If you’re a small business owner – whether you have employees or not – the thought of setting up a retirement plan can be overwhelming. 401ks and even SEP-IRAs are swimming in rules and regulations. What business owner really has enough hours in the day to deal with it?
For that reason, I asked Chad Parks to join me on the Dough Roller Money Podcast. Chad is the President and CEO of The Online 401(k). His business specializes in creating retirement savings solutions for small business owners and the self-employed.
Topics Covered in the Interview
- How The Online 401(k) Got Started
- What The Online 401(k) Offers
- How 401k Fees Work
- Expense Ratios for 401ks
- Who Chooses 401k Investment Options
- How The Online 401(k) Employees Save
- The Difference Between SEP-IRAs and 401ks
Resources Mentioned in the Interview
Rob: Chad, welcome to the show.
Chad Parks: Hi there, thank you.
What is The Online 401(k)?
Rob: Thanks for taking the time to be with us today. You are President and CEO of the The Online 401(k), is that right?
Chad Parks: Yes, that’s correct.
Rob: What in the world is The Online 401(k)?
Chad Parks: Well, we’re fortunate our name is pretty self-explanatory. When I started the business back in 1999, being online and having a financial services company online was somewhat of a new concept. What it was designed to do — we did some research and saw that small businesses in America weren’t being served by the financial services industry and weren’t having workplace retirement savings plans being made available to them.
So with the advent of the internet, we saw that as a great opportunity to deliver solutions digitally over the web. What we do is turnkey retirement plans for small businesses and their employees. That means everything to run a plan, including plan documents, administration, testing, tax return filings, employee enrollment, access to investments— helping people buy and sell their investments and servicing, statements and everything that goes with that.
Chad Parks: That’s kind of what we do. I think what makes us unique is that we want to work for small businesses when most others don’t. And we’re able to do that because we have a flat-fee-for-service remedy model where a business will pay us a small fee every month. Therefore, we don’t care if you have one dollar or a million dollars, we’re happy to work with you.
Rob: Okay. I want to talk to you more about your company as well as 401k fees, which we’ll get to in a minute. But, before we jump into all of that, why don’t you tell folks about who you are?
Who is Chad Parks?
Chad Parks: Sure. Well, like many people, I went west. I moved out to San Francisco in the early 90s. I studied for my Masters in finance, and when I got out I became a retail stock broker. I didn’t really like that, but my studies and desire to be a financial planner led me to earn my Certified Financial Planner designation. So I quit the brokerage firm and started my own independent practice and was working with a lot of small business owners on their holistic financial needs.
In doing that, one part of that meant looking at tax savings and retirement finance. Many times I would recommend a plan and they would say, “No, go find me something else,” so that’s where I had to go out into the market and start studying what was available. I was amazed that there was such a real lack of options for small businesses and working independent advisors.
There were programs out there that would probably work on a commission basis (that charge high fees) but that really wasn’t serving me or my clients well. Being the entrepreneur that I am, I basically leaped of the cliff— took the leap of faith and started the company back in 1999.
Rob: There you go. Now, on your company website there’s a page about you including your answers to 10 questions that I found—
Chad Parks: Yeah…
Rob: See— I do some research before I get on the phone with someone. It’s the lawyer instinct in me—never ask a question you don’t already know the answer to. One of the questions there (on the page about you) is, “Would you prefer to jump from a plane or scuba dive with sharks?” And your answer is that you’ve done both.
Chad Parks: That’s correct.
Rob: I’m curious. Where and when did you scuba dive with sharks?
Chad Parks: Down in Tahiti— there’s an island north of Tahiti called Rangi Willow. It’s in the Motu region, and it’s known for its big game diving. Basically, it’s the big blue so schools and schools of sharks go out there to feed. It was one of those things where it was frightening, but also where you wanted more. It defies logic, but I was in a school of sharks.
Rob: Well, when I read your other questions and answers, what it tells me is that you’re a risk-taker. Is that fair?
Chad Parks: It is. Being an entrepreneur, you tend to take risks. You have an appetite for it. And I’m glad you asked that because a lot of people think entrepreneurs are gamblers. Gamblers who go to Vegas don’t control the odds. Risk-takers generally know how to manage that risk and hedge themselves by always having a backup plan or a plan ‘B’.
All About 401k Fees
Rob: Right, right. You and I met online, and what brought us together initially was a discussion about 401k fees, so let’s just start at a high level. For folks listening who have a job and a 401k or a 403b at work, what are the fees associated with a 401k and how does that effect individuals trying to save for retirement?
Chad Parks: That’s a great question. And I’m glad we’re talking about this because in many studies still today, people don’t think they have any fees associated with their savings plans, and it’s kind of a shame because generally, the way the fees work is a business will pay a flat-dollar or hard-dollar cost to a provider like ours to run the plan. But then there are internal expenses related to the investments the employees are choosing and those expense ratios, those fees, are generally associated with mutual funds or exchange traded funds (ETFs).
In some cases some plans have an insurance company type of wrapper on it called a [inaudible 0:07:45.7] annuities, so there are going to be fees associated with that too. And, they’re not always easy to know what you’re paying. It’s very hard to know if it’s high or low.
It’s not good benchmarking, so the Department of Labor saw this as a big problem and several years ago issued new regulations that require fee disclosure to the businesses that put these plans in place. And more importantly, to their employees. So the data is now there, but, as much of our industry is built on high fees, they prefer not to tell you that, so they still make it very difficult for you to find out how much you’re paying.
Generally, what that’s going to be is a percentage of your assets. And it comes off the top, so you won’t even know that you’ve been paying it. And example is, if a mutual fund returns 10% gain in a year, and they charge a 1% fee, they’re going to report back to you that you earned 9%. So you really have no way of knowing that that’s what you paid.
The reason this is important is because higher fees erode your account balance. One percent may not sound like a lot but if you were to calculate that over a 20 or 30 year period and have 10% instead of a 9% return, we’re talking about hundreds of thousands of dollars difference in your ending account balance. I’ve seen other math that says that one percent fee difference ends up costing you 28% of your account value over the lifetime.
Rob: Right, right. The fees that you’re referring to are expressed as expense ratios for the individual mutual funds or ETFs an employee might—
Chad Parks: Yeah, that’s generally what we’re going to see. There would be some exceptions and some other fees sometimes, but this is the rule of thumb we’re talking about.
Rob: Are there ever times where the management fees— not for the individual investments but for the 401k plan itself— where the employer passes them down to the employee? Or does the employer always pay for those 401k management fees?
Chad Parks: That’s another good question. There are various ways in which the employers could have the employees pay for that. What providers like my company and others could (or would) do there would be to charge that directly to the individual employee, kind of like a pro-ratio share of what the expenses to run the plan is.
Most of our employers – I would say almost all the employers who use us – they pay for their portion of the expense of running the plan because we’re so economical. We’re talking about $100 a month. But you’re correct in other cases. Employees do bear the cost of running the plan as well as the investment and management expenses.
Rob: I assume if that were the case, that would have to be disclosed to the employee in some fashion?
Chad Parks: That’s right. It is all disclosed. It’s just a matter of how hard it is for you to decipher it.
Chad Parks: So, it’s definitely worth paying attention to. One of the questions is always, “What’s reasonable? How much should I be paying?” It really depends on who you ask. The person charging 2.5% would gladly say that’s reasonable.
Rob: I’m sure they would. I should warn you though, you’re talking to a bunch of listeners who have been bombarded by me about how painful fees are and how you should try to keep them as low as you possibly can. But go ahead, you’ve got 2.5% which is clearly reasonable.
Chad Parks: I have a proposal from an insurance company that offers plans to small businesses, and that’s what their overall internal expenses are, 2.5%.
Rob: You see, I’m not even sure how a company like that stays in business. I don’t know who in the world would say, “That’s a good deal,” whether you’re the employer looking for a plan, an employee— I don’t know how those kinds of companies stay in business.
Chad Parks: Yeah, they take advantage of people not paying attention to it and not really understanding it. This really is a little bit of a complicated area, so they don’t tell you what you want to hear.
Rob: Okay— Sorry, go ahead.
What are Reasonable 401k Fees?
Chad Parks: I was going to say, “What’s reasonable?” As an example, if you don’t have an investment advisor relationship or you don’t know where to start, one of the things we offer is a series of ten custom target portfolios. They’re professionally managed and use ETFs as the underlying assets.
Everything, all included, such as management funds, trust and custody fees, on average, are 25 basis points. We feel like that’s a pretty good deal because we’re not in it for the money. We want to pass on the savings so those returns can be higher for you and help you get a higher balance in the end.
Rob: Yeah, and so the 25 basis points includes the administrative fees associated with running the 401k?
Chad Parks: Nope. It’s just for the investment portfolio.
Rob: Oh, I see. So the administrative fees would be paid by the employer, and the employee would pay the 25 basis points?
Chad Parks: That’s correct.
Rob: Okay. In that case, who is running those target date retirement funds?
Chad Parks: It’s professional institutional management. In this case we utilize a firm called Invest Net for retirement services. In our world, that type of advisor would be called a 338 advisor. So they take on full responsibility of managing investments inside the retirement account.
There are many of them out there and people can do this. It just so happens we have a good working relationships with investment management. We also offer products from Morningstar. Morningstar also has investment management. In our case, I think they tend to be a little bit more expensive than the others available, so I’m not always promoting them as much as we did in the past.
Rob: Yeah, I mean, 25 basis points for a target date retirement fund, I think, is pretty reasonable. I don’t know what Vanguards are, but they’re in that range, which I kind of use as a benchmark.
Chad Parks: Absolutely. I should mention, some of the ETFs in those portfolios are actually Vanguard ETFs.
Deciphering Expense Ratios
Rob: Oh, okay. I want to go back to the 401k fees for just a second because you mentioned the Department of Labor made a change in terms of disclosure. Before that, of course, mutual funds had to report their expense ratios, but this is specific to 401k plans.
And one of the things—and I’m actually looking at my 401k right now online as we talk, which is with Fidelity. I know what my expense ratios are because I track them and pick mutual funds in part based on their cost, but one things I was looking for was, I thought that in the 401ks statements that you get (whether you get them electronically or in the mail) I thought they had to convert the expense ratios from whatever funds you’ve chosen into an actual dollar amount of the expenses you paid that quarter.
Is that true or not true?
Chad Parks: Unfortunately, it’s not. That is what I had hoped for, and that is what had been proposed before at one point and that’s what makes the most sense. In terms of real dollars, “How much am I paying? Do you have to make me do the math and everything?” And the Department of Labor backed off on that, and they kind of went with softer regulations on the employee fee disclosure.
Rob: Yeah. Okay. You mentioned Morningstar. I use it just as a research tool and to track my portfolio, but that’s one of the things that it does. It will take your expense ratios and actually convert it into a dollar amount in your portfolio so you can actually see what you’re paying. I do wish they would put that in statements though.
I know my wife who has a 403b— she works for a charity, and they do put that information in the statement, which I think is really good. I think it would help keep this in folks minds as they get their statements and look at them each month or quarter.
Chad Parks: You’re right, it is important. It’s something you want to keep on top of your mind and paying attention to. The real challenge – even for professionals – is that benchmarking is so hard to do. We don’t know what is high, low or average expenses. That’s why we all talk about the lowest being better so you can have 25 basis points under 50 basis points for sure.
Those are the kinds of things people have to keep in mind. The one thing I always caution people on is, people need to get paid to do what they do in their adding value to your account. So it’s not always about the lowest cost. That being said, you sure don’t have to pay more than what’s fair.
Rob: Yes. And part of it comes down to whether someone wants help, whether they want an actual advisor. When it comes to mutual funds expense ratios, many people want to talk about the average. Like you said, that’s hard to determine. I’ve heard somewhere just over 100— 1% I think the last thing I saw was 112 basis points.
But from my prospective, why should that be the benchmark? Why not start with the lowest and use that as the benchmark? That’s kind of why I use Vanguard as a benchmark. There’s a place for actively managed funds here and there, I think. Anyway, that’s my own sort of ‘war on fees.’
Chad Parks: Yeah, yeah. We agree with that. For sure!
Don’t Forget About IRAs
Rob: Your company also manages IRAs, right?
Chad Parks: Correct. We offer payroll deduction IRAs. That means, if a small business would like to try a retirement plan and is not ready to commit, we offer basically a 401k ‘in training’ which technically uses IRAs but it works all the same. Employees can sign up and say, “Save X dollars from my paycheck and move it over,” and it gets invested just like a 401k plan. And we have individual IRAs for people who want to open it and save themselves or perhaps don’t have access to retirement plans at work.
Rob: I’m guessing that you guys aren’t the custodian of the assets, I assume?
Chad Parks: That’s correct. We have relationships with companies like Charles Schwab, TD Ameritrade and other third-party trust companies where they actually are the ones who hold the assets and provide us access to the investments.
Who Decides on Investment Options?
Rob: Okay. Here’s a question that has stumped me, and I think has stumped other folks. Let’s say an employer’s got 50 employees, and they come to you guys wanting to start a 401k plan for their employees. How do the investments that end up in the 401k, the mutual fund, the choices— who decides that?
We hear this all the time, where they’ve got crappy choices in their 401k and you wonder who exactly is making these decisions? In the case of your company, how does it go? You work with the employer, you’re going to set it up. How do you go about deciding what investments end up in the 401k?
Chad Parks: You mentioned Fidelity and that you have your 401k there. Odds are that you have all Fidelity funds available to you.
Rob: Yeah. And we have a Vanguard, but, yeah.
Chad Parks: Okay. First and foremost is, who is the provider of the plan and is their objective to run investments? In Fidelity and Vanguards case, yes. What’s differentiates us is that since we are not investment managers, we can have pretty much the entire universe of mutual funds available to our clients. The way it goes about, technically, is the plan sponsor (the business owner who puts the plan in place) has the responsibility of choosing the funds to be made available to their employees.
That’s the type of responsibility that most business owners don’t want, so they either work with a third-party financial advisor, who will take that responsibility and help them pick the funds, maintain and monitor them. Or (in our case) if they work with us, we have a starter list they can use to choose from. Technically and legally it’s the business owner who is ultimately responsible for that, which is why it’s important to maintain and monitor those funds because, as you said, some people are stuck with crappy funds.
Rob: Is there a limit? Can an employer come in and ask for 50 options? Or does that increase costs eventually?
Chad Parks: From a technical and system standpoint there’s not limitations. From a practical standpoint, too much choice is sometimes too much choice. What we’re finding is, no more than 30 funds. And that’s going to be a variety. You’re going to have some target dates, stand alone funds. You’re going to have international, bond funds, stock funds, large cap and small cap, so 30 is a good number.
Some providers may limit the number of funds either because of their system limitations or maybe they philosophically believe only 20 is the right number. But there’s no legal requirement to offer more or less.
Rob: Okay. Well, let me throw a curve ball at you and change subjects a little bit. Individual 401k versus SEP IRA. Does it matter?
Chad Parks: Oh, yeah, it matters. The individual 401ks— we happen to have a lot of what you call ‘single ks’. They are the result of the tax law change in 2002, and they’ve been around for quite awhile. And we have many thousands of customers who use it.
What it is, is it’s designed for self-employed people or companies with no employees, like a couple of partners or husband and wife type of thing. It gives you the full benefit, the full contribution amounts and tax savings of a traditional 401k, but for you, the individual. So you can save $17,500 of your pay— and it also comes automatically combined with a profit-sharing plan which means you can get another 25% of your earnings, not to exceed $52,000 this year. And if you’re over 50, you can get a catch-up provision of another $5,000 on your contribution of your paycheck. Then you get another catch-up on profit-sharing.
So for an individual who’s doing well and is looking for a way to save some money you can get over $50,000 put away, tax-deferred every year in an individual 401k plan.
Now how that compares to the SEP IRAs, much lower contributions than a SEP IRA, and I think you also have the phase out of income because it’s under the IRA rules, so if you earn too much you aren’t even able to use it to deduct a certain amount. And, the other challenge is, if you happen to get employees down the road with an individual 401k, that can easily be converted into a traditional company 401k. But the SEP IRA you’re going to have to do mandatory matching in any event you do have employees down the road.
Rob: Yeah. Employees definitely make all of this more complicated. I think on the SEP IRA—I’ve had that for awhile, and I don’t know that there’s an income limit, at least on the SEP IRA. Well, there is in a sense. As you mentioned, on a 401k, on the profit-sharing portion if you’re the only employee of your company, you can contribute whether it’s the 25% of your net income up to that limit of $52,000.
I think with the SEP IRA, for the owner, it’s 20%. Tell me if I’m wrong here, but I think you have to have more net income to get that $52,000 limit. I think the limit is the same for both. You mentioned the catch-up provision which I believe is at $5,500 this year so in effect, am I correct that on a SEP IRA you could effectively put in (if you’re 50 or older) $57,500, right?
Chad Parks: Right.
Rob: The $5,500 is above that $52,000 limit. And you don’t have that with a SEP IRA, right?
Chad Parks: Right.
Rob: I have a SEP IRA and I am seriously considering rolling it all over into an I-401k. The other thing is, are you familiar with back door Roth IRA?
Chad Parks: Yes. I am familiar with that.
Rob: So if you have an IRA that’s both—you have some pre-tax money and after-tax money, you can’t just pick and choose what dollars you want to roll over. It’s got to be done on a pro-rata basis. If you convert your $5,500 for the year or whatever, you could get hit with taxes. Now this is where the tax laws are just insane. If you move your IRAs into a 401k and then open up a new IRA and put after-tax dollars in it you can convert it and not have to worry about the pro-rata rule because you have no other IRA money.
Chad Parks: Yeah, yeah. You’re right. There are ways, and that’s a very good strategy. A couple other benefits of doing that also, know that with a 401k it’s what’s technically called a ‘qualified retirement plan.’ It falls under a different set of rules, and it’s actually a protected asset. So, in the worst case scenario, if something happens to you and you’re either in a lawsuit or you’ve declared bankruptcy, the 401k dollars are always off limits, whereas IRAs are not necessarily off limits. So that’s something to take into consideration.
The other benefits we see, especially with self-employed people using this is, in our particular plan, we allot a loan provision. It’s a very good strategy for people who are maybe a little bit cash-flow strained. But they can go ahead and fund it, take the deductions and save themselves $15,000 or so in taxes then turn around and borrow some money right back out of their own account. It’s a nice handy tool for that. I don’t think you can borrow from SEP IRAs.
Rob: No, I don’t think you can. Of course, that may be an advantage to a SEP IRA though—the fact that you can’t borrow from it.
Chad Parks: Yeah. But it depends on the—
Rob: It’s not very effective.
Chad Parks: You don’t want to look at it as your own ATM.
The Online 401(k)’s Employee 401k
Rob: So with The Online 401(k), does your company have a 401k for its employees?
Chad Parks: Oh, yeah. Absolutely!
Rob: I thought so, but I just thought I’d ask.
Chad Parks: We do a match. We do what is called a ‘safe harbor’ match where we match 4% of pay. So it’s a nice benefit for everybody. As a matter of fact, I was talking to someone the other day who said, “So what’s the participation in your plan?” I said, “I don’t know. Let me look.” And we are about 64 employees and we have 63 who are participating, so I think that’s a pretty good sign.
Rob: Sixty-three out of 64?
Chad Parks: Yeah.
Rob: Wow. That’s amazing. You need to give a call to that 64th person—
Chad Parks: Yeah, I know. I’m just saying.
Rob: What do you think about plans that automatically enroll people into the plan?
Chad Parks: It’s a good thing. It’s been around for many years, and large companies have been some of these early adopters. The beta now shows that it’s very effective. I think the rule of thumb— with people who are automatically enrolled, only about 20% opt out and 80% stick with it. And then they have the starting at saving 3%, and that escalates every year up to 6 or 8%. It’s really up to the plan. But people say they generally don’t miss it. They’re glad that it’s being done for them.
401k Record Keeping
Rob: Yeah. So for folks who have a 401k with you guys, (employers that have used your service) when their employees login to look at their 401k balance, are they logging in at your website the Online 401k?
Chad Parks: That’s right. Part of what we do is called ‘record keeping’ and so your accounts are with us and we keep track of your investments, contributions, your interest, dividends and your buys and sells. You will see that all on our platform, our system. But, as we mentioned before, the money actually lives at Schwab or somewhere else.
Chad Parks: And we have an institutional relationship where we aggregate all the data and the trades files every day, and we send that to Schwab and they execute for us. They settle that, and we get all the confirmations. We bring them back in and process them on our system.
Rob: Okay. One last question Chad, before I let you go. And I appreciate your time today. I just want to circle back to one thing on the 401k fees. I take it that obviously an employee can—they have some level of control over the fees they pay based on the funds they choose. Is that correct?
Chad Parks: Sure. They’re given the list of funds, and there are ones that are less expensive, so you’re free to choose them.
Rob: Okay. So hopefully they can find a few inexpensive choices. I do get email from folks who claim they don’t have anything under 1%.
Chad Parks: Well, in those cases, remember, employers have a responsibility to make sure that they’re offering you the best value and the best plan they can get. So, if you’re finding yourself in a situation where you don’t think you have low-cost alternatives, you have every right to go in to your employer and say, “I would like to have lower-cost options available to me.”
Then document it and put in your request. If they don’t do it, there could be some very serious problems there. I mean, I’m not saying to sound the alarm bell or anything, but if you bring it up to the Department of Labor they will most definitely pay a visit, and ask what’s going on with that plan.
Rob: Good. Alright Chad, I appreciate that tip. One last question. Do you have a favorite personal finance or investing book or author or website that you go to that gives you some great information on how to manage your money?
Chad Parks: I do. He’s a little bit controversial, but he’s been right. He’s an economist named Harry Dent. If people aren’t familiar with him, he’s written several books. He’s what you would consider a demographic economist, and he has thousands and thousands of data points on the cohorts on the boomers and such, and how that drives stock markets, housing markets and stuff.
Back in the early 90s he wrote a book called, The Great Boom Ahead. When the Dow was around 3,000 he said it was going to 12,000 and everyone thought he was crazy. But sure enough, it did. And look where we are today. Now he’s on the other side of that saying, “The great crash is ahead,” so he’s definitely worth paying attention to. I really enjoy his books.
Rob: Okay, good. I will link out to his book. I appreciate that tip. I’ll check him out too.
Chad Parks: Alright.
Rob: Hey, Chad. I appreciate your time so much today.
Chad Parks: My pleasure, Rob. Thank you for the opportunity. It’s been great.