The New WCI 401K

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WCI is ten years old this Spring and we’re now on our third 401(k). It’s been a long and winding road. Our first 401(k) was a simple, cookie-cutter Vanguard Individual 401(k). And when I say “our”, I mean “my”, since I was the only one working here and the only one contributing to it. It certainly served my purposes.

When I gave away half the company to my dear wife, she also started contributing to this individual 401(k).

When the Tax Cuts and Jobs Act was passed and the 199A deduction was born, our financial situation was such that it no longer made sense for WCI to make tax-deferred 401(k) contributions on our behalf. The Vanguard plan wouldn’t allow us to do Mega Backdoor Roth IRA contributions, so we had to look elsewhere. We had staff members at that time, but they were all still independent contractors, so, with Mark Nolan’s help at mysolo401k.net, we simply restated our individual 401(k) into a customized individual 401(k). The money itself moved from Vanguard to Fidelity. The new individual 401(k) came with the additional benefit of being a true checkbook, self-directed 401(k). We never got around to taking advantage of that particular feature, but we did our Mega Backdoor Roth IRA contributions each year with it.

Fast forward to 2020, we were hiring like mad and our general counsel said we could no longer justify telling the IRS that our staff members were independent contractors, not employees. Most of the new ones we hired as employees anyway, but we made plans to transition the rest to employees starting in 2021. That brought up three challenges to solve:

1. We could no longer use an individual 401(k). If you have any eligible employees besides your spouse, you need a real 401(k)
2. Our staff members who were previously independent contractors with their own individual 401(k)s didn’t want to lose the ability to make the large contributions to retirement plans that they were currently doing
3. We promised the new hires the world’s best 401(k) starting in 2021

 

The Process of Creating the World’s Best 401(k)

So we embarked on a process that took us most of six months. We started by reaching out to folks on our recommended retirement plan list. While we eventually had to decide on just one, we were very pleased with the input and assistance we received from others on the list. The reason it took so long was that I was very picky. I really did want the world’s best 401(k). Let me define what I mean by that:

1. The lowest possible costs for the employees
2. The lowest reasonable cost for the employer
3. All expenses possible to be paid by the employer as business expenses
4. The best possible investments
5. Excellent default investment options
6. Easily automatable investment process
7. Automatic rebalancing process
8. Automatic enrollment (opt-out, not opt-in)
9. Automatic increase in contribution rate
10. Roth Contributions
11. 401(k) Loans
12. The ability for every employee interested to max out the account ($58K/$64.5K for 2021)
13. A true self-directed account, at least for owners
14. The ability to do after-tax contributions
15. The ability to do inservice withdrawals/rollovers
16. The ability to do in-plan Roth conversions

Unfortunately, we were not able to get every single item on my list. But we got 11 1/2 out of 16, which wasn’t too bad, and we can live with and work around all of the others.

1. The lowest possible costs for the employees
2. The lowest reasonable cost for the employer
3. All expenses possible to be paid by the employer as business expenses
4. The best possible investments
5. Excellent default investment options
6. Easily automatable investment process
7. Automatic rebalancing process
8. Automatic enrollment (opt-out, not opt-in)
9. Automatic increase in contribution rate
10. The ability for every employee interested to max out the account ($58K/$64.5K for 2021)
11. 401(k) Loans
12. Roth Contributions
13. A true self-directed account, at least for owners 1/2
14. The ability to do after-tax contributions
15. The ability to do inservice withdrawals/rollovers
16. The ability to do in-plan Roth conversions

Why couldn’t we get them all? Well, it turns out it was mostly Vanguard’s fault. We began by talking to the retirement plan providers to see what was possible to do with this wish list. They found it immensely challenging. None of them had ever tried to accomplish all this in a single retirement plan. Numbers 13-16 were particularly challenging. In order to get even some of them we had to give up a few items. Actuaries, TPAs, custodians, and advisors went back and forth trying to figure out how to give us most of what we wanted. Some, such as Vanguard, told us they simply could not customize to the level we wanted. We actually could have had 5, 6, 7, and 9 with them as the custodian, but they weren’t willing to give us 14 too, which was the most important feature for Katie and me.

Employee Input, Compensation, and Education

Early on in the process, we had to go to our staff members and ask them what they really wanted. That meant we had to educate them right along with us about what was really possible in a 401(k). We also helped them to recognize that their compensation package all came out of a single pot. We asked questions like:

• Do you want more in salary or more in retirement account contributions?
• Do you want more in health insurance premiums or more in retirement account contributions?
• How much do you really want to contribute to a retirement plan?

Within legal limits (and there are many), we then designed their employment contracts around their desires for the form of compensation they most valued. It turns out that in this company (surprise, surprise) the employees highly value the ability to reduce their taxes, protect their assets, and grow their investments through the use of a retirement plan. We even discussed putting in a cash balance/defined benefit plan. However, the employees really didn’t want to put enough into it to justify the costs, and Katie and I had no interest in it given the negative tax arbitrage it would involve for us due to the 199A deduction. (DBP contributions reduce ordinary business income and thus the 199A deduction, so we were looking at saving only 29% on the money going in and then paying 37% on the money coming out).

Once we knew how much they wanted to put into the plan each year, the actuaries could run the numbers. It still took them a long time to understand that my goal as the owner, apparently unlike most business owners, was not to screw the employees. Once they realized it was not a problem for me to make additional contributions into the retirement account on behalf of the employees should the law so require, solutions were found. Trust me when I say most TPAs have no idea how to design a 401(k) so every person in the company can get $58K into it each year despite some not making all that much more than that.

 

The 401(k) Plan We Created

We ended up selecting iQ401k (a Division of FPL Capital Management) to run our plan. We’ve known the guys from FPL for a long, long time. They’ve been sponsoring the blog for years and have sponsored every single WCICON. They even send us King Cakes. We know they’re not afraid to be creative and that they understand the importance of keeping costs low. Naturally, being able to say “We do the 401(k) for The White Coat Investor” has a certain amount of marketing value to it. So we asked for and received a bit of a discount on our fees. But I think they deserve every bit of publicity they get from this. They did a bang-up job putting this all together and are still working hard to make this the world’s best 401(k).

They normally work with Vanguard Retirement Plan Access (VRPA) as a custodian, but had to shift when VRPA couldn’t handle the Mega Backdoor Roth IRA contributions. We ended up with a more laborious/cumbersome plan for all involved (us and FPL), but we did get the features that were most important to us.

Okay, let me brag for a bit about this cool 401(k) we all created together. We’ll again use that list of my desired features.

Employee Costs

There are no mandatory costs to the employees aside from the expense ratio on Fidelity index funds. These generally range from 1.5 basis points for their Total Stock Market Fund to 12 basis points for their Fidelity Freedom Index Funds (the equivalent of Vanguard Target Retirement Funds).

Employer Costs

The costs are reasonable for the business and the lowest of the quotes we got (still several thousand a year, of course).

Pre-Tax Dollar Plan Expenses

All plan expenses are paid by the company using pre-tax dollars (it’s a business expense). We spend so much time and effort getting money into retirement accounts, why would you want to pull it out in order to pay fees with it, especially when you can already pay them with pre-tax dollars?

Investment Freedom

The custodian is Fidelity, so the plan allows us to buy anything available in a 401(k) at Fidelity and then some. This is a bit of a two-edged sword, but I’m confident my staff can handle it. You see, they can buy Tesla stock, triple leveraged ETFs, and all kinds of other investments that never show up in a typical 401(k). Laws don’t permit them to short stocks, buy options, or buy on margin. Fidelity doesn’t let you buy their Zero index funds in 401(k)s either. But other than that, if you can buy it in a brokerage account, you can buy it in this 401(k). That means ALL of the following is available:

• Fidelity Index Funds
• Vanguard Index Funds
• Vanguard ETFs
• iShares ETFs
• DFA Funds
• Schwab ETFs

Pretty hard to complain about that fund line-up eh? The access to DFA funds is because of FPL being a “DFA-approved” advisor, not every Fidelity 401(k) gets that. All ETF transactions are free. Unfortunately, neither Vanguard nor DFA funds are on the Fidelity no transaction fee list. In our particular 401(k), Vanguard fund transactions carry a $30 commission and DFA fund transactions carry a $10 commission. So that’s a little quirk our staff will have to work around. Basically, if they want to use traditional mutual funds they can just use the Fidelity line-up.  If they really want Vanguard funds (or prefer ETFs), they have the entire Vanguard line-up available. To minimize commissions, they could even invest in the Fidelity funds all year long and then transfer into Vanguard or DFA funds once a year. If you can’t construct a decent portfolio out of this line-up, you really need some help. Speaking of help, our staff can also go to FPL for assistance with their portfolios and asset allocation. All included.

Default Investment Options

With a typical recordkeeper like Vanguard (VRPA), we could have set up default investment options such as Target Retirement Funds. But we couldn’t get the flexibility we wanted, too. So we let this one go. A lot of our staff members are just fine with the cash account being the default option anyway, but we figured we could work around this one with good education.

Automation

One thing we had to give up was an easily automatable investment process. Fidelity will let you set up “automatic buys”, but only for mutual funds and only after you’ve purchased them once. It only lets you set them up as dollar amounts, not a percentage of what is contributed, but it’s better than nothing and I think some of our staff will choose this option.

Rebalancing

Likewise, we don’t have an easily automated rebalancing process in the 401(k). Frankly, everyone in the company has multiple investing accounts already so they can’t really use this benefit, but it would be nice to have.

Automatic Enrollment

Automatic enrollment is more an HR function than it is a 401(k) function, but our automatic enrollment is 6% of salary going into the 401(k). Since this is a discussion we have while putting together their contracts, we certainly have the process in place. I mean, we might have the highest 401(k) participation rate of any company in the world. Not only are 100% of eligible employees contributing, but 100% of employees plan to max it out. And not just at the $19,500 limit. At the $58,000 limit.

Automatic Annual Contribution Increase Option

Best practice for a 401(k) is to have the option to increase your contributions each year automatically. It’s a nice feature to have, but it’s hard for our staff to increase contributions beyond maxing out the account. Again, I think this is a feature that the typical FPL/VRPA plan has, but it just isn’t useful for us at this stage of the company.

Maxing it Out

Now we’re getting into the really cool aspects of this plan. As mentioned above, this involved everything from how we write our contracts to the calculations done by the actuaries. With a company this small, how much you contribute can affect how much others can contribute, so we all had to work together in order to make sure everybody could max it out. But it’s definitely a priority for all of our staff members at the present time. As the company grows and more people become eligible for the 401(k), it could cause issues with the calculations, but so far so good. Speaking of eligibility, you have to be at the company for a year before you become eligible, unless you were employed as of 1/1/2021. So all of our independent contractors turned employees became instantly eligible.

401(k) Loans

I basically wanted every feature possible in a 401(k), including 401(k) loans. Unlike IRAs, you can borrow from a 401(k)—the lesser of 50% of the balance or $50,000. The terms are a little better than they used to be, since if you separate from the company you now have until the next tax day to pay the money back, rather than just 60 days, as the law used to be. A 401(k) loan isn’t something I would make a habit of using, but it’s nice to have it available if you need it. Like borrowing against your cash value life insurance or your taxable investing account, you don’t need good credit or a bank’s approval to do it.

Roth 401(k) Option

This was actually ridiculously easy. We told them we wanted a Roth 401(k) option and they gave it to us. If your 401(k) still doesn’t offer Roth contributions as feature, call HR and tell them to get out of the stone age.

BrokerageLink

There are really three kinds of 401(k)s. Most of you have what I call a “typical 401(k).” This contains a line-up of mutual funds you can choose from.

The second type is sometimes available in a nice 401(k). It basically gives “advanced investors” the opportunity to opt-out of the fund line-up and access a brokerage window where they can buy whatever stocks or ETFs they want. At Schwab, they call this PCRA — Personal Choice Retirement Account. My clinical partnership 401(k) offers this for an additional fee. At Fidelity, it’s called BrokerageLink.

The third type is a true self-directed 401(k), one you can use to buy the property down the street, physical gold, Bitcoin, etc.

Our 401(k) is the second type. However, even private investments can be purchased in the 401(k), so long as the fund has a CUSIP number and is “on the list” at Fidelity. Two of the three private real estate debt funds we invest in are on the list, so this will give us the opportunity to move that asset class into a tax protected account, which will help us with our asset location issues.

So how do we protect WCI from liability for “abandoning our fiduciary duty” to our employees by letting them buy whatever they want? We make them sign a release. That was the fastest document we ever got signed in the history of the company. I guess if there had been anyone who didn’t want to sign it we would have just had FPL construct an interface to give them the “dumbed down version” of the 401(k). Probably filled with nothing but Fidelity Freedom Index Funds and maybe a few other index funds. And it still would be a great 401(k).

Mega Backdoor Roth

A really important feature for Katie and me was the ability to do a Mega Backdoor Roth. We definitely want to max out our retirement accounts, but it doesn’t make sense for us to do tax-deferred retirement contributions from WCI due to losing the 199A deduction. In order to do that, we needed to be able to make after-tax (not Roth) contributions. In this plan, we can contribute $58K in after-tax money. So I did. That leaves my employee contribution available to be used in my other 401(k). Interestingly enough, we learned that there are two separate tests that must be done on the 401(k) to ensure the non-highly compensated employees aren’t getting hosed. One is done on pre-tax “profit-sharing” contributions and a separate one is done on after-tax contributions. Unfortunately, this means Katie and I have to decide to either give her a raise this year (and pay the associated Social Security taxes), or not max out her 401(k). We’re still trying to decide whether it’s worth paying another $8,000 in Social Security taxes in order to get another $25,000 or so into a Roth 401(k) instead of investing it in taxable. It might make sense in the long run, but it’s going to be a long time to break even. #firstworldproblems

Roth Conversions

The other requirement to do a Mega Backdoor Roth is to be able to convert those after-tax contributions immediately into a Roth IRA. There is no tax cost for that, since there was no deduction for the contribution. Voila! A “$58K Roth IRA”! Cool right? Well, there are two ways a plan can allow the conversion. The first is to roll the money out without separating from the company. Our plan allows this.

In-Plan Conversions

The second way to do a Mega Backdoor Roth IRA is to do an in-plan conversion. Our plan allows this, too, and in fact, this is what I did since I have more investing options (although similar asset protection in my state) in the 401(k) than my Vanguard Roth IRA. One little phone call to Fidelity and I had done our 2021 Mega Backdoor Roths. That was even easier than with our last plan.

The Bottom Line

We have an awesome new 401(k). It costs us more than the old one, but there was no getting around that now that we have employees. If you’re in the market for a 401(k) and have employees, this is no longer a do-it-yourself project. Be sure to check out iQ401K and our other recommended retirement plan providers. There are also people on that page that can help you with a true self-directed individual 401(k).

What do you think? Are you jealous of our awesome new 401(k)? Ready to come work for WCI? Have you put a 401(k) in place for your company or group? What features did you want in it? Comment below!

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