The pooled 401(k) plan-yet another reemerging trend?
If you follow popular culture, "throwback" trends are gaining popularity. This might even include the pooled 401(k) plan for dentists. But watch out for new regulations.
John K. McGill, JD, MBA, CPA
Brett Miller, CPA, CFA
If you follow popular culture, "throwback" trends are gaining popularity. While many of these trends are in the world of fashion, one of keen interest to dental practice owners is the investment structure of company-sponsored 401(k) plans. The current 401(k) industry is dominated by participant-directed platform-based structures; however, the Department of Labor's new fiduciary regulations (released this spring) have brought a new level of regulatory scrutiny.
At the heart of the new regulations are the refined responsibilities of doctors to the plans, specifically the responsibility of selecting, monitoring, and managing plans' 401(k) investment assets. This heightened scrutiny has shifted the landscape of liability over investments for employees. As a result, doctors should look into the benefits of switching to an ERISA 3(38) advisor in a pooled, trustee-directed 401(k) plan structure. While the thought of pooling an entire 401(k) plan into a single investment pool might sound foreign, it is a classic plan structure that is reemerging among savvy plan sponsors.
ERISA 3(38) advisor
Doctors have long been cautioned that pooling their office retirement plan assets into a single investment account can increase their fiduciary responsibilities. However, this is only true if doctors plan to manage the pooled investments by themselves. If a doctor uses a 3(38) advisor in conjunction with a pooled account, a doctor's fiduciary responsibilities will actually be limited.
This is because a 3(38) investment manager is a special type of fiduciary-an advisor who has been specifically appointed to have full discretionary authority and control to make the actual investment decisions within the plan. The advisor has full authority over the investment options offered in the plan. Once in place, the 3(38) investment manager has full fiduciary responsibility for investment decisions, subject to the terms of the plan documents and the investment policy statement. Most importantly, the plan sponsor and all other plan fiduciaries are relieved of all fiduciary responsibility for the investment decisions made by the investment manager.
As trustees, doctors still bear the responsibility to properly select and monitor their 3(38) advisor. But using a 3(38) advisor is a great way for doctors to "act in the best interest of their participants" by transitioning the responsibility for the plan investments to a qualified investment professional.
Investment fees are one of the primary drivers of the Department of Labor's new regulations. High fee products with very little transparency are a known issue that have frustrated many small business owners and plan participants. In a pooled 401(k) account, fees for investment management and third-party administration can be paid by the business as a legal and administrative expense. This is in lieu of being deducted out of individual participant balances.
This results in an estimated 2% annual reduction in fees paid by individual participants, which can be significant over time! Pooled accounting can further reduce fees by helping participants gain access to lower cost index funds and institutional class mutual funds. An astute 3(38) advisor will help doctors identify and analyze these fees associated with their retirement plan investments.
Profit sharing funding
Profit sharing is the goal of any well-designed 401(k) plan. Unfortunately, most doctors must wait until the end of the plan year to determine and fund the profit sharing contribution, which leads to a suboptimal contribution. By switching to a pooled 401(k) account, doctors can "prefund" the majority of their profit sharing contribution during the actual plan year.
Leveraging the benefits of automatic monthly recurring drafts, doctors can dollar cost average their profit sharing contributions. At year end, the practice can easily top off the maximum profit sharing after the annual calculations have been completed. Our experience has shown that doctors who fund profit sharing via a monthly draft are much more likely to fund to the maximum amount.
The benefits of pooling a 401(k) plan lead toward a single overarching goal-improving investment opportunities for the plan participants. By creating efficiencies, a 3(38) advisor can help participants avoid many of the common pitfalls that harm individual investors, while shifting a sizable portion of liability to trained professionals with clear fees. While often unnoticed, these inefficiencies can be as much as 3.52% per year, the average underperformance of equity investors over the last 20 years.1 Allowing a professional 3(38) advisor to manage the plan assets in a diversified allocation can help to avoid many of these common mistakes.
John McGill, JD, MBA, CPA, provides tax and business planning for the dental profession and publishes the McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC. Brett Miller, CPA, CFA, provides investment advice through McGill Advisors Inc. (RIA). Both are members of the McGill & Hill Group LLC, a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com for more information.
1. Wild R. Dalbar's 22nd Annual Quantitative Analysis of Investor Behavior. The Complete Solution website. http://thecompletesolution.com/c/wp-content/uploads/2014/04/ 2016-Dalbar-QAIB.pdf. Published December 31,2015. Accessed June 20, 2016.