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Exploring Tax Qualified Retirement Plans
EXPLORING Tax Qualified Retirement Plans
Harvey Sarner, LL B, Chicago
Since the enactment of the Keogh Act, formally known as Self-Employed Individuals Tax Retire ment Act of 1962, there has been much confusion as to the tax benefits available to dentists who par ticipate in the various retirement plans. The pur pose of this report is to acquaint the dentist with various plans or methods for participating in tax qualified retirement plans, especially as they com pare to the American Dental Association Mem bers Retirement Plan. The basic features of the Keogh Act are summarized. Is th e plan q u a lifie d Not all retirement plans are Keogh Act qualified. It behooves the dentist considering a retirement plan to establish whether or not the program is qualified under the Keogh Act. A program is not qualified under the Keogh Act unless prior clear ance is obtained from the Internal Revenue Ser vice for each individual’s plan. This means that an individual does not have a Keogh Act qualified plan unless he has a personalized form letter from the Internal Revenue Service notifying him that his plan has been approved as conforming to the Keogh Act. There have been instances where den tists have been told by zealous insurance salesmen that they have a Keogh Act qualified plan, but the plan has not been submitted to the IRS for ap proval. The result is that the doctor files an er roneous tax return. Even when the doctor is able to show good faith, he risks the imposition of in terest penalties when the Internal Revenue Ser vice later challenges his tax return. In d iv id u a l in s u ra n c e p lan s Many life insurance companies are selling to den tists individual retirement plans which are merely
their usual paid-up life insurance programs labeled as retirement programs. The doctor should be aware that the Keogh Act contains certain restric tions, such as maximum contributions and bring ing in employees after three years. If the insurance salesman suggests that his plan avoids these re strictions, then he is not selling a Keogh Plan. The doctor should be cautious about any plan that de scribes only the advantages of the Keogh Act and not the advantages of the particular plan. The Keogh Act provides penalties for with drawing funds from an approved pension plan be fore age 59V2. However, these penalties are rela tively minor compared to the penalties imposed by insurance companies for premature cancella tion of an insurance program. Anyone who has had an experience in cancellation of an endow ment or savings life insurance policy is aware of the very severe penalties for cancellation. These cancellation or withdrawal features should be known by the dentist before he commits himself to the policy. The Keogh Act permits the coupling of some amounts of life insurance with the retire ment plan. It is impossible to evaluate a life in surance plan with a nonlife insurance plan unless you are able to separate the costs of the life insur ance from the pension fund contributions. A dentist considering a pension plan which in cludes life insurance should ask the salesman to break down the costs into life insurance and pen sion contributions so an evaluation can be made. It is likely that the dentist will find that he will be much better off maintaining his life insurance and retirement programs separately. Most experts will agree that there is no logical place for life insur ance in a Keogh Act program. This brings up the major difficulty in evaluating individual tax qualified retirement programs un der the Keogh Act. They usually emphasize the 497
a life insurance company, he is getting the indi vidual rate which is usually substantially higher than the same insurance company’s rate if sold on a group basis. Many group programs also provide for the variable annuity, where the participant’s funds, after retirement, are invested for him in Common stocks so his monthly pension or retire ment income will fluctuate with the stock market. This very desirable feature is usually not available in individual life insurance programs.
Mutual fund details of the Keogh Act as the incentive for buy ing the policy rather than emphasizing the details o f the policy itself. Since the benefits of the Keogh Act are available in any qualified plan, the den tist should ask why he should participate in a par ticular qualified plan. There are some distinct disadvantages to an in dividual life insurance Keogh Act plan. The first is that the doctor cannot evaluate his policy against group programs because the individual policy usually includes some form of life insur ance which is usually not in a group retirement plan. The second major disadvantage is that the individual policy has severe cancellation or with drawal penalties. Sales commissions run high on this form of insurance so the company has to re capture these funds in the event of cancellation. The individual insurance program is also very restricted because it is limited to fixed investments and this is a major disadvantage. The funds of the dentist and his employees are invested by the in surance company in fixed investments such as mortgages and bonds. These provide a relatively secure form of investment with a minimum oppor tunity for keeping pace with inflation and increases in the cost of living. Most professional persons who enter into Keogh Act retirement programs look for growth possibilities which are not pres ent in an individual insurance company retire ment policy. There is also the question of annuity purchase rates. Annuity purchase rates are the expense or cost of purchasing an annuity; ie, the price at which the insurance company will sell annuities. These prices vary from one insurance company to another; and within an individual insurance com pany between individual and group annuity pur chase rates. The lower the annuity purchase rate the more annuity (lifetime income) a fixed num ber of dollars will purchase. When a dentist buys an individual annuity from 498 ■ JADA, Vol. 76, March 1968
Many dentists and other self-employed individuals have entered into mutual fund programs. These Keogh Act qualified programs are virtually the same as the usual mutual funds except that the dentist must meet the Keogh Act requirements. The mutual fund also offers the tax postponement benefit which is available to all Keogh Act quali fied retirement programs. The mutual fund program is usually coupled with a life insurance program and can be sold on an individual or a group basis. The major advan tage of the mutual fund is that the doctor’s con tributions are invested in common stocks. This provides the normal hedge against inflation and opportunity for growth with the economy. The advantage of a Keogh Plan involving a mu tual fund over a mutual fund outside the Keogh Act is the tax postponement which is common to all Keogh Plans. A doctor considering going into mutual fund investments should consider the ad-
H ig h lig h ts o f th e Self-Em ployed In d iv id u a ls Tax R etirem ent A ct of 1962, as amended, the so-called Keogh Act
1. Contributions to an individual’s retire ment program are deductible in the year they are placed in the retirement program. 2. Earnings on funds contributed to the re tirement program are not taxed until funds are withdrawn. This permits a speedier ac cumulation of earnings. 3. The dentist need not retire to start with drawing funds from the retirement program.
vantages and disadvantages of a Keogh plan ver sus a non-Keogh plan. If the doctor invests “out side” Keogh, he need not provide for his employ ees and he may withdraw from the stock market as he wishes. The Keogh plan obviously does not provide the same speculative investment oppor tunities. If the doctor elects to fund his retirement plan .by mutual fund investments, he has an in vestment plan rather than a retirement plan. This becomes apparent at the time the doctor retires or wishes to withdraw his funds. By using the mutual fund mechanism the doctor at any age between 5 9 Vi and 72 has only the opportunity to withdraw funds from the mutual fund either by a lump sum distribution or by periodic withdrawals as he de cides. The lump sum withdrawal can reduce the tax savings under the Keogh Act, and the periodic withdrawals are more akin to an investment pro gram than a retirement program. This should be contrasted to other Keogh retirement plans where the doctor can purchase an annuity at the time of retirement which will provide monthly income for the remainder of his lifetime. If the participant in a mutual fund program de cides to purchase an annuity at retirement, he usu ally has to withdraw all the funds and purchase his annuity with two resulting disadvantages. First, he has made a lump sum withdrawal so he must pay immediate taxes which does not give him the full impact of the tax savings features of the Keogh Act; and second, he purchases an indi vidual annuity which usually means that he is purchasing at a higher annuity purchase rate than if he were in a group plan— this means his money purchases a lower monthly income. The variable annuity, which permits further hedge against in flation by gearing the monthly annuity to stock market performance is usually not available when an individual annuity is purchased, so the doctor could have a third disadvantage in this form of retirement program. Use of the mutual fund usually requires an ad ministrator or coordinator which may increase the administrative or starting costs for the doctor. Mu tual funds are available on a no-load basis al though many funds do provide for as much as an 8% front-end load for sales commissions. The doc tor selecting a mutual fund pension program should ask for a complete statement of all costs before he enters into the program.
Balanced fund On an individual or a group basis there are socalled balanced funds available to dentists. A bal
anced fund is an attempt to combine the best fea tures of both insurance and mutual fund programs. The balanced fund usually involves four parties: an administrator or promoter, a custodian, a mu tual fund and an insurance company. The admin istrator or promoter is usually the key person set ting up the program. His profit is in insurance com missions, the front-end loads, and in administra tive fees for his services. Using this mechanism the participant gets assistance from the administrator and pays his funds to the custodian. The custodian, usually a bank, then puts the participant’s funds, as he directs, into the mutual fund or into the in surance company’s side of the program. The money going to the insurance company can then be used to purchase immediate annuities or placed in fixed investments for a purchase of an annuity at retirement. The difficulty with this four-sided retirement program is that there are so many places where the doctor’s money is diverted to other people or organizations who are helping him. The main ad vantage is that the balanced program permits the doctor to put part of his money in common stock investments and part in fixed investments. Often the insurance company will provide the doctor with the group annuity purchase rate or relatively better rates than he could purchase as an indi vidual. The hidden loads and expenses of the balanced fund are often difficult to uncover. The adminis trator gets a fee for costs of administration and promotion. The bank gets a fee for acting as a custodian. The mutual fund may or may not be a no-load fund. The administrator usually has to charge a front-end load for getting into the pro gram so he can have funds available for promotion and his own profits. The insurance company pays the administrator a commission on funds invested in annuities so there must be some cost to the doc tor here. Sarner: TAX QUALIFIED RETIREMENT PLANS ■ 499
One of the difficulties experienced with the balanced fund is the tendency of participants to place all or almost all of their funds into the mu tual fund side. If the mutual fund is no-load, the mutual fund does not contribute to the costs of ad ministering or promoting the program. The life in surance company may lose interest or at least lose interest in further promotion of a plan that offers no attraction. The administrator may, therefore, find that it is necessary to require that a minimum percentage, eg, 10-20% of funds invested by each participant must be placed with the insurance com pany in the fixed or insurance company invest ments. To the extent this is required, the doctor is restricted in his investment opportunities.
All insurance company programs
Sometimes the balanced funds, and even the other Keogh investment programs, mislead the dentist by giving illustrations which show the ap preciation of his money after a stated period of time. For example, the illustration may show the doctor investing $1,000 earnings at 8%, and after 20 years he has the accumulation of his $1,000 times 8 % plus his compound interest. Besides the questions of the illegality of predicting future earnings, these illustrations make the faulty as sumption that the entire $1,000 finds its way into the retirement program. Except for the American Dental Association Members Retirement Plan, all major group Keogh plans reviewed by the Coun cil on Insurance have front-end loads; this means that 3%, 5% or 8% of the invested money goes to the administrator before the money is put into the doctor’s retirement account. At 5 % the contribu tion of $1,000 results only in $950 going into the account and earning interest. In the hypothetical example discussed earlier, a more honest evalu ation would be $950 less administrative expenses times 8%, plus compound interest earnings. All Keogh plans have some initial enrollment fees and annual administrative fees. These fees will be discussed later but the point here is that no illustration is factual unless it shows the sub traction of these fees. These comments apply to all Keogh plans and not just to the balanced funds. But they seem ap propriate to mention at this point because there are so many fees and charges involved in the bal anced fund and it is often difficult to recognize them. 500 ■ JADA, Vol. 76, March 1968
Individual retirement programs are available from life insurance companies and they may or may not involve life insurance. The individual insur ance program was discussed earlier but for com parison purposes it should be recalled that this mechanism provides only for fixed or relatively low-yield investments. Group Keogh Act programs are available through many large life insurance companies which provide all the benefits of the balanced pro gram and some additional benefits. The all-insur ance company group program reduces the number of participating agencies to only one or two, the variable being whether an administrator or broker is involved in the program. Many of the large insurance companies are now allowed by law to invest funds in common stocks, so the insurance companies have created so-called separate accounts that are the equivalent of mu tual funds. They are, in fact, mutual funds wholly owned by the insurance company. Under the usual group program underwritten by an insurance company and sponsored by a den tal society, the participating dentist can elect to have his funds invested in fixed return investments or common stock accounts. The investment per formance of the insurance company-owned com mon stock funds is generally on a par with the best mutual funds. Using this mechanism, the dental society-spon sored insurance program provides the dentist with good investment opportunities and group annuity purchase rates. Sometimes these rates are guaran teed against increases for stated periods of time. The major difficulty with this kind of program is that it usually contains a front-end load. This is
a charge which is placed against the participant’s contributions before his funds are placed in his investment accounts. The front-end loads vary from 3% to 8%, and they substantially reduce the benefits of the program. Sometimes there is con fusion between the use of a no-load mutual fund and a no-load retirement program. A Keogh Act qualified retirement program can utilize a noload fund; but still be a 3 % or 5 % load retirement plan. The American Dental Association Members Retirement Plan is the only plan of this kind which does not have a front-end load. It must be quickly added that the American Dental Associ ation plan does not have a rear-end load or other hidden costs. The expenses and the need for these loads are not present, or needed, in the American Dental Association Plan as they are in the smaller plans. The reason for the front-end load is for com missions to be paid the salesmen and the costs of promotion of the plan. The American Dental As sociation Members Retirement Plan does not pay any commissions so there is no need for the frontend load. One of the difficulties with a program of this kind, sponsored by a local or state dental associ ation, is that the commissions which are paid to the representatives of the insurance companies are relatively small in relation to commissions paid for individual programs. There have been instances reported where a state dental association has spon sored a program o f this kind, and the representa tives of the insurance company visit the dentists who have indicated an interest in the state society program. Once in the office, the salesmen’s incen tive changes to trying to sell an individual plan suggesting or not suggesting that the individual plan also has the endorsement of the dental so ciety which sponsors the group plan. When this was reported in one state, the response from the insurance company was that these were commis sion salesmen who they could not control.
American Dental Association Members Retirement Plan This program is underwritten by the Equitable Life Assurance Society of the United States. It is a one-party plan involving just Equitable. There are no front-end or rear-end loads and the best possible group annuity purchase rates are avail able. Commission costs are eliminated. However, salaried representatives of the Equitable are avail
able to attend dental society meetings. In addition, a telephone consultation service is available in most large cities. The Council on Insurance of the American Den tal Association serves as trustee of the plan and works directly with Equitable. To date, this has been a very effective relationship, and it is obvious that the voice of the dental profession should be heard in this program because of the potential size of the total participation of dentists and their employees. Additional information about the Association plan is available by writing to the Council on In surance, American Dental Association, 211 E Chi cago Ave, Chicago, 60611; or to the American Dental Association Members Retirement Plan, Box 2470, GPO, New York 10001.
Expenses, loads and other charges One of the most important elements in evaluating various Keogh programs is the comparison of the various expenses, loads and other charges. As pointed out earlier this is virtually impossible in an individual insurance program especially when it involves some life insurance features. ■ Participation Fees: Many programs, if not all, require that an initial fee be paid to start this program. The participation fee, sometimes called the “start-up” or enrollment fee, is a one time charge. The fee is either on the basis o f a fee “per plan” or “per participant.” A per plan fee means that if the doctor and his employees enter the
Highlights of the American Dental Associa tion Members Retirement Plan
1. Opportunity to invest in fixed (bonds and mortgages) and growth (common stocks) funds. 2. No front-end or rear-end loads usually found in Keogh Act Programs. 3. Opportunity to purchase annuities at group rates. 4. The Council on Insurance serves as trust ee of the retirement program. 5. Annuities can be purchased at the lowest prevailing rate.
Sarner: TAX QUALIFIED RETIREMENT PLANS ■ 501
plan, only one fee is paid; a per participant fee means that the fee is charged to each of the par ticipants. Participation fees are relatively low, usually in the area o f $15 to $25. ■ Administration fees: These are annual fees charged against each of the participant’s accounts. For example, if the annual administration fee is $12, the doctor will pay $12 per year and any of his employees in the plan will also pay $12 per year for administration. Sometimes these administration fees are on the basis of one account and two account fees. This is true under a program which permits some funds to be invested in common stocks and some in fixed investments. If the individual puts all his contri butions in either one or the other account, he pays the one account fee. If he splits his contribu tions between the common stock fund and the fixed investment account, then he pays the two ac count fee. For example, this may be expressed as $7.50, one account, $12, two accounts. ■ Front-end loads: This is a percentage of the money contributed each year which is deducted before the funds are invested. A front-end load of 5 % means that 5 % of all contributions go to the administrator or broker “off the top” of the mon ies invested that year. In comparing front-end loads with enrollment or administration fees, there may be a tendency to simplify and say there is no difference between two plans because one has a higher enrollment fee and the other has a higher front-end load. How ever, these comparisons are more meaningful than that because the impact of a front-end load is al ways greater than the administration fee or the en rollment fee. For example, compare the American Dental Association enrollment fee ($25) and ad ministrative fee ($12) which are among the high est with the front-end loads of other plans. In the first year, the $2,000 investment would be re duced by $25 and $12 so the participant would have $1,963 for investment in the American Den tal Association Plan. In another program with lower enrollment fees ($15) and lower adminis tration fees ($10) and a 5% front-erid load, the $2,000 contribution would provide only $1,875 for investment purposes. In subsequent years, when there is no enrollment fee, the differences between the two would be increased. ■ Investment charges: Most group plans provide for a 0.5% investment charge per year. This is gen erally the same as is charged against mutual fund 502 ■ JADA, Vol. 76, March 1968
investments. This is the usual charge for invest ment services common to most plans. ■ Custodian charges: Where a bank participates in the plan as a custodian of funds, the bank will impose a custodian charge. This charge is usually found only in the balanced funds where the ad ministrator utilizes the programs of both a mutual fund and an insurance company. ■ Trustees charge: In some instances, the orga nization or association sponsoring the plan in curs some substantial expenses in creating the re tirement program, or will incur charges in connec tion with the program. There may be an addition al charge imposed in the program to recoup these expenses. The plan may include reference to a “trustees charge” even though none is currently being charges.
Summary The Council on Insurance selected the Equitable plan after reviewing a considerable number of other proposals. A substantial part of this retire ment program was created especially for the Amer ican Dental Association and provides benefits not available under other programs. The Council also appreciates that members of the Association may for some reason prefer to participate in an indi vidual program or a program sponsored by an other association. This summary of the various kinds of programs available under the Keogh Actwas intended to present the member with some basis for comparing programs. There is no inten tion to disparage any particular existing or pro posed plan.
Harvey Sarner, LL B, Chicago
Since the enactment of the Keogh Act, formally known as Self-Employed Individuals Tax Retire ment Act of 1962, there has been much confusion as to the tax benefits available to dentists who par ticipate in the various retirement plans. The pur pose of this report is to acquaint the dentist with various plans or methods for participating in tax qualified retirement plans, especially as they com pare to the American Dental Association Mem bers Retirement Plan. The basic features of the Keogh Act are summarized. Is th e plan q u a lifie d Not all retirement plans are Keogh Act qualified. It behooves the dentist considering a retirement plan to establish whether or not the program is qualified under the Keogh Act. A program is not qualified under the Keogh Act unless prior clear ance is obtained from the Internal Revenue Ser vice for each individual’s plan. This means that an individual does not have a Keogh Act qualified plan unless he has a personalized form letter from the Internal Revenue Service notifying him that his plan has been approved as conforming to the Keogh Act. There have been instances where den tists have been told by zealous insurance salesmen that they have a Keogh Act qualified plan, but the plan has not been submitted to the IRS for ap proval. The result is that the doctor files an er roneous tax return. Even when the doctor is able to show good faith, he risks the imposition of in terest penalties when the Internal Revenue Ser vice later challenges his tax return. In d iv id u a l in s u ra n c e p lan s Many life insurance companies are selling to den tists individual retirement plans which are merely
their usual paid-up life insurance programs labeled as retirement programs. The doctor should be aware that the Keogh Act contains certain restric tions, such as maximum contributions and bring ing in employees after three years. If the insurance salesman suggests that his plan avoids these re strictions, then he is not selling a Keogh Plan. The doctor should be cautious about any plan that de scribes only the advantages of the Keogh Act and not the advantages of the particular plan. The Keogh Act provides penalties for with drawing funds from an approved pension plan be fore age 59V2. However, these penalties are rela tively minor compared to the penalties imposed by insurance companies for premature cancella tion of an insurance program. Anyone who has had an experience in cancellation of an endow ment or savings life insurance policy is aware of the very severe penalties for cancellation. These cancellation or withdrawal features should be known by the dentist before he commits himself to the policy. The Keogh Act permits the coupling of some amounts of life insurance with the retire ment plan. It is impossible to evaluate a life in surance plan with a nonlife insurance plan unless you are able to separate the costs of the life insur ance from the pension fund contributions. A dentist considering a pension plan which in cludes life insurance should ask the salesman to break down the costs into life insurance and pen sion contributions so an evaluation can be made. It is likely that the dentist will find that he will be much better off maintaining his life insurance and retirement programs separately. Most experts will agree that there is no logical place for life insur ance in a Keogh Act program. This brings up the major difficulty in evaluating individual tax qualified retirement programs un der the Keogh Act. They usually emphasize the 497
a life insurance company, he is getting the indi vidual rate which is usually substantially higher than the same insurance company’s rate if sold on a group basis. Many group programs also provide for the variable annuity, where the participant’s funds, after retirement, are invested for him in Common stocks so his monthly pension or retire ment income will fluctuate with the stock market. This very desirable feature is usually not available in individual life insurance programs.
Mutual fund details of the Keogh Act as the incentive for buy ing the policy rather than emphasizing the details o f the policy itself. Since the benefits of the Keogh Act are available in any qualified plan, the den tist should ask why he should participate in a par ticular qualified plan. There are some distinct disadvantages to an in dividual life insurance Keogh Act plan. The first is that the doctor cannot evaluate his policy against group programs because the individual policy usually includes some form of life insur ance which is usually not in a group retirement plan. The second major disadvantage is that the individual policy has severe cancellation or with drawal penalties. Sales commissions run high on this form of insurance so the company has to re capture these funds in the event of cancellation. The individual insurance program is also very restricted because it is limited to fixed investments and this is a major disadvantage. The funds of the dentist and his employees are invested by the in surance company in fixed investments such as mortgages and bonds. These provide a relatively secure form of investment with a minimum oppor tunity for keeping pace with inflation and increases in the cost of living. Most professional persons who enter into Keogh Act retirement programs look for growth possibilities which are not pres ent in an individual insurance company retire ment policy. There is also the question of annuity purchase rates. Annuity purchase rates are the expense or cost of purchasing an annuity; ie, the price at which the insurance company will sell annuities. These prices vary from one insurance company to another; and within an individual insurance com pany between individual and group annuity pur chase rates. The lower the annuity purchase rate the more annuity (lifetime income) a fixed num ber of dollars will purchase. When a dentist buys an individual annuity from 498 ■ JADA, Vol. 76, March 1968
Many dentists and other self-employed individuals have entered into mutual fund programs. These Keogh Act qualified programs are virtually the same as the usual mutual funds except that the dentist must meet the Keogh Act requirements. The mutual fund also offers the tax postponement benefit which is available to all Keogh Act quali fied retirement programs. The mutual fund program is usually coupled with a life insurance program and can be sold on an individual or a group basis. The major advan tage of the mutual fund is that the doctor’s con tributions are invested in common stocks. This provides the normal hedge against inflation and opportunity for growth with the economy. The advantage of a Keogh Plan involving a mu tual fund over a mutual fund outside the Keogh Act is the tax postponement which is common to all Keogh Plans. A doctor considering going into mutual fund investments should consider the ad-
H ig h lig h ts o f th e Self-Em ployed In d iv id u a ls Tax R etirem ent A ct of 1962, as amended, the so-called Keogh Act
1. Contributions to an individual’s retire ment program are deductible in the year they are placed in the retirement program. 2. Earnings on funds contributed to the re tirement program are not taxed until funds are withdrawn. This permits a speedier ac cumulation of earnings. 3. The dentist need not retire to start with drawing funds from the retirement program.
vantages and disadvantages of a Keogh plan ver sus a non-Keogh plan. If the doctor invests “out side” Keogh, he need not provide for his employ ees and he may withdraw from the stock market as he wishes. The Keogh plan obviously does not provide the same speculative investment oppor tunities. If the doctor elects to fund his retirement plan .by mutual fund investments, he has an in vestment plan rather than a retirement plan. This becomes apparent at the time the doctor retires or wishes to withdraw his funds. By using the mutual fund mechanism the doctor at any age between 5 9 Vi and 72 has only the opportunity to withdraw funds from the mutual fund either by a lump sum distribution or by periodic withdrawals as he de cides. The lump sum withdrawal can reduce the tax savings under the Keogh Act, and the periodic withdrawals are more akin to an investment pro gram than a retirement program. This should be contrasted to other Keogh retirement plans where the doctor can purchase an annuity at the time of retirement which will provide monthly income for the remainder of his lifetime. If the participant in a mutual fund program de cides to purchase an annuity at retirement, he usu ally has to withdraw all the funds and purchase his annuity with two resulting disadvantages. First, he has made a lump sum withdrawal so he must pay immediate taxes which does not give him the full impact of the tax savings features of the Keogh Act; and second, he purchases an indi vidual annuity which usually means that he is purchasing at a higher annuity purchase rate than if he were in a group plan— this means his money purchases a lower monthly income. The variable annuity, which permits further hedge against in flation by gearing the monthly annuity to stock market performance is usually not available when an individual annuity is purchased, so the doctor could have a third disadvantage in this form of retirement program. Use of the mutual fund usually requires an ad ministrator or coordinator which may increase the administrative or starting costs for the doctor. Mu tual funds are available on a no-load basis al though many funds do provide for as much as an 8% front-end load for sales commissions. The doc tor selecting a mutual fund pension program should ask for a complete statement of all costs before he enters into the program.
Balanced fund On an individual or a group basis there are socalled balanced funds available to dentists. A bal
anced fund is an attempt to combine the best fea tures of both insurance and mutual fund programs. The balanced fund usually involves four parties: an administrator or promoter, a custodian, a mu tual fund and an insurance company. The admin istrator or promoter is usually the key person set ting up the program. His profit is in insurance com missions, the front-end loads, and in administra tive fees for his services. Using this mechanism the participant gets assistance from the administrator and pays his funds to the custodian. The custodian, usually a bank, then puts the participant’s funds, as he directs, into the mutual fund or into the in surance company’s side of the program. The money going to the insurance company can then be used to purchase immediate annuities or placed in fixed investments for a purchase of an annuity at retirement. The difficulty with this four-sided retirement program is that there are so many places where the doctor’s money is diverted to other people or organizations who are helping him. The main ad vantage is that the balanced program permits the doctor to put part of his money in common stock investments and part in fixed investments. Often the insurance company will provide the doctor with the group annuity purchase rate or relatively better rates than he could purchase as an indi vidual. The hidden loads and expenses of the balanced fund are often difficult to uncover. The adminis trator gets a fee for costs of administration and promotion. The bank gets a fee for acting as a custodian. The mutual fund may or may not be a no-load fund. The administrator usually has to charge a front-end load for getting into the pro gram so he can have funds available for promotion and his own profits. The insurance company pays the administrator a commission on funds invested in annuities so there must be some cost to the doc tor here. Sarner: TAX QUALIFIED RETIREMENT PLANS ■ 499
One of the difficulties experienced with the balanced fund is the tendency of participants to place all or almost all of their funds into the mu tual fund side. If the mutual fund is no-load, the mutual fund does not contribute to the costs of ad ministering or promoting the program. The life in surance company may lose interest or at least lose interest in further promotion of a plan that offers no attraction. The administrator may, therefore, find that it is necessary to require that a minimum percentage, eg, 10-20% of funds invested by each participant must be placed with the insurance com pany in the fixed or insurance company invest ments. To the extent this is required, the doctor is restricted in his investment opportunities.
All insurance company programs
Sometimes the balanced funds, and even the other Keogh investment programs, mislead the dentist by giving illustrations which show the ap preciation of his money after a stated period of time. For example, the illustration may show the doctor investing $1,000 earnings at 8%, and after 20 years he has the accumulation of his $1,000 times 8 % plus his compound interest. Besides the questions of the illegality of predicting future earnings, these illustrations make the faulty as sumption that the entire $1,000 finds its way into the retirement program. Except for the American Dental Association Members Retirement Plan, all major group Keogh plans reviewed by the Coun cil on Insurance have front-end loads; this means that 3%, 5% or 8% of the invested money goes to the administrator before the money is put into the doctor’s retirement account. At 5 % the contribu tion of $1,000 results only in $950 going into the account and earning interest. In the hypothetical example discussed earlier, a more honest evalu ation would be $950 less administrative expenses times 8%, plus compound interest earnings. All Keogh plans have some initial enrollment fees and annual administrative fees. These fees will be discussed later but the point here is that no illustration is factual unless it shows the sub traction of these fees. These comments apply to all Keogh plans and not just to the balanced funds. But they seem ap propriate to mention at this point because there are so many fees and charges involved in the bal anced fund and it is often difficult to recognize them. 500 ■ JADA, Vol. 76, March 1968
Individual retirement programs are available from life insurance companies and they may or may not involve life insurance. The individual insur ance program was discussed earlier but for com parison purposes it should be recalled that this mechanism provides only for fixed or relatively low-yield investments. Group Keogh Act programs are available through many large life insurance companies which provide all the benefits of the balanced pro gram and some additional benefits. The all-insur ance company group program reduces the number of participating agencies to only one or two, the variable being whether an administrator or broker is involved in the program. Many of the large insurance companies are now allowed by law to invest funds in common stocks, so the insurance companies have created so-called separate accounts that are the equivalent of mu tual funds. They are, in fact, mutual funds wholly owned by the insurance company. Under the usual group program underwritten by an insurance company and sponsored by a den tal society, the participating dentist can elect to have his funds invested in fixed return investments or common stock accounts. The investment per formance of the insurance company-owned com mon stock funds is generally on a par with the best mutual funds. Using this mechanism, the dental society-spon sored insurance program provides the dentist with good investment opportunities and group annuity purchase rates. Sometimes these rates are guaran teed against increases for stated periods of time. The major difficulty with this kind of program is that it usually contains a front-end load. This is
a charge which is placed against the participant’s contributions before his funds are placed in his investment accounts. The front-end loads vary from 3% to 8%, and they substantially reduce the benefits of the program. Sometimes there is con fusion between the use of a no-load mutual fund and a no-load retirement program. A Keogh Act qualified retirement program can utilize a noload fund; but still be a 3 % or 5 % load retirement plan. The American Dental Association Members Retirement Plan is the only plan of this kind which does not have a front-end load. It must be quickly added that the American Dental Associ ation plan does not have a rear-end load or other hidden costs. The expenses and the need for these loads are not present, or needed, in the American Dental Association Plan as they are in the smaller plans. The reason for the front-end load is for com missions to be paid the salesmen and the costs of promotion of the plan. The American Dental As sociation Members Retirement Plan does not pay any commissions so there is no need for the frontend load. One of the difficulties with a program of this kind, sponsored by a local or state dental associ ation, is that the commissions which are paid to the representatives of the insurance companies are relatively small in relation to commissions paid for individual programs. There have been instances reported where a state dental association has spon sored a program o f this kind, and the representa tives of the insurance company visit the dentists who have indicated an interest in the state society program. Once in the office, the salesmen’s incen tive changes to trying to sell an individual plan suggesting or not suggesting that the individual plan also has the endorsement of the dental so ciety which sponsors the group plan. When this was reported in one state, the response from the insurance company was that these were commis sion salesmen who they could not control.
American Dental Association Members Retirement Plan This program is underwritten by the Equitable Life Assurance Society of the United States. It is a one-party plan involving just Equitable. There are no front-end or rear-end loads and the best possible group annuity purchase rates are avail able. Commission costs are eliminated. However, salaried representatives of the Equitable are avail
able to attend dental society meetings. In addition, a telephone consultation service is available in most large cities. The Council on Insurance of the American Den tal Association serves as trustee of the plan and works directly with Equitable. To date, this has been a very effective relationship, and it is obvious that the voice of the dental profession should be heard in this program because of the potential size of the total participation of dentists and their employees. Additional information about the Association plan is available by writing to the Council on In surance, American Dental Association, 211 E Chi cago Ave, Chicago, 60611; or to the American Dental Association Members Retirement Plan, Box 2470, GPO, New York 10001.
Expenses, loads and other charges One of the most important elements in evaluating various Keogh programs is the comparison of the various expenses, loads and other charges. As pointed out earlier this is virtually impossible in an individual insurance program especially when it involves some life insurance features. ■ Participation Fees: Many programs, if not all, require that an initial fee be paid to start this program. The participation fee, sometimes called the “start-up” or enrollment fee, is a one time charge. The fee is either on the basis o f a fee “per plan” or “per participant.” A per plan fee means that if the doctor and his employees enter the
Highlights of the American Dental Associa tion Members Retirement Plan
1. Opportunity to invest in fixed (bonds and mortgages) and growth (common stocks) funds. 2. No front-end or rear-end loads usually found in Keogh Act Programs. 3. Opportunity to purchase annuities at group rates. 4. The Council on Insurance serves as trust ee of the retirement program. 5. Annuities can be purchased at the lowest prevailing rate.
Sarner: TAX QUALIFIED RETIREMENT PLANS ■ 501
plan, only one fee is paid; a per participant fee means that the fee is charged to each of the par ticipants. Participation fees are relatively low, usually in the area o f $15 to $25. ■ Administration fees: These are annual fees charged against each of the participant’s accounts. For example, if the annual administration fee is $12, the doctor will pay $12 per year and any of his employees in the plan will also pay $12 per year for administration. Sometimes these administration fees are on the basis of one account and two account fees. This is true under a program which permits some funds to be invested in common stocks and some in fixed investments. If the individual puts all his contri butions in either one or the other account, he pays the one account fee. If he splits his contribu tions between the common stock fund and the fixed investment account, then he pays the two ac count fee. For example, this may be expressed as $7.50, one account, $12, two accounts. ■ Front-end loads: This is a percentage of the money contributed each year which is deducted before the funds are invested. A front-end load of 5 % means that 5 % of all contributions go to the administrator or broker “off the top” of the mon ies invested that year. In comparing front-end loads with enrollment or administration fees, there may be a tendency to simplify and say there is no difference between two plans because one has a higher enrollment fee and the other has a higher front-end load. How ever, these comparisons are more meaningful than that because the impact of a front-end load is al ways greater than the administration fee or the en rollment fee. For example, compare the American Dental Association enrollment fee ($25) and ad ministrative fee ($12) which are among the high est with the front-end loads of other plans. In the first year, the $2,000 investment would be re duced by $25 and $12 so the participant would have $1,963 for investment in the American Den tal Association Plan. In another program with lower enrollment fees ($15) and lower adminis tration fees ($10) and a 5% front-erid load, the $2,000 contribution would provide only $1,875 for investment purposes. In subsequent years, when there is no enrollment fee, the differences between the two would be increased. ■ Investment charges: Most group plans provide for a 0.5% investment charge per year. This is gen erally the same as is charged against mutual fund 502 ■ JADA, Vol. 76, March 1968
investments. This is the usual charge for invest ment services common to most plans. ■ Custodian charges: Where a bank participates in the plan as a custodian of funds, the bank will impose a custodian charge. This charge is usually found only in the balanced funds where the ad ministrator utilizes the programs of both a mutual fund and an insurance company. ■ Trustees charge: In some instances, the orga nization or association sponsoring the plan in curs some substantial expenses in creating the re tirement program, or will incur charges in connec tion with the program. There may be an addition al charge imposed in the program to recoup these expenses. The plan may include reference to a “trustees charge” even though none is currently being charges.
Summary The Council on Insurance selected the Equitable plan after reviewing a considerable number of other proposals. A substantial part of this retire ment program was created especially for the Amer ican Dental Association and provides benefits not available under other programs. The Council also appreciates that members of the Association may for some reason prefer to participate in an indi vidual program or a program sponsored by an other association. This summary of the various kinds of programs available under the Keogh Actwas intended to present the member with some basis for comparing programs. There is no inten tion to disparage any particular existing or pro posed plan.