Dave Cain: Welcome to unsuitable on Rea Radio, the award winning financial services and business advisory podcast that challenges your old school business practices and the traditional business suit culture.
Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie, while offering you meaningful modern solutions to help enhance your company’s growth. I’m your host, Dave Cain.
Warmer weather and longer days comes with a lot of perks, which is probably why I consider summer to be my favorite time of year. I get to spend time outside with my family, friends, cold beer out of the ice chest, good music, a little golf. I also enjoy watching The Tribe on TV. What’s not to love about that?
I’ve heard that today’s guest is a sports fan. In fact, I’ve been told that this time of year you will find her on the ball field instead of in the stands. Even though we could probably spend this entire episode talking about sports, I’ve been told by our marketing team, “Don’t do that. You got to get into the topic.”
Andrea McLane, a manager on Rea’s pension administration team is here in her Dublin office, is going to talk to us about what business owners can do to hit the retirement plan design out of the park. Welcome to unsuitable, Andrea.
Andrea McLane: Thank you. Thanks for having me.
Dave: Hey, no problem. I want to talk about … Since we’re not allowed to talk about sports, we’re going to start by talking about sports. I understand that you coach basketball.
Andrea: I do coach basketball for St. Timothy School here in Columbus.
Dave: Volleyball, softball, all of that stuff.
Andrea: I coached volleyball and I still play volleyball and I still play softball.
Dave: And what’s the kids’ sports activity this time of year?
Andrea: Volleyball, volleyball, volleyball.
Dave: How in the world do you guys schedule a family vacation?
Andrea: We actually do have a family vacation coming up next week. We’re going to the Outer Banks.
Dave: Perfect. So you probably have one or two weeks off during the whole summer, and that’s what you’re doing.
Andrea: Yep. We’ll start right back up in August.
Dave: See, a lot of our listeners have the same issue, so maybe we can talk about how to plan that family vacation around a busy, busy schedule.
Andrea: Sounds like a plan.
Dave: So you teach shooting a three?
Andrea: No. I was actually never allowed to shoot outside of the paint. If I got caught dribbling, I sat on the bench, so we’re going to stay in the paint today, shoot layups.
Dave: All right. We’re going to shoot layups. We’ll give you the layups, but we talked about retirement plans many times on the podcast and just how important those are and how we have found situations where those retirement plans just aren’t where they should be, and I think you’re seeing that out in the community.
Andrea: Absolutely.
Dave: So let’s talk about some of the things that you’re finding in a retirement plan design. We’re going to knock this out of the park, by the way, but what are you seeing on retirement plan designs that are just flat out wrong?
Andrea: Well, I think the first thing is that you need to encourage participants to put money into the plan and participate in the plan. A lot of times, they’re just going to wait on the employer to make a contribution, but what you really need to do is encourage the participants to become active participants in the plan.
Dave: So it’s certainly a built-in savings plan. It’s a type of financial planning.
Andrea: Absolutely, and they have to help themselves get to retirement. We cannot just rely on social security nowadays.
Dave: Now are you seeing that employers may not be educating the employees or coaching them that this is a good vehicle?
Andrea: Absolutely. I think that you have to … It’s a three-pronged approach. You have to have the employer engaged in the process. You have to have your investment broker engaged in the process, and you also need a capable TPA that can guide you through the process.
Dave: TPA, for our listeners, what are those initials stand for? Third party something?
Andrea: Exactly. I apologize if I go into the acronym land. Please stop me, but TPA is a third party administrator.
Dave: Perfect, and that’s certainly needed in this triangle, if you will, of retirement plans.
Andrea: Absolutely. We help a lot of clients who don’t navigate the waters very well and end up needing a TPA to get them out of trouble, so it’s a very good idea to have all of your advisors on board to help you.
Dave: In a year’s time, I know this is kind of an informal question, informal survey, but in a year’s time, how many plans might you run into that just aren’t up to date?
Andrea: Up to date as far as their plan document? This time of year, we should have everyone on board having their plan documents up to date. We just had a PPA restatement period, Plan Protection Act.
Dave: Oh, okay. All right.
Andrea: I knew you were going to ask.
Dave: One of those things.
Andrea: Congress updates pension law constantly, and so it came about that we were obviously updating our plans too often, so the IRS came up with a program where we only have to update the plans every six years, so we just recently went through at the end of 2016 restatement period, so most of our plan documents should be up to date.
Dave: Okay. Now as a business owner, I know I have to file a tax return every year. I can remember that, but if I got to update my retirement plan every six years, there’s no way I’m going to remember that. I could get in trouble pretty fast.
Andrea: Absolutely. You can get in trouble very quickly.
Dave: So that’s where the TPA, that’s where you come into play, and you got to call me and say, “Look. Let’s get that done.”
Andrea: Absolutely. Absolutely. And there actually is, which some people don’t know, some people don’t remember, there actually is a plan filing for the 401k plans and the defined benefit plans that needs to be filed every year, and it’s an off … We have a different due date. The due date is July 31st, and it can be extended until October 15th, so you need to make sure that that return is getting filed. That return is an informational-only return, but it’s very expensive if you don’t file it every year.
Dave: Come on. It’s information. If I’m late, they’re not going to fine me, are they?
Andrea: Absolutely. They will.
Dave: Is that the Department of Labor or the IRS?
Andrea: That is the Department of Labor.
Dave: Oh, they’re kind of tough on that.
Andrea: Yes, they are.
Dave: And I guess rightfully so because it’s to protect the workforce. That’s your money, that’s my money that’s in the plan, so that should be protected. Why is this so complicated? I mean, it seems like they continue to make the retirement rules more and more complicated.
Andrea: It’s all to protect the participants because they don’t want the owners taking advantage of their participants. I’m not sure how much you know about the retirement plan thing, but one of the big things that the Department of Labor is interested in now are fees, because as participants are taking their hard-earned money and putting it into the plan, congress is very interested in making sure that participants are protected and that they know what fees are coming out of that account to eat up their profits and eat up their account balances.
Dave: I’ve talked before about mistakes, they’re happening in the plan. How can I avoid making those mistakes?
Andrea: I think the major thing that you need to be aware of is that you need to make sure that you’re following the terms of your plan documents. A lot of times on takeover plans, and we’ll see that the person who is administering the plan thinks that their eligibility is one year of service and you come in quarterly, and then when we come in and look at the plan document, what the plan document actually says is, “It’s one year of service, and you come in on January 1 and July 1.” And so I think it’s very important for you to review the terms of your plan document to make sure that you’re actually following what’s in the plan and not what you always have done or what the person before you had done.
Dave: So that plan just needs reviewed every year by someone like yourself to make sure that I’m following those rules.
Andrea: Absolutely.
Dave: And also, you have a reputation with your clients and around the firm as being very creative when it comes time to plan design, and I guess that means you can find a way for myself as a business owner to put more money into a plan, defer more money.
Andrea: Absolutely. When we go out and meet with a new client or meet with a takeover client, we want to find out what their goals are. Some of the plan owners want to make sure that they’re getting the most in the plan and they want to give the least amount to the participants, and we can get really creative in that plan design, and then there are other owners who want, they want to be benevolent. They want to make sure that they’re taking care of their staff so when they retire, they’ve got a nice pot of money and they’re excited about their retirement. So we can meet with clients and talk to them about their goals and fit the plan design in with that.
Dave: You and I both had conversations with our clients in prospects, and they talk about, “How can I lower my tax bill?” Or, “Is there a tax shelter that I can invest in?” And certainly, a retirement plan I think fits that bill where you can get tax deferred and compounding of interest. It doesn’t get much better than that.
Andrea: Absolutely. Absolutely. And the 401k plans, the plan participants can get a tax deduction by putting free tax money into the plan, and then of course, any employer dollars that the employer puts into the plan are a tax deduction.
Dave: We talked about creativity and being out of compliance, and I want to go back to the out of compliance issue. Let’s say we’re working together, you’re looking at my plan design and plan documents, and you find that I am out of compliance. What’s the next step? Do I need to go hire an attorney? Do I need to go straight to the neighborhood bar? What do I need to do? Maybe both?
Andrea: Absolutely both, I would advise. The best thing for you to do is have us review the plan. We come into that situation all the time, especially with takeover plans. We’re going to look at the plan document. We’re going to see what rules have been followed and not been followed, and here’s another acronym for you, we can take them through what’s called VCP with the Department of Labor, and that’s the Voluntary Compliance Program, and if it’s an egregious error, we would have to go through the VCP process, and also depending on the time that has lapsed since the mistake, sometimes we can do self-correction, so we can take the client through that process. If it’s something that we can handle, we will certainly handle. If it’s something that’s kind of outside of our scope, we can involve an ERISA attorney, but we walk a lot of our clients through that VCP process and have had successful results.
Dave: So there is an opportunity that if we do find a problem, you can, I guess I can get some amnesty. I don’t know if that’s the right term, but …
Andrea: Well, yes. Once you go through the program, you’ll get a letter, but it’s also, there are going to be some fines and penalties, and there’s usually money, restitution that needs to be put into the plan to make everyone, all the participants whole.
Dave: Okay. We see situations throughout the year where an individual may make a loan, take a loan from their plans, as you just stuck your tongue out and knocked over the mic. Apparently, you’re not a fan of loans out of a retirement plan. Let’s talk about that. Threw a little salt in the wound there.
Andrea: Yeah. Absolutely. Loans are a great vehicle for participants who have an event where they need to get some money, but again, what you do when you take a loan out of your account, is you’re taking money out of your account, and you’re paying yourself back interest, which sounds really great, but the period of time that you have that money out of the plan, you’re not gaining any interest. You’re not getting any gains or losses. That money is out of the plan and in your bank account and not earning money for you. So one of the things that I want to make for sure everyone realizes is that participant loans are available in your plan, but the owner doesn’t have to select that provision. I get a lot of phone calls where somebody’s like, “Oh, my husband took a loan from his 401k plan. I want to take a loan. It must be available.” But that’s an individual, that’s an owner’s choice of whether or not to allow plan loans in their plan document. One of the other things that happens that drives me nuts-
Dave: All right. Now we’re there.
Andrea: Now we’re there.
Dave: Now we got you going.
Andrea: It’s kind of like what we like to call the cubicle effect. Somebody actually wants to take a loan, so the owner doesn’t want to allow loans, but they say, “Okay. I’m going to allow you to do it,” and they put that provision in their plan, and then that person talks to the person next to them, and they tell two people, and they tell two people, and what ends up happening, not one loan comes out of the plan, but six loans come out of the plan, and it’s just another withholding. It’s another opportunity to make a mistake and not pay those loans back.
Dave: Okay. My mind’s racing a little bit. What kind of interest rate do I have to pay myself back? Can I do 10%?
Andrea: No.
Dave: Oh, come on.
Andrea: It’s usually really-
Dave: I thought you were creative.
Andrea: Well, that’s-
Dave: I’ll take eight.
Andrea: No, you can’t have eight. It’s written in the plan document. It’s usually based upon the prime rate, and we usually see prime plus 1% or prime plus 2%, and I have had a few people, not doctors or lawyers, who’ve said they want to pay themselves back 15% and that would not be within the rules.
Dave: So are those plan rules or DOL, is that a Department of Labor?
Andrea: Actually, that may be IRS, but yes.
Dave: May be IRS. Okay.
Andrea: But it’s written in your plan document, and we usually see and we usually suggest prime plus 1% or prime plus 2%.
Dave: What would be a good reason to borrow money from the plan? Obviously maybe hardship, medical. I don’t know. College? Home, buying a home. You want to buy a boat. You want to go on vacation.
Andrea: Actually, one of the very first years that I started doing this, I had somebody call me up around Christmas time, and they wanted to take a loan from their plan, and they actually, when I said they weren’t allowed or they didn’t have enough money in their plan, they said, “Santa’s not coming if I can’t get this participant loan from my 401k plan,” and I felt awful, but that is an example of something that would not be a good reason. A lot of times we see it for college planning, which isn’t very good planning, but we see it for college and we see it for houses. We see it for cars. So that’s one of the reasons why having that option available is … You know, the participants, it’s a benefit, but they don’t always use that money wisely.
Dave: Okay. As a trusted advisor, and I’m sitting down with you with my plan, would you advise me to write that plan so participants cannot take a loan? Am I allowed to do that?
Andrea: Yeah, absolutely. You’re allowed to do that. There’s another provision that you can allow on your plan called a hardship distribution, and a hardship distribution is different than a loan. That’s money that you take out of a plan and you don’t have to pay it back, which again, isn’t a very good option, but that hardship distribution is only available for specific instances. So it would be for college education, to prevent eviction from your home, medical bills, and so that’s something that you can take in the case of an emergency. You can’t take it for an amount that’s greater than your financial need, and that’s something that you actually have to prove. You actually have to bring in a statement saying that you’re being evicted from your home, or you need to bring in the college tuition bill, so that’s some way that you can manage it a little better and actually make sure it’s for an emergency and not necessarily to go buy a motorcycle.
Dave: Okay. So let’s go back to loans, and then we’ll hit those distributions. You were fired up. You were banging your hand on the table. You’re not allowed to do that in a podcast. You know that we’ve given you those rules, not once, but twice.
Andrea: I didn’t pay attention to the rules.
Dave: Well, that’s right. Well, you paid attention to not shooting threes, I guess, right?
Andrea: I didn’t want to sit on the bench.
Dave: You shoot threes now?
Andrea: Mm-mm.
Dave: No? You still don’t.
Andrea: I can’t.
Dave: You can’t.
Andrea: No.
Dave: Got a hook? Got a hook shot?
Andrea: Oh, yeah.
Dave: Oh, yeah. Bad hook shot, huh?
Andrea: I got a baby hook. I got a baby hook.
Dave: Pretty good. Pretty good. But these loans, are there limits on how much I can take out?
Andrea: Absolutely. There are limits. You can only take 50% of your account balance, and I should back that up. 50% of your vested account balance up to $50,000.
Dave: Okay. So there are limits there. They’re protection. Okay. Let’s jump over to distribution because that one-
Andrea: Sorry. I jumped ahead.
Dave: No. You’re fine. You’re good. It’s your podcast. You can talk about whatever you want to talk about. You want to talk basketball? We can go there.
Andrea: Thank you.
Dave: Distributions. Okay. Again, good idea? Bad idea?
Andrea: I think they’re a good idea for cases of emergency, but basically, as an owner, if you want those participants to have that money available at retirement, you should cut down on the ways that they’re able to get the money out of the plan.
Dave: Okay. So again, you hit the loans. We can build a provision. I probably can’t build a provision to limit distributions, can I?
Andrea: Actually, I was just looking at a plan the other day, and the only two methods of distribution that were available were termination and death. So you can lock down that plan so there are no loans, no in-service distributions, no hardship distributions. We have a plan document that allows for that.
Dave: So let’s talk about a few of the hardships that you mentioned. Medical would be one. College.
Andrea: College, yes.
Dave: First-time home buying.
Andrea: No. That’s actually in an IRA. It’s to prevent eviction.
Dave: Eviction.
Andrea: Yes. You can buy it for the purchase of your primary residence. You can’t take a hardship distribution to go buy a condo in Belize.
Dave: No way?
Andrea: Way.
Dave: What if my business is upside down and I need to take a distribution to put that into the business for needed capital?
Andrea: You could take a participant loan up to $50,000, but anything over that that you would need for your business you would have to find from another source or take an in-service distribution.
Dave: And certainly I think there was a bit of a misunderstanding that I run across, you probably do the same, is when you take that money out in the form of distribution, you got to pay tax on it, and maybe a penalty, right?
Andrea: Absolutely. If you’re under the age of 59 and a half, you have to pay a 10% early withdraw penalty.
Dave: 10% of … Okay. Okay. Which can be pretty significant if you’re in a high bracket, because you’d have your regular tax. You’d have your state tax, and would you have local tax on it? Probably not local tax because that’s tax at the source, but you would have that plus the penalty, so very, very expensive source of money.
Andrea: Absolutely. And then we would automatically withhold 20%, so that 20% would be withheld and sent to the IRS, so you would have to pay the difference.
Dave: So if I take 50k out as distribution, can I put it back in in six months without paying the penalty and the tax? Why are you looking at me like that?
Andrea: Because I’m being creative in getting … I help people get money into the plan. I’m not shady in getting money out and back into the plan.
Dave: Okay. So that’s a “no”. See, where I’m going with all that is what you’re trying to do with your creativity and plan design is to protect not only the business owner and the employees, and not create unnecessary risk.
Andrea: Absolutely.
Dave: And so the examples that you and I went through do create some risk for the business owner, and I think that’s what we like to talk about on this show is try to keep business owners from going down that risk lane, and I think you’ve done a nice job of explaining that. Our guest today has been Andrea McLane from Rea’s pension administration team, and she’s celebrating that her podcast is just about over, but we have more questions for her, so hang in there, but thanks again for joining us on unsuitable today. Great insight on what to do and what not to do. I think you covered that very well about how to encourage employees to save and avoid the mistakes, and we talked about many of them, and also help participants avoid the pitfalls of loans and distributions, so well done.
It’s really amazing to learn just how effective a well-designed retirement plan can be, and I really appreciate that you took the time to discuss the importance of education, particularly with regard to borrowing and distributions. We set you up a little bit, but you did well.
Listeners, be sure to check out our website at www.reacpa.com/podcast for several great resources that can help you learn more about the benefits of plan design, and if you liked this episode, let us know. You can share it, review it, or even just give us a thumbs up. We’ll take what we can get. Be sure to let us know if you would like to dive deeper into this topic on a future episode of unsuitable. Until next time, I’m Dave Cain encouraging you to loosen up your tie and think outside the box.