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No small business owner I have talked to knows their 401k plan fees or their effective tax rate. One of the questions on we have is “Do you know your effective federal income tax rate?" I have yet to find anyone who actually knows this answer.
Most people just take their receipts and other tax related info to their tax preparer and hope for a refund. However, this approach does help plan to reduce taxes aka tax planning. Small business owners are in a unique situation to leverage your business owner status.
The drag of 401k plan fees and fiduciary
Amidst “deflategate” and Presidential primary news you may not have heard about the many high profile class action lawsuits asserting that plan overseers, the fiduciaries, did not properly watch over the fees being paid to their service providers. The latest one being Boeing. As many of the fees are typically hidden, this requires some investigative work or working with a third party to do the digging. I have heard from many conversations Fortune 1000 companies must have highly sophisticated employees that know all of the ins and outs of plan monitoring
As a small business owner you may feel behind the eight ball because you do not have the luxury of staff dedicated to plan oversight. However, you have a unique choice that larger firms may not have. You may decide to pay the plan fees directly. Working with your tax preparer, you may deduct the fees as a business expense. This makes the most sense when your individual account, is one of the largest individual accounts.
Let me explain. Let’s say that you are paying fees of 2% for your plan. If you are like the majority of small business plans, those fees are being paid through the investments in the individual participant accounts. Let’s assume plan assets of $1,000,000 and an individual account of $500,000. Multiplying your $500,000 by 2% means that you are paying $10,000 in to the pot that pays plan expenses. If your plan has 5 additional participants with a total balance of $500,000 your balance is subsidizing the plan cost for the others. Moreover, the 2% fee is dragging down your investment results. The SEC, General Accounting Office and Jeff Marzinsky of Millliman reported on the harmful effects of fees. Marzinsnky reported his findings in “Hidden costs: Are 401(k) fees taking a bite out of retirement savings?” He calculates “Hidden fees are troublesome because, over a lifetime of contributing $5,000 a year, assuming an annual gross rate of return of 9%, a participant paying an additional fee of just 1% would retire with $1,918,678 rather than $2,448,895, or $530,217 less. That 1% difference in fees could wipe out 26% of the employee’s retirement nest egg1.”
Addressing 401k plan fees for fiduciary and taxes
Instead, you decide to have your company, “You, Inc.” pay the fees. It now can be considered a business expense along with the other plan costs like administration and matching contributions. You have just given yourself an increase in your rate of return because you have decreased the fees.
You have gotten the 401k plan fees off of the radar of the Department of Labor Investigators that are concerned that your plan fees are not excessive and therefore harmful to your employees. Besides your return, you have given your employees a similar bump in their rate of return too.
However, this requires that you are working with an investment advisor that charges a fee vs. the more typical commission or share class world. Find out if your 401(k) financial advisor can charge you fees if they aren’t already. If they can’t you may have to evaluate if the benefits of working with them are worth the loss in investment performance and tax deductions. If they can, then get them together with your tax preparer and start enjoying the benefits. Once you make the switch, do an employee meeting to let them know the benefit of the change to them. Make sure they know why it is beneficial to work for you vs. a competitor that may not be a savvy as you.