you with your fiduciary duties. With most other plans, you probably will to get no help. If you are overwhelmed with the process of establishing and managing a 401(k) plan for your firm, there are excellent providers who can walk you through everything without a lot of stress.

It’s a 401(k) world!

If you are a professional organization such as a legal or CPA firm, a physician group or dental practice, you will quickly outgrow less sophisticated plans. Rather than convert an inferior plan after only a few years, it is far preferrable to design a 401(k) plan that complements your current business revenue growth and is flexible as you grow the business. For you, it’s a 401(k) world!

Brian C. Rall

President – Strategic Retirement Partners, LLC

February 27, 2020

Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.

Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.

Toss Those Market Forecasts in 2020

Toss Those Market Forecasts in 2020

If you are like me, your email this month is full of Holiday invites, year-end offers, and requests for charitable donations. 

December is also the month those market guesses (politely referred to in the industry as “market forecasts”) begin to pour into my inbox from seemingly every investment firm and advisor on the planet.

While I confess these forecasts to be highly entertaining (Barrons Roundtable has been my personal ritual for 41 years) they are neither useful nor beneficial for investors saving for retirement. In fact, they can actually be harmful to your long-term retirement outcome.

The widespread practice of producing annual market predictions is one of the worst tendencies in the retirement industry. Investors whose goal it is to fund their child’s future college expenses or retirement income are by definition looking to compound their returns over many years. A one year time horizon is both irrelevant and reinforces an emphasis on short-term thinking that can actually harm most retirement participants. 

The widespread practice of publishing annual market predictions is among the worst tendencies in the retirement industry.

Just think about that for a minute. If your time horizon is one year, you should not even be in the market. And if you are in the market, you better be right.

It should not be surprising to anyone that these Wall Street experts make excellent guests on the financial networks. After all, the producers at Fox Business News and CNBC have much to gain by simply keeping alive the mistaken belief that smart people can routinely predict what the market will do in the short term.

As we tune in to watch these Ivy League educated experts in $3000 suits discuss their current macro theory – weaving together monetary policy at the Federal Reserve, geopolitical threats and a massive developing short position in soybeans – we observe an impressive human ability for higher order thinking and pattern recognition. What we don’t often see is that these strategists are seldom right about what actually takes place in the markets during the next 12 months.

So why is that the case?

Daniel Crosby, an expert in the field of behavioral investing, offers us some compelling clues based on normal human behavior. He compares these market wizards to “a game show contestant who has overcomplicated the task by half”.

In Crosby’s view, set out in an outstanding article titled, Are You Smarter Than a Rat, “the elegance of the story has overtaken the likelihood of its occurrence.” 1.

The elegance of the story has overtaken the likelihood of its occurrence.

Daniel Crosby on market forecasts.

In other words, it sure sounds smart even though it probably will never happen! According to Crosby, even a rat makes better decisions than a human, because he simply acts on what will probably happen most of the time.

Most of us should learn to think like a rat. But believe it or not, that’s harder than it seems

‘It’s like the old days in the lab, Charlie. You learn the maze, you get the food pellet, you go home. What else can I say?’

I have always wondered why market strategists get paid big bucks by their investment firms to make forecasts which have a little probability of working out as advertised. For example, few experts this January predicted that the S&P 500 would be up 23.16% through October 31 when the same benchmark actually declined 13.52% in the 4thquarter of 2018. Even fewer these experts forecast the whopping year to date annualized return of the S&P U.S. Treasury Bond Current 30-Year Indexof 24.03%. Who saw that coming?

You should know that while the individual forecasts themselves are seldom correct, their authors always hedge their bets, usually imbedded in fine print in the footnotes:

“These views are subject to change without prior notice.”

I consider myself fortunate to have known some very successful investors in my 30+ year career in the financial services industry. When asked for their market forecast, most have no grand thesis or series of dominoes waiting to fall. Rather, they will talk about a disciplined investment process as being the key to investment success. To them, the rest is just crowd noise.

Successful investors talk about a disciplined investment process. The rest is just crowd noise.

To be clear, these investors are usually not invited to participate in CNBC’s year end roundtable. If they do come on, they are seldom invited back (unless your last name is spelled B-U-F-F-E-T ). Sadly, when it comes to financial new shows, there is far more demand for sophisticated nonsense than boring-but-true market wisdom.

The urge to “do something” is usually bad.

When average retirement fund participants hear these forecasts, they think they should be looking at how their portfolio will perform next year. There is an urge to “do something” and therefore believe that the more engaged they are, the better their returns will be. In practice, the exact opposite is true.


Investors who have a sound, disciplined process and make infrequent portfolio changes are far more likely to do better over the long term. As Crosby explains:

“(successful investors) live in the world of a process driven path which tilts probability in their favor at every turn, secure in the knowledge that “probably” is the most powerful word in investing”.

Daniel crosby, Ph.D-Chief behavioral officer, Brinker Capital

Common Sense Investment Advice

For an investor saving for retirement, here are three practical ways you can boost your success:

Disengage from the day-to-day fluctuations of the market.

Ok, on the surface this may sound irresponsible. But for most of us, our ideas about money are very much tied to our emotions. The inevitable short term market changes often trigger fear of loss or inspire a false optimism that cause us to make poor decisions. The more we can emotionally disengage with day to day market changes, the better our long term results 

Throw away your account statements.

This is another radical practice, but I know a lot of successful long term investors who operate this way. I highly recommend it for those who tend to be emotionally impacted by short term market volatility. Market declines are always temporary, but the urge to “do something” often produces activity that results in permanent loss. I know a lot of 401(k) participants wh refused to open their statements during the last recession. Most of them are glad they did!

Toss those statements!

Seek professional advice.

One of the biggest mistakes I see investors make has to do with ego and the belief that they are smart enough to do this on their own. An experienced advisor can help you with some of the heavy lifting such as creating a custom portfolio allocation based on your goals and needs. But in my opinion, the true value of seeking investment advice is simply gaining objectivity when markets are volatile. Good investors have mastered their emotions. An experienced advisor can help you overcome making emotional decisions when often the best course of action is to do nothing. 

As we head into the new year, I suggest that you ignore the annual investment forecasts. Sure, they can be highly entertaining but they are not likely to be predictive of what happens in the year ahead. 

Instead, focus on saving more, worrying less and living in the world of a process-driven path!

Brian C. Rall- President, Strategic Retirement Partners, LLC

  1. Daniel Crosby, “Think Like a Rat”, November 2017

Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.

Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.

Audit Proof Your Company’s 401(k) Plan!

It is highly probable that your company’s 401(k) plan will be subjected to audits conducted by the DOL and the Internal Revenue Service at some point in the future. If you are not 100% certain what documents you will need, download this free copy of our “Fiduciary Audit File Checklist” and be sure!