Bottom Line Up Front

• Making contributions to your company’s 401(k) plan and then transferring the balance to a Roth 401(k) can allow you to increase contributions and help decrease your taxes.
• In 2026, a participant can contribute up to $24,500 from their pre-tax earnings and up to $47,500 after taxes into their 401(k) plan for a total of up to $72,000 (indexed) — not including catch-up contributions.
• The Mega Roth Backdoor IRA can be effective under a plan with ideal demographics and generous employer contributions to save more in a Roth IRA or Roth 401(k) than you would normally be able to.

You know that Mega Backdoor Roth thing your friend mentioned or that you stumbled across online? The one where you can make substantial contributions to your employer-sponsored 401(k) plan and then transfer them to a Roth 401(k) essentially saving you more on taxes in the long run. It may sound too good to be true, but it can work wonders for those who qualify and are in the right plan. It’s especially helpful if you’d typically be unable to contribute to a Roth account due to exceeding income limits. 

The Logistics

Under the IRS Code, 401(k) plans have a variety of contribution limits (excluding catch-up contributions):

• Employee Deferral – $24,500 for 2026 (indexed)
• Maximum Account Addition – $72,000 for 2026 (indexed)

Beyond that, 401(k) plans have various non-discrimination rules to ensure that the plan does not overly benefit highly compensated employees (“HCEs”). As it relates to this situation, the key testing is the ADP/ACP test.

As an example – we have a small company with two (2) owners and five (5) employees. The plan has reasonable participation with the employees on average contributing 7.14% of their pay and an employer match of 50% up to 6.0% of pay deferred yielding a Non-Highly Compensated Employee (“NHCE”) Average Contribution Percentage (“ACP”) of 2.40% for our NHCE group.

Based on these figures our owner’s contributions of 9.08% as employees and the employer match ACP of 3.00% allows them to easily pass our ADP & ACP tests.

Now, let’s add an after-tax feature to our plan. The owners see that they are far from their $72,000 total contribution limit and they have additional money they’d like to save for retirement. Owner 1 contributes the full $38,500 of that potential $38,500 available to maximize their account to the after-tax source in the plan. It’s important to remember that after-tax contributions are treated as employer contributions for purposes of the ACP test.

So, let’s see what happens:

The ADP test still passes easily as there was no change. However, they now fail the ACP test and the Owner 1 will be required to take a return of $22,575 in excess after-tax contributions – that’s not going to be a pleasant conversation for the TPA to have with them.

So, what’s the big deal? I put money in, and I get it back if we fail?

Well, let’s remember the objective here. You were putting money into the after-tax source with the goal of immediately converting it to a Roth either within the plan or via an in-service distribution to a Roth IRA. Well, that conversion/rollover would be ineligible and would need to be disgorged from their account – and you thought the 1st TPA conversation with Owner 1 was going to be rough!

Bottom Line

The Mega Backdoor Roth can and does work. But you need to have ideal demographics and likely a very generous employer contribution to the plan. If so, this can be a great benefit.

The short answer – talk to your TPA or consultant, evaluate the demographics and objectives, and do a preliminary ACP test in advance to see if it will work.

If you’d like to know more, you can reach out to us here. We’d be happy to help answer any questions you may have.

The post Mega Backdoor Roth & After-Tax Contributions in Your 401(k) Plan appeared first on Odyssey Advisors, Inc.

As your business grows, upgrading your retirement plan from a SIMPLE IRA to a 401(k) can be a smart move. To make this change, ensure that all SIMPLE IRA participants receive notification of the termination by the deadline.

Previously, the notification deadline was November 2, as the IRS mandated a 60-day notice. However, with the implementation of SECURE 2.0 rules last year, you now only need to provide a written notice of the SIMPLE plan termination at least 30 days before the effective date.

How to Terminate Your SIMPLE IRA?

To terminate your SIMPLE IRA and upgrade to a 401(k) plan for 2026, you’ll need to follow a couple of steps. Here’s a general guideline on how to go about it:

1. Notify Employees: If you have employees who are participating in the SIMPLE IRA, you must inform them about your decision to terminate the plan. The IRS requires that you provide a 30-day notice before the end of the calendar year, which would be December 2nd, 2025.
2. Provide Notice to Financial Institution: Notify the financial institution that manages your SIMPLE IRA of your intention to terminate the plan at the end of the year. They will guide you through the process of closing the account.

If you’d like a SAMPLE termination notice to send to your employees, we have one available for download here.

Good to note: You do not need to notify the IRS that you’ve terminated your SIMPLE IRA plan.

You can work with your financial professional to determine the appropriate 401(k) Plan design & provider before year-end to maintain continuity without the constraint of an IRS deadline. Be aware, if you’d like it to be a “safe harbor” plan similar to the SIMPLE-IRA, that does have a December 1st notice date to employees.

As always, if you have questions on this or need more, please contact an Odyssey consultant.

The post Want to Upgrade Your SIMPLE IRA to a 401(k) Plan in 2026? The Deadline is Now appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Frequent RMD withdrawals may look smart, but transaction fees can quietly drain thousands from your retirement income
• A $100 fee on monthly withdrawals can eat up more than 16% of annual distributions, undermining the benefits of a steady withdrawal strategy
• Simple fixes like consolidating withdrawals, rolling over to an IRA, or choosing a no-fee custodian can protect more of your money

You planned carefully, saved for years, and finally retired. But what if something as small as a $100 fee could quietly add up to thousands of dollars from your nest egg? For many retirees taking Required Minimum Distributions (RMDs), that’s exactly what may be happening.

RMDs are mandatory withdrawals that the IRS requires once you reach a certain age, designed to ensure the government eventually collects taxes on tax-deferred retirement accounts.

A recent Wall Street Journal article highlighted a new trend: more retirees are taking their RMDs in smaller, regular installments rather than in a lump sum each year. On paper, this approach resembles dollar-cost averaging in reverse, spreading out withdrawals to reduce timing risk.

Here’s the catch: while the strategy looks smart in theory, transaction fees can turn it into a pretty costly mistake if you’re not careful.

The Appeal of Dollar-Cost Averaging in Retirement

At first glance, spreading out your RMDs through smaller, regular withdrawals seems like a safe and disciplined approach. The idea, often called “reverse dollar-cost averaging,” is that by taking steady payments throughout the year, you can reduce the risk of bad timing.

Instead of worrying about pulling a lump sum right before a market downturn, you smooth withdrawals across different points in the market cycle. For many retirees, this method also provides a sense of stability, almost like receiving a paycheck again, which can make day-to-day budgeting easier. On top of that, it removes the stress of trying to guess the “right” moment to take money out, reducing the temptation to make timing mistakes that could hurt long-term returns.

The Cost Nobody Talks About: Transaction Fees

Here’s where things get tricky. Many employer-sponsored retirement plans, particularly 401(k)s, charge a fee each time you take a distribution.

Example:

Imagine a retiree withdrawing $600 every month from their 401(k). If each transaction comes with a $100 fee, that’s 17% gone immediately before investment returns and before taxes.

Compare that with an IRA or brokerage account, where ACH transfers are often free. Suddenly, the “safe” strategy looks expensive.

When the Math Doesn’t Math

Let’s break it down further:

• $100 per withdrawal x 12 months = $1,200 in annual fees
• If your RMD is $7,200 for the year, that’s more than 16% lost to fees
• Over a decade, that’s $12,000 drained from your retirement income

Not only do these recurring fees reduce income, but they can also amplify the sequence of return risk — the danger of selling investments at the wrong time. Paying extra fees accelerates the erosion.

Better Withdrawal Strategies

The good news is that retirees have several ways to minimize or even eliminate transaction fees on their RMDs. One of the most effective approaches is rolling assets from an employer-sponsored plan into an IRA, since many custodians don’t charge for routine distributions. Another option is to rethink the frequency of withdrawals. Instead of taking money out every month and racking up charges, some retirees opt for quarterly or even a single annual distribution. This reduces the number of transactions while still meeting IRS requirements.

It’s also worth comparing custodians, because some providers offer no-fee transfers while others tack on steep charges for each withdrawal. Even if you’re happy with your current setup, reviewing the plan documents and fee schedule can uncover hidden costs you may not have realized you were paying. A little attention to these details can mean thousands of dollars saved over the course of retirement.

Questions Retirees (and Advisors) Should Be Asking

Before setting your RMD schedule, ask:

• Am I required to pay a fee every time I take a distribution?
• Would consolidating withdrawals save me money?
• Is my retirement account the best vehicle for my withdrawal strategy?

A few simple questions can prevent thousands of unnecessary costs.

Final Thoughts

Reverse dollar-cost averaging can be a smart way to manage retirement income, but only if the math works in your favor. Transaction fees are often overlooked, yet they can quietly eat away at your nest egg, turning a sound strategy into an expensive one.

Before settling on a withdrawal plan, retirees and advisors should carefully evaluate the real costs. Sometimes, the smartest move isn’t about timing the market; it’s about avoiding unnecessary fees.

The post The Hidden Costs of RMDs: Why Transaction Fees Matter More Than You Think appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Contributing too quickly to your 401(k) or changing your contribution rate during the year could cause you to miss out on employer matching dollars if your company matches per paycheck.
• Ask your employer if they offer a year-end “true-up” or pace your contributions.
• Staying aware of plan rules, raises, and contribution limits ensures you don’t leave free retirement money on the table.

When it comes to saving for retirement, a 401(k) employer match might be one of the easiest wins—free money just for contributing to your retirement plan? Yes, please. But what if we told you that you could be accidentally leaving some of it on the table?

Let’s break down what’s really going on with employer matches and how to make sure you’re not unknowingly leaving money on the table.

First, What Is a 401(k) Match?

A 401(k) match is one of the most valuable benefits an employer can offer. Essentially, it’s when your company contributes to your retirement savings based on how much you contribute. For example, your employer might match 25% of the first 6% of your salary that you contribute.

That means if you earn $80,000 a year and contribute 6% of your salary ($4,800), your employer would contribute an additional 25% of that amount — $1,200. That’s an immediate 25% return on your contribution.

So why would anyone turn that down? They probably don’t mean to, but it happens more often than you think.

Learn more: Matching Contribution: What It Is, How It Works, FAQs (Investopedia)

The Hidden Pitfall of Front-Loading Contributions

Some employees, especially high earners or young professionals living at home with low expenses, try to ‘front-load’ their 401(k) contributions. The thought is: contribute as much as possible early in the year, then take a break once they’ve hit the annual limit.

While that strategy can be efficient in some ways, it may backfire when it comes to employer matching.

Here’s why: many employers tie their matching contributions to each paycheck. If you stop contributing mid-year, after reaching the IRS annual limit, your employer may also stop matching. You might have maxed out your personal contribution, but if your employer only matches based on per-paycheck contributions, you could miss out on months of matching dollars.

Real Talk: That’s Money You Could’ve Had

Let’s say you hit the IRS contribution limit by the end of July. Great! But if your employer doesn’t “true-up” your contributions at the end of the year (more on that below), you could be missing five full months of matching funds.

How to Make Sure You’re Getting Every Dollar You Deserve

Avoiding this mistake isn’t complicated, it just takes a little planning. Here’s how to do it:

1. Find out if your employer offers a year-end “true-up”
   
   Some employers run a true-up process at the end of the year. That means they review your total contributions across the year and make up any matching shortfalls, even if you stopped contributing mid-year. If your company does this, great! You’re likely covered.
   
   Action: Contact HR or check your Summary Plan Description (SPD) to see if a true-up is part of your plan design.
   
2. Pace yourself
   
   If your employer doesn’t offer a true-up, you’ll want to time your contributions so they’re spread out over the year. That way, your contribution gets matched with every paycheck.
   
   Pro Tip: Use your payroll calendar to calculate how much to contribute per pay period to hit the annual limit by your final paycheck.
   
3. Monitor changes throughout the year
   
   Raises, bonuses, and other compensation shifts can throw off your contribution pacing. If you receive a bump in pay or a large bonus that’s eligible for 401(k) contributions, reassess your per-paycheck contributions to avoid maxing out to early.
   
4. High Earners: Know Your Options
   
   Some companies offer non-qualified plans to supplement their standard 401(k) offerings, typically for certain employees who exceed plan limits or hold specific roles. These plans allow for additional retirement savings opportunities, though they often come with different rules and considerations.
   
   If you’re in a higher income bracket or leadership position, it’s worth asking whether your company offers a non-qualified plans as part of your overall package.

The Bottom Line

An employer match is essentially free money for your future. But like any benefit, it’s only as valuable as your ability to access it.

By pacing your contributions, understanding your plan’s match structure, and staying proactive throughout the year, you can avoid one of the most common 401(k) mistakes and maximize your retirement savings.

The post Are You Missing Out on Your 401(k) Match Without Realizing It? appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• If you have a full-time job and a side business with no employees, you can contribute to both a regular 401(k) and a Solo 401(k).
• Employee contributions are capped at $24,500 total across all 401(k) plans in 2026 ($32,500 if 50+ with catch-up).
• Employer contributions are separate for each plan – each employer can contribute up to $72,000, but this amount is reduced by any employee contributions made to that plan.
• If you contribute the full $24,500 as an employee, the maximum combined employer contributions across both plans would be $119,500, bringing the total possible contributions to $144,000 ($152,000 if 50+).

Absolutely! If you have a 9-to-5 with a company 401(k) plan and a side hustle with 1099 income, you might be leaving money on the table if you’re not using a solo 401(k). Many people don’t realize that having multiple income streams means you can also have multiple retirement plans – allowing you to stack contributions and maximize tax savings.

Unlike IRAs, which have a hard cap on contributions no matter how many you have, 401(k) plans work differently. Your side business opens the door to another retirement account, allowing you to save even more. The best part? You get to play both roles: employer and employee, meaning you can potentially sock away thousands more in tax-deferred (or tax-free, if Roth) savings. Let’s break down how it works.

Why Having Two Retirement Plans Can Be a Smart Move

Many people assume that if they have a 401(k) through their employer, they’ve maxed out their retirement contributions—but that’s not entirely true. If you also have a side business with a Solo 401(k), you have additional tax-advantaged savings opportunities. The key is understanding how the limits work.

A 401(k) has two types of contributions:

1. Employee Contributions: This is the portion you contribute from your paycheck or side business income. In 2025, the total employee contribution limit is $24,500 across all 401(k) plans ($32,500 if you’re 50+).
   
   
   • For example, if you contribute $10,000 to your employer’s 401(k), you can only contribute $14,500 more as an employee across either your employer’s plan or your Solo 401(k).
     
     
2. Employer Contributions (Profit-Sharing): This is where things get interesting. Employer contributions are separate for each plan because they’re based on each employer’s earnings.
   
   
   • Employer contributions are separate for each plan, meaning each employer can contribute up to $72,000, but this amount is reduced by any employee contributions made to the plan.
     
   • If you maximize employee contributions ($24,500), the combined employer contributions across both plans would be $119,500.
     

Unlike employee contributions, where the limit is shared across plans, the employer contribution limit applies separately to each plan – which is why a Solo 401(k) can be a powerful tool for increasing retirement savings.

Perks of Having Both a 401(k) and a Solo 401(k)

• Double the Savings Potential: While you’re limited on employee deferrals, employer contributions give you another bucket of tax-deferred savings. You get to wear both hats and can make contributions as both an employee and employer.
  
• Lower Your Tax Bill: Contributing more means reducing your taxable income from both your day job and side hustle.
  
• More Investment Choices: Employer-sponsored 401(k)s often have limited options, while solo 401(k)s can offer more flexibility, including real estate and alternative investments.
  
• Tax Planning Flexibility: You can choose a Roth or traditional for both plans, letting you balance taxable income now vs. tax-free withdrawals later.

Common Solo 401(k) Misconceptions

“If I max out my work 401(k), I can’t contribute to my Solo 401(k) at all.”

Not true. You can still make employer contributions from your self-employment income, even if you hit the employee limit at your day job.

“Solo 401(k)s are for full-time business owners.”

False! Even if your side hustle only brings in a few thousand dollars a year, you can still take advantage of tax-advantaged savings.

“I should just open a SEP IRA instead.”

Maybe, but Solo 401(k)s generally allow higher contributions at lower income levels because they let you contribute both as an employee and an employer. SEP IRAs only allow employer contributions.

Having two retirement plans isn’t just possible, it’s a smart strategy for anyone juggling a 9-to-5 and a side business. Next, let’s break down how to maximize your contributions without running into issues with the IRS.

Maximizing Contributions Without Overstepping IRS Rules

The key to maximizing contributions is understanding how the IRS limits apply across both plans. Here’s how to make the most of your retirement savings without accidentally contributing too much.

1. Know the Two Types of 401(k) Contributions
   
   There are two main types of contributions to be aware of:
   
   
   • Employe Deferrals: You can contribute up to $24,500 in 2026 ($32,500 if 50+) across all 401(k) plans combined.
   • Employer Contributions: Your employer (including your own business) can contribute up to 25% of your compensation from each job up to a total of $72,000 for each job (reduced by the amount of your employee contributions to that plan excluding the catch-up).
     
     
2. Max Out Your Employee Deferrals Wisely
   
   Since the employee contribution limit is shared between both plans, you’ll need to decide where to contribute first:
   
   
   • If your W-2 job offers a match, contribute there first to get free money.
   • Once you’ve maxed out your match, you can split additional deferrals between both plans or focus on the one with the better investment options and lower fees.
     
     
3. Use the Employer Contribution Loophole
   
   Even if you max out employee contributions at your W-2 job, your side business can still contribute to your solo 401(k) as an employer. Here’s how:
   
   
   • Sole Proprietorship / Single-Member LLC: Employer contributions are 20% of the net self-employment income (after deducting half of your self-employment tax).
   • S-Corp: Employer contributions can be 25% of your W-2 wages from the business (not total revenue). Remember that S-Corp dividends are NOT considered compensation for retirement plan purposes.
     
     
     
4. Consider Roth vs. Traditional Contributions
   
   If you expect higher income in retirement, Roth contributions (tax-free withdrawals later) might be better. If you want to lower your taxable income now, traditional (pre-tax) contributions make sense.
   
   You can mix and match: Roth for one plan, traditional for another.
   
5. Avoid Common IRS Pitfalls
   
   
   • Excess Employee Deferrals: You can contribute $24,500 to each plan (traditional, Roth, or combined). The limit is shared across every 401(k).
   • Miscalculating Employer Contributions: Employer contributions are separate, but they still can’t exceed 25% of your eligible earnings from each employer.
   • Missing the Tax Filing Deadline: Solo 401(k) contributions must be made by your business’s tax return deadline (including any extensions). A great tip? Set a calendar or phone reminder for when you want to contribute.
     
     
6. Track Contributions and Work with a Tax Pro
   
   401(k) rules can be complicated – especially with multiple plans. Keep a running total of contributions throughout the year and work with an accountant, TPA, or financial advisor to stay within IRS guidelines.

The Bottom Line

By strategically using both a Solo 401(k) and an employer-sponsored 401(k), you can maximize tax-deferred (or tax-free) savings, reduce your taxable income, and accelerate your retirement goals as both an employer and employee. It definitely pays to know your retirement plan options.

Keep in mind that you need to understand the difference between employee and employer contributions to avoid overstepping IRS rules. That’s why it’s important to work with an experienced retirement third-party administrator, financial advisor, or tax pro to ensure you’re making the most of your savings while staying compliant.

The post Can I have a Solo 401(k) and a Company 401(k)? appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front 

• Understanding the elements of 401(k) plan design can help you mold your plan to fit your company’s and employee’s needs.
• 401(k) plans are not one-size-fits-all; they require careful consideration and customization to suit individual circumstances and goals.
• Some of the features you’ll need to narrow down when starting a 401(k) include the plan type, contributions, vesting, and distributions, among others, to ensure alignment with your company’s objectives.

A 401(k) plan is a popular retirement savings vehicle.  It is an employer-sponsored retirement plan that allows employees to save for retirement. Whether you’re looking to start offering one or upgrade your current plan, it’s important to know that the specifications of your 401(k) plan can vary based on your design choices.

1. Eligibility

Who will be allowed to participate in the plan? Legally, there are a few parameters that state a company must allow an employee to participate in their qualified plan if they: 

• Are 21 years old
• Have one year of service (1,000 working hours or more within 12 months)

As the employer, you have the option to allow employees to participate in the plan earlier than these requirements. Having more relaxed eligibility rules may be a way to attract new employees while meeting the extended eligibility rules may help retain employees.

2. Plan Type

There are 3 common types of 401(k) plans that you can choose from to best suit the needs of your company:

Traditional Plan

• Offers maximum flexibility
• Allows participants to make pre-tax contributions
• Annual testing

Safe Harbor Plan

• Not subject to many of the complex tax rules such as nondiscrimination testing

SIMPLE Plan

• A cost-efficient way to offer retirement benefits to employees
• Not subject to annual nondiscrimination tests
• 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding year
• Employers can’t maintain any other retirement plans

Additional reading: Step-by-Step Guide to Starting a 401(k) Plan

3. Contributions

Employee Contributions

Employee elective deferrals are subject to limits. In 2024, the maximum allowable contribution is $23,000 for traditional and safe harbor plans and $16,000 for SIMPLE 401(k) plans. Additionally, employees aged 50 and above can also make “catch-up” contributions, allowing them to contribute beyond the standard limit. In 2024 eligible participants can contribute an extra $7,500 for catch-up contributions.

To streamline the process and promote retirement savings, some plans offer automatic enrollment. This feature enrolls eligible employees into the plan by default unless they choose to opt-out. Automatic enrollment is designed to boost participation rates and encourage more employees to start saving for their future. 

Employer Contributions

Many employers opt to match a portion of their employees’ contributions or make nonelective (aka “profit sharing”) contributions which can be tax-deductible on the employer’s federal income tax returns. However, these matching and/or nonelective contributions must adhere to IRS limits. 

In addition, all 401(k) plans are required to undergo non-discrimination testing to ensure fairness between highly compensated and non-highly compensated employees. Understanding these tests is crucial for maintaining compliance with regulations. 

4. Vesting

Vesting refers to the ownership of the funds an employer contributes to an employee’s account. It indicates how much of those funds an employee owns and can take with them if they leave the company or retire. As the employer, you can set the vesting schedule. Employers typically choose between two types of vesting schedules: graded vesting and cliff vesting.

Graded vesting schedules gradually grant more ownership of employer contributions for each year of service. For example, a plan may state that an employee becomes 25% vested for each year of service until they are 100% vested. You can choose the rate at which vesting occurs, as long as it’s at least as generous as the minimum of 20% vested at two (2) years increasing by 20% per year until the employees are fully vested at six (6) years.

Cliff vesting schedules hand over full ownership of contributions after a period of no ownership. For example, a plan may state that the employee must complete two (2) years where then they will be 100% vested. Cliff vesting schedules require that employees are 100% vested upon completion of three (3) years of service. 
It is important to remember that vesting refers to employer contributions. The money that the employee puts aside through elected deferrals is always immediately 100% invested.

5. Investment Options

Where will the plan assets be invested? Index funds are a popular choice due to their diversity and low maintenance requirements. Plan sponsors should regularly monitor investment options to ensure they are optimal for employees. Whatever you choose, compliance with ERISA 404(c) mandates a diverse range of high-quality investment options as well as employee education so that they can make informed choices.

6. Plan Administration

Some companies hire a third party administrator or “TPA”. Rather than spending time and money to train someone regarding retirement plan rules, a lot of companies choose to hire an outside expert. The TPA is responsible for running the plan. This entails making sure that the plan remains compliant with ERISA standards, communicating with the company answering questions, and helping to minimize claim and administrative fees.

7. Distributions

Retirement plans offer various distribution options for participants. When an individual leaves employment, they may have the choice of receiving a lump sum distribution, where they take the entirety of their vested account balance at once. Some plans may also offer installment payments or partial distributions. 

Some plans allow participants to request distributions while still employed, known as “in-service” distributions. These may be granted upon reaching a certain age, typically 59 ½ or older, or in the event of a hardship that is defined by the law. 

Additionally, if a participant decides to move to another job, they may elect to do a rollover, a type of distribution, where the funds from an existing account are transferred to a new retirement plan or IRA tax-free.

Every Detail Matters

In crafting a 401(k) plan, every detail matters, from the type of the plan to contribution structures, vesting schedules, and distribution options. There is no such thing as a one-size-fits-all 401(k). It’s also important to remember that you must clearly outline the details you choose in your plan document. 

If you have any questions about your plan design – or are looking for a third-party administrator to help design your retirement plan – contact us today.  

Looking for more? Explore these excellent articles on retirement plans and design: 

How Much Does it Cost to Start a 401(k) Plan?
Understanding Asset Allocation
Top 3 Employer Fiduciary Responsibilities for 401(k) Plans

The post 401(k) Plan Design: An Overview appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Setting up a 401(k) plan is affordable for small businesses, with initial costs ranging from $500 to $2,500 and the SECURE Act providing substantial tax credits. 
• Ongoing administration fees vary, and many businesses benefit from using a third-party administrator. 
• Offering a 401(k) plan is an effective tool for attracting and retaining employees, providing them and the business significant tax advantages and financial growth opportunities. 

As a small business owner, you might be curious about the expenses associated with offering a 401(k) plan to your employees. You might have even dismissed the idea, assuming that 401(k) plans are exclusively for larger companies due to their perceived high costs. However, this is not accurate. The cost of a 401(k) plan can vary significantly based on factors such as company size, plan complexity, investment choices, and associated fees. Today, many 401(k) plans are quite affordable. In this article, we will delve into the specifics of these costs. 

You can use our guide to a 401(k) plan to learn more about these plans and how they can greatly benefit you and your employees. 

Please note that the information provided in this article is not intended as legal advice or a comprehensive interpretation of ERISA or any other applicable laws. It should not be misconstrued as financial or investment advice. Always consult with a qualified professional for legal, financial, and investment guidance specific to your circumstances.

Initial 401(k) Set-Up Costs

Setting up your 401(k) plan typically costs between $500 and $2,500, which is known as your one-time startup fee. These fees cover the cost of working with a retirement plan specialist in order to design the plan. Other costs associated with the plan’s set-up are establishing a recordkeeping system to keep track of contributions and transactions. You will also need to provide educational materials to help employees understand the features of the new 401(k) plan.

However, there is a tax credit available to small companies that are initially starting a 401(k) plan: 

1. When the SECURE Act 2.0 was signed into law, it included enhanced tax credits for small businesses of up to 50 employees who are starting a new 401(k) plan. However, it does phase out for businesses with 51 to 100 employees.

2. You can also earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan which is available for the first three years the feature is effective.
   

Now if combined, these credits can total up to $5,500 per year for a total of up to $16,500 for 3 years. 

401(k) Plan Administration Fees

401(k) plan administration involves annual fees paid to the plan administrator for managing the plan effectively unless you plan to handle these on your own. Many small businesses choose to hire a third-party administrator (TPA) to handle the day-to-day administration.

These administrators play a crucial role in maintaining your plan’s smooth operation. They handle various tasks, including recording participant contributions, managing investment choices, processing transactions, and conducting compliance testing to ensure the plan adheres to legal requirements. Additionally, administrators prepare annual statements, such as the Form 5500, and provide assistance for plan-related inquiries. 

Many of the plan administration fees come from: 

• Nondiscrimination testing
• Form 5500 
• Informational materials for employees 
• Annual statements 

The fees charged by third-party administrators can vary based on the plan’s size and complexity but typically fall within the range of $1,750 to $5,000 per year.

Employer Match Contribution Costs

You can also contribute a percentage of employee’s contributions to the plan. For example, an employer might match each dollar of the employee’s contribution up to 5% of their pay. Therefore if the employee earns $100,000 and contributes $5,000, then the employer will also contribute $5,000.

Although there is no law requiring employers to match employee contributions, most do as it is a way to build goodwill and loyalty with their employees. Another reason employers often contribute to the plan is to reduce taxes. Employers can deduct matched contributions from their income taxes. However, the IRS sets contribution limits each year for how much employees may contribute. For 2024, the 401(k) limit is $23,000.

Investment Fees

Investment fees are typically associated with the costs of managing and maintaining the investment options offered within the plan. Different investment options in the plan will have an expense ratio, which represents the percentage of assets deducted each year to cover operating expenses. 

There are other potential fees depending on the features of the plan, typically with more complex plans having higher fees. These fees are not typically paid by the employer, however as the employer your choice for plan asset provider will influence the fees employees will have to pay.

Tax Benefits of Starting a 401(k) 

So while a 401(k) plan is an investment, many small businesses are choosing to make the switch for the plethora of benefits. Aside from attracting and retaining employees, there are many tax benefits that can offset the total costs of the plan. 

The SECURE Act, passed in late 2019, increased the tax credits for small businesses (of up to 50 employees) to cover 100% of qualified start-up costs (up to a maximum of $5,000 per year for the first three years of the plan). 

And, as mentioned above, if you offer an employee match contribution, any match you make is tax-deductible. 

If you’re interested in learning more about how to get started, check out this step-by-step guide to starting a 401(k) plan. 

In Summary 

Long story short, offering a 401(k) plan is not only feasible for small businesses but also comes with several financial benefits. With the initial setup ranging from $500 to $2,500, and the SECURE Act providing substantial tax credits, especially for businesses with up to 50 employees.

If you’re looking to contribute more to your retirement plan, a 401(k) is the way to go. In fact, 401(k) plans offer the flexibility to contribute significantly more than other retirement plans. For an in-depth look at how you can maximize your contributions, especially through advanced techniques like cross-testing, read our article on 401(k) Cross-Testing.

As a specialized third-party administrator, we provide comprehensive services to streamline the setup and management of your 401(k) plan. Our expertise ensures compliance, efficiency, and maximized benefits for you and your business, allowing you to focus on growth while offering a valuable employee benefit. By partnering with us, you can leverage the full potential of a 401(k) plan without the administrative complexities.

Contact us today to learn how we can help you provide retirement benefits for your employees and stay ahead of the curve.

The post How Much Does it Cost to Start a 401(k) Plan? appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Cross-testing is a strategic method in retirement planning that allows for the fair and tailored allocation of profit-sharing contributions, focusing on individual employee needs based on their age and compensation.
• This approach ensures higher contributions for older, highly compensated employees while maintaining fairness and compliance with regulatory standards, using methods like age-weighted and new comparability.
• The cross-testing method is most beneficial for companies with diverse employee demographics, particularly where older, higher-earning employees, like owners and key executives, seek to maximize their retirement contributions.

Cross-testing is a strategic calculation used by retirement plan sponsors to allocate discretionary profit-sharing contributions. It’s a popular choice, often combined with 401(k) and safe harbor contributions, to maximize annual contribution limits for owners while minimizing overall costs. This approach aligns with the goal of allowing owners and key employees to enhance their retirement savings effectively.

Understanding Cross-Testing

The core of cross-testing lies in considering employees’ ages, recognizing that older employees have less time to save and therefore need to allocate more towards their retirement savings compared to their younger counterparts.

How Does Cross-Testing Work?

Consider a simple analogy: a pizza party. Just as people have different appetites, employees have different retirement savings needs. ‘Big Eaters’ (older, higher-earning employees) desire a larger share of the retirement savings ‘pizza’, while ‘Little Eaters’ (younger, lower-earning employees) are content with smaller portions. Cross-testing ensures everyone gets a fair share relative to their ‘appetite’.

1. Big Eaters:  These are the employees who earn more money or are older and closer to retirement. They want a bigger piece of the retirement savings “pizza” because they are closer to retirement age or need more money when they reach retirement. 
2. Little Eaters: These employees are those who earn less money are younger and have more time before retirement. They’re okay with a smaller piece of the “pizza” since they don’t need as much right now and they have more time to save before retirement. 

In a regular retirement plan, everyone might get the same-sized slice of the “pizza,” which isn’t always fair. However, cross-testing helps make sure that different employees get a fair amount of retirement savings based on their individual needs and circumstances. 

Traditional Contribution Methods vs. Cross-Testing

Traditional contribution methods, like uniform or pro-rata allocation, often distribute retirement contributions equally or proportionally among all employees. Cross-testing, however, adopts a more nuanced approach. It considers factors like age and compensation, using benefit accrual rates to project the value of an employee’s retirement portfolio at retirement age, leading to a more equitable distribution of contributions. 

A cross-tested plan is most effective when your Highly Compensated Employees (HCEs) are of a higher age bracket compared to the rest of your employees. Given that owners typically fall into an older age group than a significant portion of their employees, this plan can be exceptionally advantageous. 

Key Concepts for Cross-Testing

Cross-testing retirement plans involves several key concepts that help ensure fiar and compliant allocation of contributions among different employee groups. Here are a few of those key concepts:

1. Employee Grouping: Employees are divided into distinct groups based on specific criteria, such as age, compensation, or job classification. These groups serve as the basis for determining how contributions are allocated.
2. Age-Weighted Method: Older employees receive higher contributions, reflecting their shorter saving period.
3. New Comparability Method: Different groups receive varying contribution rates.
4. Equivalent Benefits: A fundamental principle in cross-testing is that all employees, regardless of their group, receive an equivalent retirement benefit. Even though contribution amounts may differ, the retirement income replacement ratio is intended to be similar for all employees.
5. Non-Discrimination Testing: Retirement plans must pass nondiscrimination testing to ensure that they don’t unfairly favor highly compensated employees (HCEs). Cross-testing plans go through these tests to demonstrate compliance and fairness in benefit allocation. These tests make sure the retirement plan is fairly benefitting everyone by looking at how much each employee defers, company contributions to each employee’s account, and how much of the plan’s assets belong to the HCEs.
   • There are two annual nondiscrimination tests for 401(k) plans, the Annual Deferral Percentage (ADP) and the Actual Contribution Percentage (ACP) test.
   • For profit-sharing allocations, they will need to pass testing under IRC 401(a)(4) and IRC 410(b) – basically are benefits offered to a non-discriminatory group of employees and that the benefits do not overly benefit the HCE group.

Benefits and Advantages of Cross-Testing

Cross-testing allows for higher contributions to key employees and promotes fairness and compliance with regulations. It tailors contributions based on individual needs, benefiting those closer to retirement while still supporting younger employees. 

Real Life example (showcases the impact of cross-testing on contribution limits) 

Consider ABC Enterprises with two employees, Sarah (owner, higher salary, older) and Michael (younger employee, lower salary).

In a regular retirement plan without cross-testing, both Sarah and Michael might receive the same percentage of their salary as contributions, let’s say 5%. However, if ABC Enterprises uses cross-testing, they might group Sarah as an HCE and Michael as an NHCE which would allow for a more strategic allocation of contributions based on their needs. 

In this example, cross-testing has allowed ABC Enterprises to maximize contributions while staying within regulatory limits. Sarah benefits from the larger contribution percentage due to her age and income level and Michael receives a smaller contribution percentage, reflecting his longer time for the contribution to grow. 

It’s important to remember that these contributions must be tested for nondiscrimination annually under IRC 401(a)(4) and IRC 410(b) to ensure that the benefits do not overly benefit the HCE group. Before that testing may even be done, the contributions just pass a “gateway” test such that each NHCE must receive the lesser of ⅓ or 5% of the employer contribution made for any HCE.

Eligibility and Considerations for Cross-Testing 

When considering cross-testing for your defined contribution plan, you should evaluate factors like your employee demographics, owner/key employee objectives, contribution goals, budget, and company growth. 

1. Employee Demographics: Cross-testing works best when you have a diverse employee group with varying ages and compensation levels.
2. Owner/Key Employee Objectives: If you’re seeking to maximize your contributions as an owner or key employee, cross-testing can be beneficial. 
3. Contribution Goals: Cross-testing is ideal when you want to allocate contributions in a way that rewards long-serving employees or those closer to retirement, while still offering benefits to younger employees. 
4. Budget and Cost Considerations: Make sure to determine if the potential increase in contributions aligns with your budget and how it may impact your overall plan costs. 
5. Company Growth and Changes: Consider how cross-testing will adapt as your company evolves. Will it still be effective as your workforce grows or changes over time?

Implementing Cross-Testing

Implementing cross-testing in your retirement plan involves a structured process that starts with evaluating your plan’s unique needs and objectives. Here’s a simplified guide to help you get started: 

1. Assess your Employee Demographics: Begin by analyzing your employee population, considering factors such as age, compensation, and job classifications. Cross-testing works best if you have a diverse workforce with varying attributes. Identifying distinct employee groups will form the basis for contribution allocation. 
2. Design Your Plan: Work with retirement plan experts to design a plan that aligns with your goals and your employees’ needs. This includes selecting the cross-testing method that best suits your objectives, whether it’s age-weighted or new comparability. Ensure that your plan complies with IRS regulations and non-discrimination testing requirements. 

Remember to communicate the changes to your employees. Transparency and clear documentation are essential to ensure that your team understands how contributions are allocated and the potential benefits of their savings. 

To Sum It Up: The Importance of Cross-Testing in Modern Retirement Planning

Cross-testing is a powerful tool to maximize contributions while ensuring fairness and regulatory compliance. This method takes into account the diverse needs and circumstances of employees, recognizing that not everyone requires the same-sized “slice of the retirement savings pizza.” It’s increasingly relevant in today’s complex retirement planning challenges like rising healthcare costs and diminishing social security benefits. 

For personalized guidance on retirement planning and the benefits of cross-testing, contact our team of experts. We’re here to help you navigate retirement planning complexities and tailor solutions to your unique needs.

The post Maximizing Retirement Savings Through Cross-Testing: A Strategic Approach for Plan Sponsors appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Nondiscrimination testing ensures equal benefits in 401(k) plans, preventing favoritism toward Highly Compensated Employees (HCEs) or key employees such as the owners.
• These annual tests verify if HCEs receive excessive benefits compared to Non-Highly Compensated Employees (NHCEs). 
• Failing tests can lead to penalties. Solutions include corrective actions or adopting Safe Harbor Plans for smoother testing.

Nondiscrimination Testing is like a fairness check for your 401(k) plan. It’s all about making sure that these retirement plans don’t unfairly benefit the big shots in a company. Every year, your plan has to prove that everyone is being treated fairly. If it doesn’t pass the test, there could be consequences. Usually, a third party does the testing, but in this article, we’re giving you a sneak peek into the key stuff you need to know. 

What is a Highly Compensated Employee (HCE)?

Nondiscrimination testing looks at the average deferrals and company contributions of your Highly Compensated Employees (HCEs) in comparison to the average deferrals and contributions of your Non-Highly Compensated Employees (NHCEs). But how do they determine who is an HCE and who is an NHCE? 

A Highly Compensated Employee (HCE) is a term used by the IRS based on shareholder ownership and/or compensation. For 2026, an HCE is an individual who owned more than 5% of the business during the year or someone who received more than $160,000 (indexed) in compensation in the previous year.

If someone doesn’t meet at least one of those conditions, they’re considered an NHCE. 

Nondiscrimination Testing 

There are two main types of nondiscrimination tests that your retirement plan must undergo throughout the year: Actual Deferral Percentage (ADP) testing and Actual Contribution Percentage (ACP) testing. Let’s jump into these two specific tests:

Actual Deferral Percentage (ADP) Testing

The ADP test is like a way to check if everyone is saving a fair amount for retirement. It looks at how much money HCEs are putting into their accounts compared to NHCEs. 

To pass, the company checks a few things: 

1. They calculate the average percentage of pay contributed to the plan by and for employees – keep in mind that those not making or receiving a contribution count as a zero in the average.
2. They look at how much money HCEs are putting into their retirement accounts on average. 
3. They also look at how much money NHCEs are putting into their accounts on average. 

Now, here’s the rule you, the company, must follow: 

The average for the HCEs must not exceed the lesser of 200% (2x) that of the NHCEs or 2% higher (e.g., if the NHCEs contribute 4% of pay, the HCEs may not contribute beyond 6% of pay). If the HCE contribution rate exceeds that threshold, corrective actions will need to be taken – either a return of contributions to the HCEs or an employer contribution on behalf of the NHCEs. 

You MAY consider setting a limit on the contribution rate for HCEs to avoid or minimize compliance issues but this may result in the HCEs not being able to contribute as much as they otherwise could.  

Actual Contribution Percentage (ACP) Test

Now, let’s say your company not only helps its employees save for retirement but adds some extra money to their savings. The extra money can be in the form of a match (you match what they save). Now, the company wants to be fair in how they help everyone save whether they are highly paid or not. 

The ACP test is like a fairness check for this extra money. It looks at how much extra money you are giving to the two groups we mentioned above: HCEs and NHCEs. 

Here’s what ACP testing does to check if things are fair: 

1. It looks at how much extra money (matching or after-tax contributions) HCEs get from you on average. 
2. They also look at how much extra money NHCEs get from you on average. 

Now, similar to the ADP test, there are rules you must follow to pass testing: 

The average for the HCEs must not exceed the lesser of 200% (2x) that of the NHCEs or 2% higher (e.g., if the NHCEs contribute 4% of pay, the HCEs may not contribute beyond 6% of pay). If the HCE contribution rate exceeds that threshold, corrective actions will need to be taken – either a return of contributions to the HCEs or an employer contribution on behalf of the NHCEs. 

Corrective Actions

If your plan does not pass the nondiscrimination testing, don’t worry – it happens and it’s fixable – but there are corrective actions you must take to fix it. When a 401(k) plan fails nondiscrimination testing, it means that the plan is favoring HCEs over NHCEs in terms of contributions or benefits. To correct this, there are a few actions that can be taken: 

1. Return excess contributions: If HCEs have contributed more than allowed, the excess contributions need to be returned to them. This helps balance out the contributions. 
2. Make Qualified Nonelective Contributions (QNECs) or Qualified Matching Contributions (QMACs): To boost NHCEs’ participation, the plan sponsor can make additional contributions on behalf of NHCEs. QNECs and QMACs are contributions made by the employer to the plan and allocated to NHCEs. 
3. Limit HCE contributions: You may limit the contributions HCEs can make to the plan to bring their contributions more in line with NHCEs’s contributions.

The IRS also has a 401(k) Plan Fix-It Guide you can check out. It covers a few different situations that may arise with a 401(k) plan including ADP and ACP testing failure. 

Safe Harbor Plan Option

If nondiscrimination testing is an ongoing issue, there’s a solution called a Safe Harbor Plan. In this kind of plan, the money you put in belongs fully to the employees from the start. And the good thing is, these plans are deemed to pass the compliance tests as you’re contributing based on the IRS guidelines. 

Wrapping Up

All 401(k) plans must undergo nondiscrimination testing annually, it’s an inevitable part of sponsoring a 401(k) plan. Testing acts as the compass guiding fairness. It’s crucial to ensure that everyone benefits equally from 401(k) plans. While facing penalties due to test failure is a possibility, the key lies in proactive measures. Avoiding ADP and ACP testing failure requires well-designed contributions and a watchful eye. 

Collaborating with a dedicated third-party administrator adds an extra layer of expertise to ensure compliance and keep your retirement plan sailing smoothly in the fair winds of financial security. 

If you’re in search of a reliable partner to steer your retirement plan in the right direction, look no further. Contact us here at Odyssey Advisors, where expertise meets dedication, and let’s chart the course to a balanced and thriving retirement future. 

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Bottom Line Up Front

• This article provides an overview of the different financial asset classes, including Domestic Equities, International Equities, Fixed Income, Alternatives, and Real Estate.
• Each asset class has its own characteristics and risk profiles. Domestic Equities vary in size and growth potential, while International Equities involve currency exchange risk. Fixed Income offers predictable payments, while Alternatives encompass a diverse range of investment types and Real Estate includes rental properties, REITs, and raw land.
• Understanding each asset class can help you make informed investment decisions and create a diversified portfolio based on your risk tolerance and investment goals.

From pension plans, OPEB plans, 401(k) plans, or personal investments many people are faced with the dilemma of understanding various types of financial assets. This article will help you start to understand what these asset classes are and some of their basic characteristics.

You can also check out our on-demand webinar on this topic as well: Understanding Asset Allocation

What is Market Capitalization?

Conversations about asset allocation will almost always contain terms like Market Cap, Large Cap, Small/Mid Cap, etc. I’ve had several conversations where people ask, “Why are Markets or Equities capped?” Whenever you see the word “Cap” in terms of asset allocation we aren’t talking about a maximum limit on assets, the term “Cap” is short for Capitalization. Market Capitalization means the total value of a company on a financial market. The formula for calculating the market capitalization of a company is the number of shares outstanding x the cost per share of that company. For example, the Market capitalization of Coca-cola:

• Number of shares outstanding – 4.3 billion
• Cost per share assumed – $60.00
• Market capitalization – 4.3 billion x 60 = $260 billion

Domestic Equity – Large Cap

Our first asset class is “Domestic Equity – Large Cap”. Domestic Equity means that this is a U.S.-based company and Equity means we are talking about their stock or ownership shares of the company. Large Cap means the market capitalization of these companies is “Large”. Large-cap is not a single definition, different professionals will have differing opinions on what classifies a company as “Large”. In general, a market cap of about $10 billion is considered large. Large companies are more likely to be household names as well. Some that you’ve probably heard of are Apple, Microsoft, Amazon, Coca-Cola… and so on.

What are some characteristics of large-cap companies?

They tend to have at least nationwide business operations and there’s a very good chance they have large international operations as well. In general, there is less room for rapid growth for these companies. They don’t have many large untapped markets they can move their products to. On the inverse side, these companies tend to have more stable earnings than smaller companies, so they are less likely to have extreme losses in revenue.

All of that backdrop leads to a projected return (based on the 2022 Horizon Survey of Capital Market Assumptions) net of inflation of:

Domestic Equity – Mid Cap

The market capitalizations for Mid Cap companies will, again, not vary based on who you ask. However, some general guidelines include: Mid Cap companies have a market cap of $2-$10 billion. Many of these companies are still household names, although fewer are in the Large Cap category. Some Mid Cap companies you may recognize are: Yet, Hostess Brands, Harley Davidson, B.J.’s Wholesale, Crocs, and Texas Roadhouse.

Mid Cap companies compared with Large Cap companies will tend to have slightly more earnings and share price volatility. One way that is measured is with “Beta” (which will also be referred to with just the Green alphabet letter “β”). Beta measures the increased volatility of a stock or index compared to another index (generally the S&P 500). A Beta of 1.1 means that whenever the S&P moves 1% up or down the corresponding stock or index will move 1.1% up or down. Thus, a Beta above 1 means increased volatility. The Beta for a Mid Cap market index is 1.08 showing that in general Mid Cap companies are more volatile than Large Cap meaning higher potential gains and higher potential losses come with the Mid Cap territory.

While smaller than Large Cap, Mid Cap companies will still have large operations and are likely to be nationwide operations and may have some international operations as well. These companies may have more room for rapid growth if they can expand to new markets.

Domestic Equity – Small Cap

The market capitalization for Small Cap companies is generally considered to be $250 million – $2 Billion. As you start looking through Small Cap company index lists fewer of the names become recognizable household names for most people. Some names you may know are Ethan Allen and Winnebago.

Small Cap companies will tend to have even more earnings and price volatility with a Beta of 1.13, meaning these companies will tend to have even higher potential for outsized gains or outsized losses. These companies tend to have more regional operations and may have untapped markets that they could break into, rapidly expanding their market value.

The projected return for Small/Mid Cap companies net of inflation is: 

International Equity – Developed Market

International Equity, first off, is stock ownership in non-U.S.-based companies. Developed markets mean that these investments will be in areas that have developed economies and financial systems. Examples of Developed Markets include England, Ireland, Australia, Germany, France, and Japan.

International Developed companies tend to have low social and political risk. In other words, these governments and social frameworks are unlikely to create a scenario where a company experiences major changes to its business for social or political reasons. One risk that is introduced is currency exchange risk. Currency exchange risk is the variability that comes from the relative value change between local and foreign currencies. For example, if you bought shares in a U.K.-based company in pounds you had to exchange dollars for pounds to make the purchase, then when you go to sell the investment, you need to exchange the pounds back into dollars. Not only are you experiencing the risks associated with a business over that time period, but your investment can also change in value because the dollar becomes more or less valuable compared to the pound.

The projected return for International Developed companies net of inflation is:

International Equity – Emerging Market

Emerging Markets are in countries that don’t have a long-established industrial and economic environment, but are on the path to being stable and established economies. Examples of emerging Markets include Brazil, Turkey, India, China, and South Africa.

These companies have a higher potential for political or social risk and currency exchange risk. The tradeoff is that there is potential for companies in these markets to experience very rapid growth through stabilizing social, political, or economic factors as well as lots of opportunity for companies to grow in undeveloped markets. The downside is that these companies have a higher risk of volatility and a higher risk of severe losses.

The projected return for International Emerging companies net of inflation is:

Fixed Income – Domestic and International

Our next class moves us away from the equities markets and into fixed income. Fixed-income securities have a fixed payment rate over the lifetime of the investment. Investments in this category include Bonds, Treasuries, CDs, and Preferred sales. All of these investments pay a fixed rate generally annually or semi-annually, over a certain time period. Domestic Fixed income invests in these investments in U.S.-based companies or municipalities.

There tends to be less risk in fixed-income investments because the payments to the investor are known rather than being based on the company’s performance like equity investments are. Fixed-income investors also tend to be paid first in the event of bankruptcy, so there is less risk of a total loss in the investment. Along with the decreased risk comes decreased expected returns.

International fixed income has the same characteristics but introduces currency exchange risk. There is also some diversification that comes from International fixed income as the “debt cycles” may be different for international companies and municipalities compared with the U.S.

The projected return for Domestic and International Fixed Income net of inflation is:

Alternatives

The next asset class to cover is Alternatives. This can be a tricky asset class because a lot of different investments are categorized as Alternatives. We’ll briefly go over some of the major Alternative investment types:

• Commodities – Metals, wood, animal or plant produce, oil, etc. Think gold, silver, and raw materials
  • Adds diversification to a portfolio
• Hedge Funds – An investment vehicle that generally uses long and short positions to achieve a return in any market environment
  • Can invest in anything
  • Often have high expenses to cover active management
  • Can use leverage
  • Can limit liquidity
• Limited partnerships – Business structure often used to facilitate investments in private companies
  • Access to non-publicly traded companies and business opportunities
  • Low liquidity
• Private Equity – Invest in private businesses, often focused on buyouts or buying struggling businesses to turn them around
  • Access to non-publicly traded companies and business opportunities
  • Often use leverage to increase returns, also increasing risk
  • Low liquidity
• Venture Capital – Invests mostly in startup companies that are not publicly traded with the goal of seeing a few become large publicly traded companies
  • High potential returns and losses
  • Low liquidity

The projected return for Alternatives net of inflation is:

Interested in learning more? Check out our previously recorded webinar with Kathleen Glowacki on Demystifying the World of Alternative Investments

Real Estate

Real estate can be broken into categories, for this summary, we’ll break it into three categories: Rental Property, REITs, and Raw Land.

The projected return Real Estate net of inflation is:

Putting all of these asset classes together we can create a hypothetical portfolio and show expected portfolio returns:

There is certainly much more that can be covered in the area of asset allocation. Hopefully, this has helped you get a better understanding of what various asset classes are and some of their characteristics. If you have any questions or if you have any asset allocation questions you’d like us to cover in another article, please let us know! You can reach us here.

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