The Informal Solo(k) Aggregation Plan Design – Letting Demographics Drive 401(k) Account Balance Management Flexibility.
As published in the Journal of Pension Benefits Summer 2024
By Jeff Acheson.
Jeff Acheson CPWA®, CFP®, CPFA®, AIF®, CEPA®, NQPCTM, CAPPTM has 45 years of experience in the financial services and retirement plan industries, creating a value proposition that is an exceptional and diversified integration of credentialed education, experience-based knowledge, and industry leadership. His fiduciary-based business model focuses on enhancing his ability to be a trusted advisor to high-net-worth individuals, families, businesses, and their mission-critical employees, in addition to retirement plan sponsors and their participants through his private practice, the Advanced Strategies Group. Jeff is a longtime volunteer within the National Association of Plan Advisors (NAPA) having served in the past as the Chairperson of its Government Affairs Committee, a member of its Leadership Council, and President of the organization 2018/2019. He is currently Chairperson of NAPA’s Nonqualified Plan Consultant designation program and annual conference as well as being the co-author of the program’s curriculum. He is also the 2024 President and serves on the Board of Directors of NAPA’s parent organization, the American Retirement Association.
In the intersecting worlds of law and finance, the complexities of modern legal practice underscore solutions tailored to the unique needs of attorneys. Traditional 401(k) plans often fall short in catering to the diverse demographic profiles within law firms, from ambitious highly educated junior associates to seasoned financially successful partners who continue to practice law beyond what is considered normal retirement age. An innovative solution that addresses this gap is the incorporation of individual self-directed brokerage accounts within the 401(k)-plan design. These accounts work best when they are seamlessly integrated with the plan’s recordkeeping platform, offering attorneys maximum flexibility and autonomy with the investment of their retirement savings. This construct would apply to other professions where a plan’s demographics have a heavy preponderance of Highly Compensation Employees (HCEs).
Understanding Law Firm Demographics
Law firms are comprised of a wide array of legal professionals, each with distinct personalities, financial objectives, and risk tolerances. This diversity challenges the fiduciary-based, one-size-fits-all commoditized nature of countless existing retirement plans and their approach to menu construction. In many situations, law firms function as a collective of individual practitioners driving significant revenue with correlated compensation paid to them personally, while sharing staff and overheard with other lawyers within the firm.
This business model can be quite lucrative. For example, the median annual wage for attorneys in the United States as of May 2020 was $135,740 with the top 10th percentile showing a median salary of $230,200. [USA FACTS, February 29, 2024, www. usafacts.org]. Yet such figures mask significant variances based on position, specialization, and geography. As evidence, the median income for law firm partners is $675,000 with average income for partners in larger firms of more than one million dollars per year being common. [USA FACTS, February 29, 2024, www. usafacts.org]
With this level of income, and the typical retirement occurring between ages 60–70, it is not unusual for attorneys to accumulate high six to low seven figure account balances by normal retirement, suggesting varying degrees of financial readiness for retirement. Furthermore, overall retirement balances can spike higher if a firm also sponsors an integrated Cash Balance Pension Plan. These statistics highlight the need for retirement plans that can be customized to individual circumstances. A case can be made that traditional 401(k) menus and asset allocation options are insufficient diversifiers when individual balances are at the high end of or above these averages.
Attorneys, particularly those successful in their fields, between ages 45–65, typically demonstrate considerable financial success compared to the general population. The average and median retirement savings for households headed by individuals between 45–54 are approximately $313,220 and $115,000, respectively. This amount increases significantly in the 55–64 age group, with average household retirement savings of $537,560 and a median of $185,000. [Alana Benson & June Sham, “What is the Average Retirement Savings by Age?” NerdWallet, March 5, 2024]. In terms of net worth, the figures are also quite substantial. According to the Federal Reserve’s Triennial Consumer Finance Survey, for Americans ages 55–64, the average net worth is approximately $1,167,400 with overall American median household net worth closer to $192,000. [Survey of Consumer Finances, Federal Reserve Bulletin, September 2017, Vol. 103, No 3]. As such, it makes sense those attorneys with incomes in the higher strata of the general population also would accumulate retirement savings and build net worth in excess of the general population statistics.
Also of consideration, attorneys often retire later than other professionals. While the average retirement age in the United States is around 65 for men and 63 for women, attorneys tend to work beyond these ages. Specifically, 15 percent of attorneys continue working past the age of 65. This trend reflects the deep-seated passion for their work making early retirement less appealing to many attorneys. [Sharon Miki, “A Guide to Preparing for Lawyer Retirement.” www.clio.com/blog.com].
Additionally, financial factors and the personal fulfillment derived from practicing law can contribute to an attorney’s decision to delay retirement and avoid a reduction in the standard of living they have grown accustomed to. However, when attorneys decide to extend their careers beyond normal retirement age, the desire increases for investment options that provide protection from downside risks inherent in most investment markets using traditional investment management strategies.
I Am Not My Brothers Keeper!
The appeal of this kind of flexibility to HCE participants has historically created a conundrum for a plan’s designated fiduciaries. Most 401(k) plans have a demographic with more Non-Highly Compensated Employees (NHCEs) while law firms are inverted triangles with more HCEs (also peers of the plan’s designated fiduciaries), which calls for a different service model focus. (See Exhibit 1)
Exhibit 1
As such, often neither fiduciaries nor HCE-Attorneys see a need for the plan’s internal fiduciaries to look out for the HCE-Attorneys by curtailing their investment options. However, fiduciary duties remain, and are especially important for the non-attorney, non-HCEs in the plan. Further complicating the issue, if the plan’s core menu is expanded in number and complexity of options to meet the wants and needs of the HCE-Attorneys, it will add cost, oversight time, and fiduciary liability exposure for the firm and the person or committee assigned oversight of the plan. Thus, the conundrum, how to accommodate one group’s desire for flexibility and autonomy without creating fiduciary liability for the firm.
The Solution: Integrated Individual Self- Directed Brokerage Accounts
This “core and satellite” plan design configuration where a core recordkeeping system offers integrated individual self-directed brokerage accounts (SDBAs) dovetails nicely within a conceptional arrangement I would label an “Aggregated Solo(k) Plan Design.”
While the SDBA option generally must be offered to all participants, it typically is utilized only by the HCE-attorneys. The SDBAs provide attorneys with control over their investment choices, enabling access to a broader range of options beyond the core menu’s usual mutual funds and index funds. This enables attorneys to leverage their specialized knowledge and personal investment preferences, potentially enhancing their portfolio diversification, risk management and returns. Whether interested in individual stocks and bonds, real estate funds, sector specific Exchange Traded Funds (ETFs), or alternative investments, attorneys can align their investment and risk management strategies with their professional expertise, risk tolerance, and personal financial goals whether that means pursuing market out performance or mitigating or eliminating potential exposure to loss. (See Exhibit 2)
Exhibit 2
Enhanced Creditor Protections under ERISA
An additional advantage of integrating self-directed brokerage accounts within a 401(k) plan, as opposed to forcing participants to turn to in-service or termination rollovers to individual retirement accounts (IRAs) to access more sophisticated options, is the enhanced level of creditor protection afforded under plans covered by the Employee Retirement Income Security Act of 1974 (ERISA). ERISA-governed plans benefit from robust federal protections that shield retirement savings from creditors, a safeguard particularly valuable for attorneys, who may have litigation exposure due to the nature of their profession. By contrast, the protection of IRAs from creditors typically is governed by state laws, which can vary significantly in the level of protection provided. This variance means that attorneys who rely exclusively on IRAs for retirement savings post-career or death, might find their assets less protected in the event of legal judgements. Incorporating self-directed brokerage accounts within the ERISA-covered 401(k) framework not only provides attorneys with the flexibility to tailor their investment strategies, but also offers a stronger safeguard against potential future creditor claims.
Addressing Concerns and Misconceptions
Despite the advantages, some critics point to the potential risks and complexities associated with self-directed brokerage accounts, such as increased exposure to volatile markets and the demands of active portfolio management by participants ill-equipped for the responsibility. However, these concerns can be mitigated through strategic education initiatives and robust regulatory compliance measures that ensure transparency and accountability. SDBAs can be just that, self-directed, or with the right platform provider, allow the HCE-Attorney to engage an investment advisor to manage their SDBA for them with the fee for service transacted outside the plan’s obligation with responsibility borne by the HCE-Attorney individually. This flexibility with the right investment advisor offers a plethora of investment strategies. (See Exhibit 3)
Reimaging Recruit—Reward—Retain and Retirement
Offering flexible, tailored retirement plans can significantly enhance a law firm’s ability to attract and retain top talent. In a competitive legal market, attorneys look for firms that support not only their career aspirations but also their long-term financial well- being. Customized 401(k) plans featuring self-directed accounts can improve job satisfaction, firm loyalty, and overall organizational growth, thus providing a competitive edge in the legal industry.
Implementing a Customized 401(k) Plan Design
Implementing a self-directed brokerage option within a 401(k) plan requires careful planning and collaboration with third-party administrators (TPAs) and retirement plan advisors who understand the dynamics of a modern law firm, the industry’s recordkeeping options, and the legal framework required for such a design .Law firms need to also consider applicable regulatory requirements and restrictions, the firm’s specific goals, and the individual needs of their attorneys. Effective communication is critical; engaging with attorney stakeholders through seminars, workshops, and especially, the availability of one-on-one consultations can help ensure the transition is smooth and the benefits clearly understood.
Realizing Long-Term Financial Security
The aim of any retirement plan is to secure financial independence and security for its participants and their beneficiaries. By adopting self-directed brokerage accounts, law firms empower their attorneys to take charge of their retirement planning and achieve their financial goals. This proactive approach not only supports attorneys in building substantial retirement savings but also fosters a culture of financial literacy and engaged retirement planning within the firm.
Conclusion
As the legal profession continues to evolve, so must the strategies law firms use to manage and support their most valuable assets—their people. By moving beyond traditional 401(k) plan platforms and embracing the flexibility of self-directed brokerage accounts, law firms can provide their attorneys with the tools necessary for personalized, effective retirement planning extending to optimized retirement income and tax management. This not only enhances their financial well-being but also strengthens the firm’s position as a leader in the competitive legal marketplace. It is time for law firms to innovate their retirement benefits to align with the uniqueness and sophistication of their demographics.
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Reprinted from Journal of Pension Benefits, Summer 2024, Volume 31, Number 4, pages 30–34, with permission from Wolters Kluwer, New York, NY, 1-800-638-8437, www.WoltersKluwerLR.com