Attorney Case Study 3 of 3: I’m too small to have a plan
As we wind down to our final case study relating to common law firm misconceptions, I want to address those firms that think they’re too small. I’ve seen firms of all sizes say, “Oh, I’m too small, we don’t need a plan.” These offices have been anywhere from 3-10 employees, and soon enough, the state of California will require one.
Yup! Beginning June 30th, 2022, employers with five employees or more will be required to offer a retirement plan through the company or enroll your employees through the state. While this date seems far off, it’s already starting for companies with over 100 employees next year.
So let me educate on the root cause of the ‘too small mentality’ and help you understand the benefits of establishing a plan and the costs.
- A primary benefit to any retirement plan is being able to save for one’s retirement and contribute significantly more than utilizing an IRA. For 2019 the maximum contributions are $19,000 for those under 50 while an IRA limits you to $6000. If you’re over 50, then you can contribute an additional $6000 to a 401k while only an extra $1000 to an IRA.
- Saving money on taxes may be some’s primary concern and benefit through the plan. If you’re ever heard the saying, “pay yourself first” then a 401k is an effective way to achieve that. You are literally paying yourself before anyone else, including the government.
- If you’re an employer, then attracting and retaining quality employees is an extreme challenge considering the current labor markets. If you’ve interviewed candidates, a common question I’m sure they have asked is, “what benefits do you provide?”
- An additional benefit most 401k’s offer to employees is the ability to take a loan from the plan, which is not an option with an IRA. This is especially important in a state like California because of the high housing costs. Many people like to access a portion of their savings to put down for the first purchase of a home or additional investment properties.
- A forgotten benefit of a 401k, which I thought attorneys might be more appreciative of, is the fact that your 401k accounts are protected from creditors when dealing with normal debt, bankruptcy, or a civil court judgment.
- Costs - yes, we’re still in the benefits section! The costs to invest are typically lower than investing as an individual through an IRA or brokerage account. Since you’re investing your money through 401k, most investments will have lower internal costs because you’re investing in institutional shares instead of retail. Also, depending on your plan, you’re probably going to avoid transaction costs when investing or making changes to your portfolio.
- As a start-up plan, it’s important to understand the many ways plans can be charged. The most common are a flat fee, which includes a base charge and a per participant fee. These can be great because as your plan grows in assets, the costs of the plan will remain the same, but at the beginning can be quite costly depending on the providers. An alternative option is a fee-based approach which charges based on the assets within the plan. Since your plan doesn’t have any assets, fee-based can be a great place to start but needs to be monitored to not be too costly down the road. We usually see these fees around 2% for brand new plans.
- Depending on how much you want to save in taxes, you may need a more elaborate plan. In this case, you’ll need to hire a Third Party Administrator which will design the plan based on your company goals and employee demographics. In our experience, TPA’s can charge anywhere from $1250 to over $2500, depending on the complexity of the plan. But usually, the tax savings and customization are worth the cost.
- Investments' internal expenses are a cost that you typically don’t see or feel, but they impact your overall investment returns. If you’re using a plan that is based on the assets within the plan, as mentioned in point 1, then this is usually included in the overall percentage. If you’re working with flat-fee pricing, then this is an additional cost that is taken from your investments.
To summarize with simple math, if you’re earning $100,000 per year and maxing out your plan, you’re likely saving around $4300 in taxes based on falling in the 22-24% tax bracket. So even if the plan does cost you $2500 to establish, you’re still saving money on your taxes, not to mention offering an incredible benefit to employees. As your company grows, so will the 401k, so it’s important you choose a partner that can help guide you to the most reasonable options for your company and provide proactive options throughout the life of the plan. We hope to be that partner for you and always appreciate the opportunity to help educate you on your options.
This is a hypothetical example and is not representative of any specific situation. Your results will vary.
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.