Vanguard Isn't Always The Answer

Vanguard is something that people in the FIRE community hold almost as a deity.  Everything is bench marked against Vanguard, and rightfully so.  They are the fore-fathers of low-cost index investing.  They disperse ownership of the firm to the owners of their funds, therefore incentivizing the fund managers to keep costs a low as possible.  Let's discuss why Vanguard is held in such high regard amongst this community:

The servant to two masters

For a very large majority of the mutual fund industry, there are two masters.  There are share holders, or owners, and there are customers, or investors.

The customers make money by having the investments that they purchase appreciate.  Simple, you buy the fund, it goes up in value, you win, the end.

The share holders make money by charging the customers money.  Very simply, the more money the share holders can extract from the customers, the more money they make.

This dichotomy creates and interesting dilemma for the fund managers.  Their customers best interest is to return as much money as possible to them, while the share holders best interest is to return as little money as possible to the customers.  Take a wild guess who wins when push comes to shove?  That's right, the share holders, the customers are a close second, but second nonetheless.

How does Vanguard get around this?

So Jack Bogle saw this conundrum and decided that it would be best to merge the share holders and the customers into one, so that their interests are shared.  He in effect eliminated the conflict of interest, now it was in the best interest of the share holders to keep costs as low as possible because they are also the customers.  BRILLIANT!!!

What does this have to do with anything?

Now that we have the background for what Vanguard is and why it is held in such esteem by the FIRE community, we can discuss the issue at hand.  We've set up a solo 401k and as such have done quite a bit of research into 401k's.  It's even caused some issues at previous employers.  So, naturally when looking at the providers, the first place I went is Vanguard.  This is a great place to start, you can also find a very in-depth discussion here.

So we looked into Vanguard, and they have a great solo 401k plan.  But there are some short comings:

1. They don't allow Roll-Ins from traditional IRA - If you are a high income earner, you get phased out of contributing to a Roth IRA.  You also no longer have access to the deductible Traditional IRA.  But, you can do a backdoor Roth.  Here's the trick to avoid the pro rata tax for the roll over: you need to have a $0 balance in your traditional IRA to maintain the tax advantages of the Roth Conversion.  This is a little complicated so let's walk through a quick example to hopefully clear it up some.  Suppose you have $95,000 in your Traditional IRA, that is all tax deferred.  Now you contribute an additional $5,000 to that pot that is after-tax (non-deferred).  Your total balance is $100K ($95 deferred + $5 non-deferred).  Now you want to roll that $5k into a Roth from this traditional IRA.  Well, the government wants its money, so they will tax it at a "Pro Rata" rate.  Meaning that you will add 95% (the percent that is tax deferred in your total IRA balance) of the roll over amount to your AGI for your taxes during the roll over year.  So this isn't good, you put in $5k after tax, and when you roll it over, you owe tax on $4,750.  In order to get around this little issue we need to have a $0 balance in our Traditional IRA, luckily your 401k balance doesn't count against you.  So, if your 401k allows "roll ins" from traditional IRAs you can avoid this problem.  Basically, take your Traditional IRA, roll it into your newly established solo 401k.  This way you now have $0 in your IRA.  Sooooo... every year you can put your $5,500 into your trad IRA (not pre-tax), and then roll it over immediately, and so long as you roll it over the day you deposit it, you owe no taxes on it.  And boom!!  you have roth money in your account even though you are not eligible because of income.  Well, Vanguard doesn't allow you to Roll IRA's into their i401k.  You can consolidate old 401k's into it, but not IRA's.


2. You don't have access to the Admiral Shares - Everyone knows part of what gets everyone excited about Vanguard is that their costs are considerably lower than other firms.  We even discussed why they are so great a little above in this same post.  There are three classes of products that Vanguard offers, the Investor class, Admiral class and the ETF.  These are all basically the same product, except for the minimum investment amounts and the Expense Ratio.  The investor class has a minimum of $3,000 and an ER of .15% (at time of writing), The Admiral Shares have a minimum of $10k, and an ER of .04%.  The ETF is a different animal and you can only invest in the mutual funds in the i401k.  If that's the case, why is it that in their i401k you don't have access to the Admiral Shares? You would think that since Vanguard is known for their low cost investing, they would give you access to the Admiral shares??  They don't.  Weird.  I've asked and never really gotten a straight answer as to why.  So you're stuck paying 4x for the same product regardless of your account balance.

So what did we do?

We did a lot of research into this, and we ended up going with Fidelity.  Fidelity has a no cost Solo 401k that allows for IRA 'roll-ins' and they also give access to their "Spartan Shares" or the advantage class, which is the equivalent of the Admiral shares.  (At time of writing the ER on the total market index is .04%.)  We're pretty happy with Fidelity's product so far.  It's given us access to the funds that we want with the lowest ER.  It's also got a pretty good management interface online.

What's bad about it?

Well there are two main drawbacks to the Fidelity plan.

1. They don't offer a Roth option in their Solo 401k - They don't offer the Roth option in their Solo 401k.  Seems weird, but I guess Vanguard is actually one of the only ones to offer this through their i401k product.  But this doesn't matter really since the whole point of doing this is to lower our tax burden and increase the company contributions to the pre-tax account.  So, while it's a bit of a drawback, it's not a big deal, since we wouldn't be taking advantage of it anyway.


2. They don't offer ACH deposits - This really threw me for a loop.  For all the technology they have, I still have to cut checks every month and drive them down to their branch office and sit across a desk from a guy while he types it into a computer.  You would think they would at the very least allow us to do a direct ACH transfer from the bank account.  Even better would to integrate with our payroll system to deduct it with the payroll.  But no, I'm stuck in what might as well be the 1970's of writing a check for the employee amount, the employer match, each with their separate account numbers and driving down to the office to deposit the checks.  They're nice enough folks, and they have decent coffee, but there are a ton of other things I would rather do than drive to their office to drop off checks.  Trust me, I mention it every time I'm in the office about how nice it would be.

So Vanguard isn't the best option for us.

Vanguard is a great company.  We actually have most of our investments with them.  Including our Roth IRAs, and some old 401ks.  (I got access to the institutional class of investments at an old company, with an ER of .02%, so yeah it just sits in there, no need to roll that anywhere.)  But, when opening a solo 401k, Vanguard wasn't the best option.  Maybe they'll change, and I'd love to consolidate everything under one roof.  But right now we're spread across a couple different places.  Vanguard for Roth's and old 401k's,  Wealthfront for our taxable stuff, TIAA Cref for our 529 and then Fidelity with our Solo 401k.  I guess the gist is that you have to look at all the criteria in certain situations.  Don't just blindly go with someone, even if they're good in other aspects.

What's next?

As we hire outside our immediate family, we're going to have to transition to a small business 401k and away from a Solo.  Now we're going to see the costs increase dramatically.  Already got a quote from Vanguard and they are between $2,500 and $3,475 for annual maintenance fees with a $1,000 initial set up fee.  I'm getting quotes from Fidelity and some others so that we can compare and make another educated decision.  But again, maybe Vanguard is not the best, we'll find out soon enough.

Anyone use anything else for their Solo 401k's?  Any hints for providers and running a non-Solo 401k, this is going to be another fun challenge?