Thursday, July 14, 2022

Know the Risks so you can Reap the Rewards of your Company’s Retirement Plan

A guest post by Tripp Leonard, CFP ®, AIF ®, CEPA®, Partner at Irongate Capital Advisors, a VACEOs sponsor

A company’s retirement plan is more than just ‘table-stakes’ to attract & retain talented people.  Well designed & closely monitored, a corporate retirement plan will ‘connect’ to the company’s culture, empower your workforce, and provide the owners with a tax-efficient tool to reward & incentivize growth. 

A qualified retirement plan can also serve as a tax-efficient mechanism to support an owner’s exit or internal equity transition to key managers.

Qualified Retirement plans can seem complicated and come with significant fiduciary responsibility.  Three (of many) key considerations:

1. Know exactly what you are paying for administrative expenses and how these costs are retrieved

  • With more than 170 ERISA class action lawsuits filed in federal court the past couple of years1, 401k plan sponsors (the owners of the business) need to understand their fiduciary responsibility with respect to their company retirement plan.
  • The main trouble-spot is revenue-sharing within the expense ratios of the plan’s investment line-up. The expense ratio a participant sees per investment is not always what is paid to the management team selecting their stocks or bonds within the fund. There may be sub-TA or 12b-1 revenue that is paid to other parties.  This leads to administrative expenses increasing as the plan assets grow – and the potential for one participant to contribute more to plan expenses than another based on the fund selected. 
  • Tibble v. Edison & Tussey v. ABB – two often-cited and important legal cases that are important for plan sponsors to understand – highlight the importance of a prudent process, transparency with respect to plan administration expenses, and share class selection. 
  • As Charlie Munger once said – “All I want to know is where I’m going to die, so that I’ll never go there.”   Understand where the trouble spots lie with respect to fees, expenses, and regulatory precedent – reviewed, monitored, and benchmarked annually – and you will be an advocate for your workforce and create a tailwind for compounding their wealth. 

2. Conflicts of Interest

  • Depending on the recordkeeper you select for your company’s retirement plan, it is important to understand the various layers of economic incentives.
  • For example, administrative pricing may be impacted by the target-date series you select for the plan.  The target-date-series is often the Qualified Default Investment Account (QDIA). Be careful here.  Ideally, as a decision maker, you do not want ‘constraints’ when it comes to selecting plan investments for your workforce. 
  • Stable Value v. Money Market Funds is another ‘category’ leading to multiple lawsuits against employers.  Anthem had a class-action suit brought against their plan – one issue being the offering of Vanguard’s Prime Money Market instead of a Stable Value Fund.  Stable Value Funds often have higher yields than money market funds with similar ‘stability’ of principal at the participant level. 
  • Not all Stable Value Funds are created equal – and often the recordkeeper selected may ‘encourage’ your stable value fund selection.  You have options. 
  • Proactive understanding of various conflicts of interest will help guide decision making that benefits your plan and your team. 

3. New Comparability Profit Sharing Formula and/or Cash Balance Plans

  • Many 401k or corporate retirement plans include a company match.  This may be done as a safe-harbor match or a discretionary match – creating an incentive for participants to save and an opportunity for the company, using cash flow from the business, to accelerate their pace of savings. 
  • The actual profit-sharing sleeve of the 401k retirement plan is often ignored.  This sleeve allows a business to evaluate at year-end whether there is a portion of corporate earnings-before-taxes that should be directed to the retirement plan.  These contributions are tax-deductible, not imputed as income to the participants, and often include a vesting schedule that provides a retention component. 
  • The default profit-sharing formula for most plan documents is ‘pro-rata.’  For closely held companies, changing that formula to ‘new comparability’ allows the flexibility to allocate profit sharing contributions to select or tiered groups.  Your administrator has specific compliance guidelines that drive the allocation formulas; however, the flexibility will often surprise you. 
  • For example, you may want to emphasize rewarding the ownership/management team first, then project managers next, then superintendents, etc.  There are multiple factors including ages, incomes, structure of any safe-harbor contributions; however, the flexibility of a new-comparability profit sharing formula justifies having iterations run so you know what is possible.  A well-designed profit-sharing plan can provide a very tax-efficient executive benefit that has an ‘equity’ feel for your workforce. 
  • Lastly, cash-balance plans are a relatively flexible version of a defined benefit plan.  For businesses with consistent, predictable cash flow, a well-designed cash balance plan can be the ‘4th leg’ to the qualified retirement plan (deferrals, match, profit sharing, cash balance) that allows owners (and key people) to receive large, tax-deductible retirement plan contributions on top of 401K Profit Sharing deposits.  For example, the 2022 maximum contribution to a 401k profit sharing plan (if age 50+) is $67,500.  A cash balance deposit for this individual can be as high as $343,000 in 2022 for a total contribution limit of $410,500.  There is ample flexibility below these max-levels, but you get the point – potential for very high current year tax-deductions and the potential for a tax-efficient planning tool to prepare an owner for retirement, exit, or simply diversification. 

As a decision maker, a well-designed and well monitored retirement plan involves looking at the right information in the right way and doing what is best for participants and their beneficiaries.  The financial health of your workforce will benefit from your time, energy, and process.  And with the right design, your company’s retirement plan can also be a highly effective capital allocation tool for the owners & management team.   

 1Bloomberg Law 4.5.22

About Tripp Leonard CFP ®, AIF ®, CEPA®

Tripp Leonard is an equity partner of Irongate Capital Advisors.  Since 1994, he has worked with private businesses, their owners, and their key people in the areas of business succession planning, capital allocation & investment management, risk management, and employee benefits.  His practice is focused on fee-based corporate & personal financial planning and investment advisory services for individuals, corporations, and qualified retirement plans.

Financial Professionals do not provide specific tax/legal advice and this information should not be considered as such.  You should always consult your tax/legal advisor regarding your own specific tax/legal situation.

Tripp Leonard is a Registered Representative and Investment Advisor Representative of Securian Financial Services Inc. Securities and Investment Advisory services offered through Securian Financial Services Inc. member FINRA/SIPC. Irongate Capital Advisors is independently owned and operated.  800 E Canal St. Suite 950, Richmond, VA 23225. TR: 4834629 DOFU: 07/2022

Posted by Scot McRoberts at 1:44 pm

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