Vanguard Small Business Retirement Plans: Are They Right for Your Business?

If you’re a small business owner researching retirement plans available for your company, you might be a little discouraged by what’s on the table. Lots of small businesses in the U.S. don’t offer employees 401(k) retirement plans because administering them can be too high-maintenance for a busy small business owner. And with steep account service fees, small businesses often pay more for solid retirement plans than large companies do.

But in a landscape of pretty grim retirement investment options, here’s a beacon of light: Vanguard small business plans. With three Vanguard retirement plans expressly for small business owners, the investment management powerhouse might have the low-cost, hassle-free retirement plan that suits your small business. Here are the details of each of these small business-centric retirement plans.

When we say “Vanguard small business,” we’re actually referring to three Vanguard retirement plans for small businesses. But why should you consider one of these plans at all?

First off, Vanguard is one of the more respected names in the investment community. They deliver great results on their investment portfolio, so you can be confident that your money is in good hands. And perhaps most importantly, Vanguard small business wins out on costs.

The costs associated with offering small business retirement plans aren’t insignificant. But Vanguard’s fund expense ratio—or the total percentage of funds going toward administrative and management fees—is 82% less than the industry average.^[1] Instead of an industry average 1.01% expense ratio, Vanguard small business plans have an expense ratio of 0.18%. Also, none of these four plans has industry-standard setup fees.

As you well know, small businesses come in all shapes and sizes and have many different needs. That’s why you’ll see a few different Vanguard small business plans to choose from, based on the kind of business you run—one Vanguard Small Business plan is a better fit for sole proprietorships, for instance, and another is a better match for a larger small business.

Let’s go through the details of each Vanguard small business plan to see if you can find a perfect match.

The Vanguard Individual 401(k) plan is for companies on the smaller end of the spectrum: Vanguard specifically designates this plan for sole proprietorships and partnerships with no common law employees. (As a reminder, a common law employee is any employee who’s not an employer, partner, shareholder of the corporation, or a respective spouse.)^[2]

If you opt for the Individual 401(k) Vanguard Small Business plan as an employer, here are your contribution regulations:^[3]

• For employers: Up to 25% of compensation, with a maximum of $55,000 per eligible employee for the 2018 tax year. Your employer contribution is considered a business expense on your tax deductions each year.
• For employees: Employees can contribute 100% of their compensation up to $18,500 for the 2018 tax year, or $24,500 for employees age 50 and over

Also note that employees can contribute to their retirement plans with either pre-tax or Roth contributions. Let’s take a step back here: What’s a pre-tax or a Roth contribution?

Vanguard Small Business 401(k) Pre-Tax Contributions vs. Roth Contributions

A traditional 401(k) has contributions that are made on a pre-tax basis. Put simply, an employer takes money out of an employee’s paycheck and transfers it in the employee’s retirement plan before withholding regular taxes.

When employees begin to tap into the retirement plan and take distributions, they’ll pay normal income tax on those distributions. The income tax that’s charged is based on the employee’s tax bracket at the time of the distribution.

Whereas a traditional 401(k) has pre-tax contributions, a Roth 401(k) has post-tax contributions. This means that the contributions are made after an employer withholds taxes. And because employees in this case have already paid taxes, they won’t need to pay taxes on the money they withdraw from their Roth 401(k) in retirement.

But here’s one caveat: If the employee’s company matches the employee’s Roth contribution, the company match is a pre-tax contribution. So any funds in the employee’s retirement plan that result and grow from company matches will be subject to regular income tax when the employee draws from the fund.

The difference between a pre-tax and Roth contribution can be complicated, but here’s really what you need to know: With a traditional 401(k), income taxes are charged on distributions from the fund. With a Roth 401(k), income taxes are charged on the contributions to the fund.

Business owners can contribute to their Vanguard small business 401(k) as both an employer and an employee, but combined contributions can’t be more than $55,000 for the 2018 tax year, or $61,000 for employees age 50 or older.

As you can imagine, Vanguard Small Business doesn’t offer these fund accounts for free. Vanguard—and other retirement fund providers—charges service fees.

The fee on an Individual 401(k) is $20 per year for each Vanguard small business fund held in an Individual 401(k) account, but there are no fees to establish this account.

Vanguard also offers account services called Flagship, Flagship Select, Voyager, or Voyager Select. If you invest $1 million to $5 million in a Vanguard small business fund, you’ll qualify for one of these select services. And if that’s the case, the $20 yearly account fee is waived for all participating accounts in the plan. The fee waiver is a great perk for business owners who qualify, but of course, you’ll have to contribute a fair amount to your retirement plan to be eligible.

If you go with this Vanguard small business retirement plan, know that you can’t take withdrawals until certain events, like ending your plan, reaching retirement age (59 1/2), or another specified event. You might be able to take out a hardship withdrawal, but if you’re under the age of 59 1/2 you’ll need to pay a 10% fee on that amount. And, finally, you can’t take out a retirement loan from your Vanguard small business 401(k).

As we mentioned, the Vanguard Individual 401(k) Plan works best for sole proprietors or partnerships with no employees. Also, using this plan is a great way to maximize your yearly tax deductions, as business owners can contribute as either employers or employees.

Also, Vanguard Small Business is one of the only investment companies that offers a Roth 401(k) option—making this plan a flexible option for business owners. You’ll have the choice of when you pay income taxes on your contribution or distribution to your retirement fund.

Next up on the list of Vanguard Small Business plans is the SEP-IRA.

For clarification, an IRA stands for individual retirement account. Put simply, an IRA is a type of retirement account that lets you stow away cash in a savings account with a fair amount of tax breaks. Whereas a 401(k) is set up by an employer, the most common types of IRAs are accounts that you open for yourself. SEP-IRAs, however, are opened by self-employed individuals and small business owners. (That’s where the “SEP” part comes in: SEP stands for simplified employee pension.)

Putting these two abbreviations together, you get the basics of how the Vanguard SEP-IRA works. This retirement account is for self-employed business owners; freelancers; or business owners with a few employees, who can use the SEP-IRA as their own account and contribute to their employees’ personal IRAs to encourage retirement savings.

If you use the SEP-IRA from Vanguard Small Business, the employer will be the one making contributions to the accounts. The employees, on the other hand, can choose to contribute to their own personal IRA accounts.

• For employers: You can contribute up to 25% of the employee’s compensation, or a maximum of $55,000 for the 2018 tax year—whichever amount is less. Self-employed individuals can contribute up to 20% of their net income.
• For employees: If employees choose to contribute to their personal account, they can contribute up to $5,500 for the 2018 tax year (or $6,500 for employees age 50 and older)

As the owner of your business, you’ll pay $20 per year for each of your Vanguard SEP-IRA funds with a balance of less than $10,000. There are no establishment fees for the Vanguard SEP-IRA account.

Also, if you qualify as Flagship, Voyager, or Voyager Select Services client—meaning you invest anywhere from $1 million to $5 million with Vanguard—the service fee is waived.

Unlike the Vanguard small business 401(k) plan, the Vanguard SEP-IRA allows account holders to withdraw contributions at any time—however, you’ll still be subject to a 10% fee if you withdraw before the age of 59 1/2, though certain exceptions will apply. And you can’t take out a loan from your Vanguard SEP-IRA.

The SEP-IRA plan from Vanguard Small Business is a great option for self-employed individuals, freelancers, or small business owners with only a few employees.

And if you’re planning on keeping your business a one-person show, then using the SEP-IRA might be your best bet. You’ll pay low account fees and your contribution limit is based on a pretty simple formula—you can put away as much as 25% of your income, up to a cap set each year.

So, if you’re looking for simplicity, an SEP-IRA is a smart choice. Signing up for a SEP-IRA from Vanguard Small Business is an easy process with minimal paperwork required—making this retirement plan a convenient option for busy small business owners.

Last on the list of Vanguard Small Business plans is the SIMPLE IRA.

The “SIMPLE” part stands for savings incentive match plan for employees. You already know the “IRA” part—individual retirement account. So, a SIMPLE IRA is just another type of traditional IRA account. Your contributions are tax-deductible, and your investments grow tax-deferred until you’re ready to take from the investment fund.

This plan works well for small business owners with 100 or fewer employees, but self-employed folks can take advantage of this account, too. Here’s what you need to know about this retirement plan.

The Vanguard SIMPLE IRA requires that employers match employee contributions. Employers have two options for making contributions, and the option the employer chooses just depends on how much they’re willing to contribute to their employees’ funds:

• Dollar-for-dollar match of up to 3% of each employee’s compensation, or reduce to as low as 1% for any two of five years
• Contribute 2% of each eligible employee’s salary.

On the employee’s side, Vanguard SIMPLE IRA allows contributions of up to $12,500 for the 2018 tax year, or $15,500 for employees 50 years of age or older. Employees aren’t required to contribute to their IRAs in any given year.

A SIMPLE IRA from Vanguard Small Business comes with a slightly steeper account service fee at $25 per year for each fund, which can be waived if you meet certain criteria. As always, you won’t be charged additional fees to establish your Vanguard SIMPLE IRA account.

You can withdraw contributions to your Vanguard SIMPLE IRA whenever you want. That said, if you pull funds before the age of 59 1/2, you’ll be subject to a federal penalty tax of 25% if you withdraw within the first two years of account opening; or 10% if you withdraw after those first two years. And as you can probably guess by now, you can’t take out a loan from your Vanguard SIMPLE IRA plan.

This Vanguard small business plan is a great option for small business owners who want a straightforward retirement plan. And if you’re willing to match your employees’ contributions, you’ll encourage your workers to contribute to their own retirement plans. Plus, SIMPLE IRAs have higher contribution limits than other IRAs, so you and your employees save more money in the long run if you make maximum contributions.

Now that you have each Vanguard Small Business plan laid out in front of you, do you know which retirement plan is right for you? You’ll need to look closely at the structure of your business, your employees’ needs, your business budget, and how you want your retirement savings to grow. Once you get a handle on your priorities for your retirement savings, you’re well on your way to choosing the right plan for your small business.