Retirement plans for small businesses

Understanding your options may help you save more for retirement and lower taxes.

As a small-business owner, you’re probably used to handling a lot of responsibility—everything from drawing up detailed business plans to creating a budget. So it should come as no surprise that funding your retirement will likely fall on your shoulders.

But what type of retirement plan is the right fit for your business? There are several types to choose from and the options can be confusing. For example, some small-business retirement plans are better for sole proprietors, while others may be more appropriate for businesses with up to 100 employees.

“Many small-business owners say they want to set up a 401(k) plan because that is the plan they are most familiar with,” says Ken Hevert, senior vice president, retirement products, at Fidelity. “However, after reviewing their situation, small business owners often conclude that perhaps another plan type, such as a SEP IRA or a Self-Employed 401(k), may be more appropriate.”

Basically, there are four types of retirement plans that small-business owners might consider:

  1. Simplified Employee Pension Plan (SEP IRA)
  2. Savings Incentive Match Plan for Employees (SIMPLE IRA)
  3. Self-Employed 401(k) plan
  4. 401(k) plan (better for larger companies given setup costs, administration, fiduciary responsibilities, etc.)

We will focus only on the first three, which are generally more suitable for very small businesses—typically, 10 employees or less. Each of these plans has different characteristics—such as the ability to cover employees, contribution limits, and administrative responsibility, to name a few. To choose the right plan for your business, you need to understand the nuances of these plans and match them to your priorities (e.g., higher contributions or simpler administration).

Understanding the differences in the plan types is an important exercise. If you have been operating a plan that doesn’t match your business needs, you could be missing out on important tax benefits, or possibly making mistakes regarding employee contributions.

Why have a small-business retirement plan?

Here are three very compelling reasons:

  • Your plan not only helps secure your future—it may be the primary way your employees can help secure theirs.
  • Offering a plan helps make your business competitive when it comes to attracting and keeping good employees.
  • There are potential tax benefits to offering a plan, because plan contributions for the business owner are deductible as a business expense.

Consider your options

Each of the three small-business retirement plans may offer certain tax advantages, including:

  • Tax-deferred growth potential, which allows contributions to grow without being reduced by current taxes
  • The potential to deduct employer contributions as a business expense
  • A tax credit of up to $500 for certain expenses incurred while starting and maintaining the plan each of the first three years, if this is your first time offering a plan

But this is where the similarities end, particularly about whether the plans cover employees and, if so, who is responsible for making contributions.

  • A SEP IRA is for self-employed people and small-business owners with any number of employees. Contributions are made by the employer only and are tax deductible as a business expense.
  • A SIMPLE IRA is for businesses with 100 or fewer employees and is funded by tax-deductible employer contributions and pretax employee contributions [similar to a 401(k) plan].
  • A Self-Employed 401(k) plan is a tax-deferred retirement plan for self-employed individuals that offers the most generous contribution limits of the three plans, but is suitable only for businesses with no “common law” employees, meaning any person working for the business who does not have an ownership interest.

Choosing the right plan takes careful consideration

“If you know what you are trying to accomplish with a retirement plan, it may be relatively straightforward to determine which plan is most appropriate for the business,” Hevert says. “For example, is ease of administration an important consideration? Is it critical that employees be able to contribute to the plan? Knowing what you want and need ahead of time is a key component, because each plan has its advantages and disadvantages.”

The chart below compares the three plans in detail.

Fidelity’s small-business retirement plans at a glance

Features SEP IRA Simple IRA Self-Employed 401(k)
Who it’s for
  • Self-employed individuals or small-business owner, including those with employees
  • Sole proprietors, partnerships, corporations, S corporations
  • Companies with 100 employees or fewer, that do not have any other retirement plan
  • Sole proprietors, partnerships, corporations, S corporations
  • Self-employed individuals or business owners with no employees other than a spouse (and no plans to add employees)
  • Sole proprietors, partnerships, corporations, S corporations with no common law employees
Key advantages
  • Easy to set up and maintain
  • No initial setup or annual maintenance fee
  • Salary reduction plan with less administration
  • Low-cost option of $25 per participant or $350 plan fee
  • Generous contribution limits
  • No initial setup or annual maintenance fee
Who contributes
  • Employer only (employee may make traditional IRA contributions to the account)
  • Employer and employee
  • Employer and employee (assuming the employee is the business owner or spouse)
Contribution limits
  • Employer contributes up to 25% of employee compensation or up to a maximum of $54,000 in 2017
  • Employer must contribute the same percentage to employee accounts in years he or she contributes to his or her own account
  • Mandatory business contribution of either: 1) 100% match on the first 3% deferred (match may be reduced to 1% in two out of five years) or 2) a 2% nonelective contribution on behalf of all eligible employees. No additional business contribution may be made.
  • Employee contributes up to 100% of compensation through salary deferral, not to exceed $12,500 for 2017
  • Catch-up contributions of up to $3,000 (2017) available for those age 50 or older
  • Employers may contribute up to 25% of compensation up to a maximum of $54,000 in 2017
  • Up to $18,000 in salary deferrals; $24,000 if age 50 or older
  • Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $54,000 for 2017
  • No Form 5500 filing
  • Employee notification of employer’s contribution, if made
  • No Form 5500 filing
  • Certain annual employee notifications
  • Annual Form 5500 filing after plan assets exceed $250,000
  • No initial setup or annual maintenance fee
  • Low-cost option of $350 plan fee or $25 per participant
  • No initial setup or annual maintenance fee
  • Immediate
  • Immediate
  • Immediate
Access to assets
  • Withdrawals at any time, which are subject to current federal income taxes and possibly to a 10% penalty if the participant is under age 59½.
  • Withdrawals any time. If employee is under age 59½, withdrawals may be subject to a 25% penalty if taken within the first two years of beginning participation, and possibly to a 10% penalty if taken after that time period.
  • Cannot take withdrawals from plan until a “trigger” event occurs, such as termination of service or plan termination. Withdrawals are subject to current federal income taxes and possibly to a 10% penalty if the participant is under 59½.

Matching a retirement plan to your business

As you consider the specific features of each plan, it’s important to remember that there are always trade-offs. Think very carefully about your priorities.

Here are some factors that may be helpful as you consider the right retirement plan for your business:

Covering employees
If you have no employees other than you and your spouse (or business partner) and want the highest possible contribution limits, consider a Self-Employed 401(k). If, however, additional employees are a possibility in the future, you may need to choose between a SEP IRA and a SIMPLE IRA, both of which can cover employees. Then it’s a matter of deciding whether you want to fund your employees’ accounts by yourself (SEP) or you want your employees to contribute (SIMPLE).

Contributions: how much and who pays?
Next, think about how much flexibility you want in terms of contribution limits and who is responsible for making such contributions.

A Self-Employed 401(k) plan offers the largest possible contributions because it recognizes that self-employed people wear two hats—as an employee and as an employer. In fact, as an employee, you can make elective deferrals of up to $18,000 for 2017. As an employer, you can make a profit-sharing contribution of up to 25% of compensation, up to a maximum of $54,000 for 2017. (Total contributions as employer and employee can not exceed $54,000 for 2017.) The plan also allows catch-up contributions of up to $6,000 for those who are age 50 or older in 2017. You are also eligible for added tax breaks. If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, the corporation can generally deduct the contributions as a business expense.

If you have a business with variable income and you want more flexibility, you might consider a SEP IRA. Just remember that, if you have employees in years you contribute, you have to contribute the same percentage for them as you contribute for yourself. As an employer, you can contribute up to 25% of compensation, up to a maximum of $54,000 in 2017. And you don’t have to contribute every year.

On the other hand, if you want your employees to help fund their retirement account, you may want to consider a SIMPLE IRA, available to businesses with up to 100 employees. With a SIMPLE IRA, employees can make salary deferral contributions of up to 100% of compensation, not to exceed $12,500 in 2017. You, as the employer, must also contribute to their accounts—you can either match the employees’ contributions dollar for dollar up to 3% of compensation (contributions can be reduced to as little as 1% in any two out of five years), or contribute 2% of each eligible employee’s compensation. The SIMPLE IRA also allows employees age 50 or older to make catch-up contributions of up to $3,000 in 2017.

Time and money
The good news is that all three of these plans are relatively low cost and easy to administer. Neither the SEP IRA nor the SIMPLE IRA requires annual plan filings with the IRS, just certain employee notifications. The Self-Employed 401(k) plan involves a little more effort, requiring an annual Form 5500 filing once plan assets exceed $250,000. To make the most of this retirement savings opportunity—both for yourself and your employees—make sure it’s the right plan for your small business before you set one up.


The 4 Best S&P 500 Index Funds

The Standard & Poor’s 500 Index (S&P 500) is an index of 500 of the largest U.S. companies, listed on the New York Stock Exchange or NASDAQ, selected by the Standard & Poor’s Index Committee based on market capitalization. The S&P 500 Index is a widely recognized barometer of the U.S. equity market. S&P 500 Index funds allow investors to establish a core allocation in large-cap U.S. equities, which have been advised by one of the most iconic American investors, Warren Buffet, also known as the Oracle of Omaha. S&P 500 Index funds seek to replicate the performance of the benchmark index by investing in S&P 500 constituents with similar weights. These funds employ a passive or indexing investment strategy and invest all or a substantial amount of their total net assets in common stocks included in the benchmark index.

Vanguard 500 Index Fund Investor Shares

The Vanguard 500 Index Fund Investor Shares seeks to provide investment results corresponding to the price and yield performance of the S&P 500 Index, its benchmark index, with a high degree of positive correlation. VFINX was issued by Vanguard on Aug. 31, 1976, and has generated an average annual return of 10.99% since its inception, as of June 30, 2015. VFINX is managed by the Vanguard Equity Investment Group and charges an annual expense ratio of 0.17%, which is 83% lower than the average expense ratio of mutual funds with similar holdings.

To achieve its investment objective, VFINX implements an indexing strategy and invests nearly all of its total assets in stocks included in the S&P 500 Index, with approximately the same proportions as the weightings in the index.


As of Aug. 31, 2015, the Vanguard 500 Index Fund has total net assets of $204.6 billion, and the investor share class has total net assets of $25.8 billion. VFINX has a price-to-earnings ratio (P/E ratio) of 19.4; a price-to-book ratio (P/B ratio) of 2.7; an earnings growth rate of 9.9%; and a return on equity of 18.4%.

Based on trailing 15-year data, VFINX has an R-squared of 100%; a correlation coefficient of 1; a beta of 1; a Sharpe ratio of 0.20; and a Treynor ratio of 1.98. VFINX’s R-squared and correlation coefficient indicate it tracked the S&P 500 Index with minimal tracking error, which was mainly attributed to its fees.

Like most S&P 500 Index funds, VFINX is best suited for long-term investors with a moderate to high degree of risk tolerance seeking exposure to the U.S. large-cap equities market. Since VFINX has a minuscule tracking error and a low expense ratio, it is an attractive core holding for an equity portfolio.

Schwab S&P 500 Index Fund

The Schwab S&P 500 Index Fund was issued on May 19, 1997, by The Charles Schwab Corporation. SWPPX is advised and managed by Charles Schwab Investment Management, Inc., and charges an expense ratio of 0.09%, while the average expense ratio of S&P 500 Index funds is 1.09%.

SWPPX is a mutual fund that seeks to provide investment results corresponding to the total return of the S&P 500 Index. To achieve its investment goal, SWPPX typically invests at least 80% of its total net assets in stocks comprising the S&P 500 Index. Additionally, SWPPX generally gives the same weights to these stocks as the index.

As of June 30, 2015, SWPPX has 506 holdings, which amount to $20.5 billion, and a portfolio turnover of 2%. As of Aug. 31, 2015, SWPPX has an R-squared of 99.99%; a correlation coefficient of approximately 1; a beta of 1; an alpha of -0.06; a Sharpe ratio of 0.21; and a Treynor ratio of 2.03.

SWPPX has a minimum initial investment of $100, which is attractive to the average retail investor. Additionally, its low expense ratio and minute tracking error provide an investment opportunity for long-term investors seeking exposure to S&P 500 constituents.

Fidelity Spartan 500 Index Investor Shares

Issued on Feb. 17, 1988, by Fidelity, the Fidelity Spartan 500 Index Investor Shares provides low-cost exposure to the U.S. large-cap equities market. FUSEX charges an annual net expense ratio of 0.095% and requires a minimum investment of $2,500. FUSEX is advised by Fidelity Management & Research Company and subadvised by Geode Capital Management, LLC.

To track the S&P 500 Index, FUSEX invests at least 80%, under normal market conditions, of its total net assets in common stocks comprising the index. FUSEX has historically tracked the index with a minimum degree of tracking error. Additionally, before fees and expenses, FUSEX has a perfectly positive correlation to the S&P 500 Index.

FUSEX serves as an alternative to VFINX and SWPPX, and is one of the top funds that offers exposure to a basket of common stocks included in the S&P 500 Index. FUSEX may serve as a core holding in a portfolio of U.S. equities. However, it is unsuitable for investors seeking exposure to the total stock market.



It was issued on the New York Stock Exchange Arca, on Jan. 22, 1993, by State Street Global Advisors. SPY charges a low annual net expense ratio of 0.0945%. SPY’s trustee and distributor are State Street Bank & Trust Company and ALPS Distributors, Inc., respectively. Similar to nearly all S&P 500 Index funds, SPY aims to achieve its investment objective by holding a portfolio of common stocks of S&P 500 constituents with similar weightings to the benchmark index.

Based on trailing 15-year modern portfolio theory (MPT) statistics, SPY has an R-squared of 100%; a beta of 1; an alpha of -0.08; a Sharpe ratio of 0.21; a standard deviation, or volatility, of 15.03%; and a Treynor ratio of 2.02. According to these statistics, SPY has a perfect positive correlation and a similar level of volatility and return to the S&P 500 Index.

SPY is one of the world’s most recognized and liquid securities tracking the S&P 500 Index. As of Sept. 22, 2015, SPY has total net assets of $163.897 billion and a trailing three-month average daily volume of 145.588 million shares. SPY is best suited for investors seeking a low-cost exchange-traded fund to gain exposure to the U.S. large-cap equities market. Additionally, it is suitable for traders who wish to trade an S&P 500 Index fund on major stock exchanges throughout daily trading hours rather than buying or selling an S&P 500 Index mutual fund at the close of U.S. markets.



How to Buy a Mutual Fund

Picking the right mutual funds is a lot like selecting the right kinds of stocks to purchase. Among the similar strategic rules of thumb: watch the fees, diversify your holdings to mitigate your risk and don’t chase performance — think long-term.

Let’s start with diversification. If your company has a 401(k) plan, you probably have a good number of funds to choose from. You don’t want to put all your eggs in one basket, so holding a diversified portfolio is important. A smart fund strategy mixes bond funds and stocks funds as well as funds that invest in domestic and overseas markets.

A smart strategy also includes “rebalancing.” Each year, you should look at your mix of funds to make sure they still dovetail with your strategy of diversification. If one strategy has done especially well, it will grow to become an outsized part of your fund portfolio. Each year, rebalancing your funds allows you to avoid overexposure to any particular portion of the market. In the tech boom of the late 1990s, those who didn’t rebalance found themselves in a bad position when tech stocks collapsed in 2000–2001. Anyone who rebalanced suffered fewer losses and found themselves in a position to better handle the downturn.

The rebalancing act is crucial to avoid a familiar pitfall for fund investors: Chasing performance. Each year, newspapers such as The Wall Street Journal list the top-performing funds. A lot of investors then plow their money into these top-performing funds. But among investors, there’s a golden rule: Past performance is no guarantee of future performance. Indeed, last year’s best-performing fund can quickly become this year’s laggard. Chasing performance is one of the most common fund investing errors. Rebalancing and sticking with your diversification strategy can help avoid this.

There are thousands of funds out there and dozens of strategies. Here are some:

Index funds are mutual funds that invest in a portfolio of securities that represents a particular market (like the entire stock market), or, a particular piece of a market (say, like, international stocks or small companies). These funds are built to replicate the performance of their relevant market – so they should track that market’s indexes. For example an S&P 500 index fund aims to provide the exact same return as the S&P 500 index. They’re low-cost, low-maintenance funds.

Actively-managed funds are actively-managed by humans. The portfolio managers, research the vast investment universe and then pick and purchase things that match their investment strategies. Usually, they’re trying to outperform certain indexes. For example, instead of trying to track the S&P 500 index, an active US stock fund manager tries to beat it.

Investors pay these managers for their work. Then they cross their fingers and hope that the manager gets it right and beats the index. Often, however, the managers don’t. It’s hard to beat an index over many years.

Lifecycle funds / Target date funds
invest in a combination of stock and bond funds. Essentially, these funds are mutual funds that are made up of investments in other mutual funds. The fund’s allocation to its underlying investments change over time as you near retirement.

The ratio of money allocated to stocks versus bonds gradually becomes more conservative as the investor grows older. So, for example, a 2040 retirement fund (named for the date that the investor hopes to retire) might be 85% stocks and 15% bonds now but 50% bonds/cash and 50% stocks in 2040.

These work well when you’d rather not pick and choose what to buy on your own, but instead have somebody else manage it for you. You only need to figure out what in which year you plan to retire – and pick the fund that most closely matches that date.

Some target-date funds, like Vanguard’s, invest only in index funds, while other providers, like Fidelity or T. Rowe Price, invest in actively-managed funds.

Lifestyle funds invest in a mix of stock funds and bonds funds that doesn’t change over time. They usually come in a few flavors signifying an investor’s tolerance for risk: conservative, moderate or aggressive. Some lifestyle funds slap on an extra fee on top of the expenses of the underlying funds; these are funds that you should probably avoid.

Balanced funds
invest in a mix of stocks and bonds. These funds typically have a somewhat conservative mix of about 60% in stocks and 40% in bonds.

Tax-managed funds attempt to keep taxable capital gains and other distributions to fund holders to a minimum. That’s why they’re often recommended for investors who buy them via normal, taxable brokerage accounts (and not via IRA’s or 401ks).

A number of investing advocates encourage investors to focus on index funds, rather than actively managed funds. Research data show that actively managed funds have a tough time beating funds that track an index. In addition, the simplified nature of index, or “passive,” investing means that index funds are cheaper and carry fewer fees.

After settling on a strategy for your anticipated needs, picking from the world of funds can be bewildering. Thousands of funds are competing for your attention. When considering a fund, a good first step is looking at the fund’s prospectus. Like a company’s IPO prospectus, a fund prospectus tells you a great deal about what a fund is doing. It contains information about investment goals, risk posture, fee information, past performance data and amount of assets held.

If you’re a 401(k) investor, you have access to a menu of funds selected by your employer. Hopefully, your company has done a thorough job and offers you a comprehensive list of good funds that will allow you to build a well-balanced investment portfolio.

If you’re looking to invest outside of your employer-sponsored plan, you have several options:

1. You can purchase mutual funds through the fund companies directly, whether it’s Vanguard, T. Rowe Price or Fidelity, to name just a few.

2. You can buy fund via a “supermarket” which offers funds from many different providers. Many fund companies like Vanguard will allow you to set up brokerage accounts where you can buy funds from elsewhere. Many of the online brokerages that house your IRA or regular brokerage account also offer fund supermarkets.

You want to pay close attention to fees when dealing with any supermarket. While they provide the convenience of one-stop shopping, one statement and easy online access, some funds carry transaction fees, akin to a brokerage’s commission. So if you invest a little money each month into three funds that carry a $35 transaction fee, those costs can quickly add up and eat into your returns. For example, Schwab makes you pay a lot to buy Vanguard mutual funds.

Obviously, the supermarkets want you to buy their house brands, so those funds are unlikely to cost you any extra fees. You can be sure it’ll cost you less to buy Schwab funds through your Schwab brokerage account that it would to buy Vanguard’s funds.

Supermarkets usually have a list of no-transaction-fee funds (these fund companies pay the supermarket a fee to get on the list, so it’s not entirely free; the expense ratio might be slightly higher) and transaction fee funds (those who don’t). Before you commit to any one supermarket, check out their wares and fee structure. If the Vanguard fund you’re after will cost a fee every time you make a deposit, look elsewhere or go to the fund company directly.

3. Lastly, you can buy funds via a human broker or certain financial planners. This route is often less cost-effective than others – brokers will tack on extra fees like sales charges and your planner may do the same. If you really want professional help, it’s probably most cost-effective to find a financial planner that charges by the hour and can unearth some good and cheap no-load funds for you.

There are a few other factors to consider when buying a fund:
Timing. If you’re investing outside of a tax-deferred account, like a 401(k) or IRA, timing may matter. Funds are required to distribute capital gains and dividends to shareholders. These distributions are taxable – so if you buy into a mutual fund right before a distribution, you’re essentially paying taxes for some sort of gain that you didn’t even benefit from.

While most distributions are made in December, some are made earlier. If you’re looking to buy a fund anytime after Sept. 1, be sure to ask about the company’s distribution — if there is a taxable distribution, make your purchase after it passes.

The type of account that will hold the mutual fund .
You want to take full advantage of your tax-sheltered retirement accounts — namely 401(k)s and IRAs — because taxes there are a non-issue.

For your taxable brokerage account, consider tax-efficient investments such as: tax-managed funds, exchange-traded funds, index funds, municipal bond funds, and stocks you plan to hold for more than a year (at which point, any gain gets taxed at 15%; it’ll be higher if you sell sooner).

In a regular brokerage account subject to taxes, you generally want to stay away from mutual funds that generate hefty tax bills from capital gains distributions or dividends, which are better off inside your retirement accounts. These include: real estate investment trusts, or REIT funds; actively-managed stock funds; high-yield junk bond funds; corporate bond funds; and stocks you plan on trading frequently.