Dock David Treece

  How to Read Your SIMPLE IRA Calculator Results Some rules of thumb for reading the SIMPLE IRA contribution calculator results include: Annual SIMPLE IRA Contributions: SIMPLE IRA contributions should be at least 3 percent of annual compensation or $5,000. If they’re more than $20,000, or 8 percent to 10 percent of your employee income, it may be better to use a SEP IRA. If you’re a small business owner with employees, consider using a 401(k) instead. Mandatory Employer Matching: Employer matching will probably equal your employee contributions. For most employees, matching will equal between $1,000 and $3,000, but if your contributions are high or you have a high income, your matching may be lower. Five-Year Growth Projection Rule of Thumb: Your SIMPLE IRA balance should grow faster each year as interest accumulates with new contributions. If your contributions are high, your account balance may be as high as current annual compensation. SIMPLE IRA Contribution Limits Using a SIMPLE IRA, employees can use salary deferrals for pretax contributions up to $13,000. Employers offering SIMPLE IRAs are required to match 100 percent of employee deferrals up to at least 3 percent of their compensation or $13,000. Total SIMPLE IRA contribution limits for 2019 are $26,000 between employee deferrals and employer matching. SIMPLE IRA contribution limits include: Employee Deferrals: up to $13,900 annually Employees can make tax-deferred contributions to SIMPLE IRAs by deferring up to 100 percent of their income or $13,000, whichever is less. Employer Matching: up to $13,000 annually Using a SIMPLE IRA, employers are required to match employee contributions up to 3 percent of annual compensation. Employers can match more than 3 percent, but must match employee deferrals at least up to 3 percent of annual compensation. Catch-up Contributions: up to $3,000 annually Account holders over 50 years old can contribute an extra $3,000 to their SIMPLE IRA each year until they are 70½ years old. SIMPLE IRA Deadlines There are several SIMPLE IRA deadlines for employers to implement a plan or for employees to participate. Using a SIMPLE IRA, employers must set up their plan between January 1st and October 1st of the year they take effect. Employees who participate must contribute between January 1st and December 31st (prior year contributions are not allowed). SIMPLE IRA deadlines for employees include: Employee Deferral Deadline: December 31 Employees who participate in a SIMPLE IRA must make all their contributions before the end of the year. Some SIMPLE IRA deadlines for employers include: SIMPLE IRA Formation Deadline: October 1 Employers who want to use a SIMPLE IRA must set up their plan before October 1st of the year it takes effect. If you are establishing a SIMPLE IRA for a company formed after October 1st, the SIMPLE must be established as early as is practicable. Employer Matching Contribution Deadline: 30 days after employee deferral Using a SIMPLE IRA, employers must match employee deferrals up to 3 percent of annual compensation. All employer matching contributions must be made within 30 days of the employee deferral being matched. If a SIMPLE IRA isn't the right retirement plan for you, consider investing in a 401(k) plan instead. See our in-depth breakdown of top 401(k) providers to learn more. How the SIMPLE IRA Calculator Works The SIMPLE IRA calculator is used to calculate annual contributions and mandatory employee matching. The calculator bases these numbers on your annual compensation and deferral percentage, and also gives you the option of doing the same calculation for employees. The calculator also caps at SIMPLE IRA contribution limits of $13,000 from deferrals and another $13,000 in matching. However, your individual results may vary if your employer matches more than 3 percent in your SIMPLE IRA. The SIMPLE IRA contributions calculator above, however, provides results based on mandatory minimum employer matching of 3 percent. SIMPLE IRA Calculator Inputs To get results from the SIMPLE IRA calculator, users have to provide annual compensation and a deferral percentage. Employers can also input compensation information for their employees if they have any. These factors are then used to calculate SIMPLE IRA contributions and employer matching based on SIMPLE IRA rules. Inputs that employers can enter into the SIMPLE IRA contributions calculator above include: 1. Annual Employer Compensation Annual compensation the biggest factor in determining mandatory employer matching contributions to your SIMPLE IRA. Using a SIMPLE IRA, employers are required to match employee deferrals up to 3 percent of annual compensation. Your employer may match more than 3 percent, but the calculator determines mandatory minimum employer matching. 2. SIMPLE IRA Deferral Percentage If you have a SIMPLE IRA at work, you can contribute as much of your income as possible up to $13,000, but your employer is only required to match contributions up to 3 percent unless they choose to match more. Employers can also cut their match to as little as 1 percent, but not for more than two years in a five-year period. 3. Plan Participant Compensation & Deferral Rates In addition to inputting your own information, you can also input information for up to three employees. Using employee compensation and deferral percentage, you can use the SIMPLE IRA calculator to determine their maximum SIMPLE IRA contribution and mandatory employer matching. SIMPLE IRA Calculator Outputs Based on the information you enter into the SIMPLE IRA contributions calculator above, the calculator determines your SIMPLE IRA contribution, which is capped at $13,000. The calculator also calculates your mandatory employer matching, which is limited to $13,000 or 3 percent of annual compensation. Lastly, the calculator shows how your account is projected to grow. The employee outputs for the SIMPLE IRA calculator above are: 1. Annual Employee SIMPLE IRA Contribution The most significant calculation provided by the SIMPLE IRA calculator above is your annual SIMPLE IRA contribution. This calculation is done by multiplying your SIMPLE IRA deferral percentage by your annual compensation. Using a SIMPLE IRA, employers must match employee deferrals but the IRS limits SIMPLE IRA contributions to $13,000 per year. 2. SIMPLE IRA Mandatory Employer Matching After the SIMPLE IRA calculator determines your annual SIMPLE IRA contributions, the calculator uses this information to provide the matching that employers are required to provide. This figure is equal to your annual SIMPLE IRA contributions up to 3 percent of your compensation or $13,000—whichever is less. Your employer may match more, but the calculator shows the minimum. 3. SIMPLE IRA 5-Year Projected Growth The last output that the SIMPLE IRA calculator above supplies is a projection of how much your SIMPLE IRA account will grow over five years. This projection is based on five years of the same annual contributions and the same employer matching, along with an annual return of 5 percent. The employer output for the SIMPLE IRA calculator above is: 1. Mandatory Employer Matching for Employees If you indicate that you have employees, the SIMPLE IRA calculator will allow you to enter information for up to three employees. By providing their annual compensation and deferral percentages, you can calculate your mandatory employer matching for up to three employees based on employer matching requirements. SIMPLE IRA Calculator Example For an example of how the SIMPLE IRA calculator works, consider Chad, an accountant for a manufacturing company. Chad’s company is small and has set up a SIMPLE IRA to provide retirement benefits for employees. Chad’s total annual compensation is $100,000, and he plans to defer 2 percent of his salary into his SIMPLE IRA. Using the SIMPLE IRA calculator above, Chad can determine how much he’ll contribute based on a deferral percentage as well as how much his employer is required to match. Chad’s employer may match contributions greater than 3 percent of employee compensation, but is required to match employee deferrals up to 3 percent. SIMPLE IRA Contribution Limits Based on Chad’s total annual compensation, Chad’s contributions to his SIMPLE IRA will total $2,000 for the year—2 percent of his $100,000 in compensation. His employer will also be required to match the $2,000 contribution unless they’ve temporarily cut their matching to as little as 1 percent. Assuming that Chad continues to make the same SIMPLE IRA contributions each year with the same employer matching and an average annual return of 5 percent, Chad’s SIMPLE IRA will grow over the next five years from $4,000 to over $27,000. SIMPLE IRA Contribution Employee Example Let’s assume now that Chad decides to raise his deferral percentage to 4 percent and his employer wants to determine how much they’ll need to contribute to Chad’s account. Using the SIMPLE IRA contribution calculator above, Chad can see that his mandatory employer matching will increase to $3,000 from $2,000. Using this calculator, Chad can also help his coworkers determine how much their mandatory minimum employer matching will be based on their respective salaries and deferral percentages. SIMPLE IRA Total Contributions Using a SIMPLE IRA, an employer can choose to match 100 percent of employee deferrals of more than 3 percent. However, in order to be compliant, the employer must at least match employee deferrals up to 3 percent of their compensation. An employer can drop their match below 3 percent—to as low as 1 percent—but not for more than two years in a five-year period. What Is a SIMPLE IRA A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a retirement benefit plan that small business owners can set up to reward employee savings by matching their contributions. Using a SIMPLE IRA, employees can make up to $13,000 in pretax contributions. Employers are required to match employee contributions up to 3 percent of employee compensation. Using a SIMPLE IRA, employees make pretax contributions to their account by deferring part of their salaries. Employees get to choose how much they defer, but are limited to $13,000 in contributions each year. Business owners then match employee contributions within 30 days. Employers can match employee contributions above 3 percent of compensation and can also cut their match to as low as 1 percent, but not more than twice in a five-year period. If you have a small business and are thinking about setting up a SIMPLE IRA, it’s important to understand the contribution limits, rules, and deadlines. You can learn more about how SIMPLE IRAs work and how to use them by reading our ultimate guide to SIMPLE IRAs. When Employers Should Use a SIMPLE IRA A SIMPLE IRA is ideal for small business owners who have several employees and want to incentivize their saving through matching contributions. SIMPLE IRAs are very similar to 401(k) plans but are much more cost-effective to administer. Using a SIMPLE IRA, employers only have to match contributions from those employees who participate. Some cases where a SIMPLE IRA is particularly beneficial include: Businesses with under a dozen employees - If your small business has four to 14 employees, it’s probably too big for a SEP IRA but too small to be worth the cost of administering a 401(k). Growing companies - Businesses that are still growing probably don’t have profit-sharing contributions because profits are still being reinvested. Matching employee contributions in a SIMPLE IRA can be a great retirement benefit plan. Business with high employee turnover - Business owners can make their own contributions to a SIMPLE IRA and are only required to match contributions for employees who participate. The SIMPLE IRA calculator above is a great tool for employees who have access to a SIMPLE IRA at work and want to know how much they’re set to contribute each year. The calculator can also tell them how much to expect in employer matching contributions and how quickly their account should grow over five years based on their contributions and match. In addition to these benefits for employees, the SIMPLE IRA calculator above is ideal for employers who want to determine how much they may be required to contribute to employee accounts. Using the calculator above, employers can calculate their required employer matching contributions for multiple employees based on annual compensation and deferral rates. What’s Not Included in the SIMPLE IRA Calculator The SIMPLE IRA calculator above is very useful but also excludes several factors. For example, this calculator bases results on the mandatory minimum employer matching—it doesn’t consider if your employer matches contributions in excess of 3 percent of annual employee compensation. In addition, the calculator above doesn’t account for employers who periodically cut their SIMPLE IRA matching to as little as 1 percent. The calculator doesn’t account for catch-up contributions that are allowed for account holders over 50 years old. Lastly, the calculator doesn’t indicate whether another type of account may be a better option for you or allow for higher contributions. Pros & Cons of a SIMPLE IRA When thinking about a SIMPLE IRA for a small business, there are several pros and cons for small business owners to consider. SIMPLE IRA contribution limits are much higher than Traditional IRAs. While contribution limits aren’t as high as 401(k)s, SIMPLE IRAs are much more cost-effective. Using a SIMPLE IRA, employees are able to make up to $13,000 in pretax contributions. While SIMPLE IRA account holders can’t withdraw money without penalty until age 59½, they also pay no taxes until they take withdrawals. What’s more, employees who use a SIMPLE IRA are guaranteed employer matching of 100 percent of employee contributions up to at least 3 percent of their annual compensation. SIMPLE IRA Pros There are many benefits to using a SIMPLE IRA for small business owners who want to encourage employee deferrals without the cost of a 401(k) plan. Employees aren’t required to participate in a SIMPLE IRA, but those that do can contribute up to 100 percent of their income or $13,000. Some SIMPLE IRA pros include: Incentivize employee saving - Using a SIMPLE IRA, employers must match employee deferrals up to 3 percent of total employee compensation. No minimum deferrals - Employees aren’t required to participate in a SIMPLE IRA if they don’t want to. Low-cost plan - SIMPLE IRAs are structured very similarly to a 401(k) but don’t have the administrative costs. Flexible investment options - Account holders can invest in many different things through an IRA. If you ever leave your company, it’s easy to use your account to set up a self-directed IRA. SIMPLE IRA Cons While SIMPLE IRAs have many distinct advantages, there are also several drawbacks to these plans that employers should consider before implementing one for their small business. The biggest disadvantage is that employers who use a SIMPLE IRA are required to match employee deferrals. The contribution limits also aren’t as high as a 401(k). SIMPLE IRA cons include: Mandatory employer matching - Using a SIMPLE IRA, employers are required to match employee deferrals up to at least 3 percent of employee compensation. Employers can match more than 3 percent and they can also cut their match to as low as 1 percent—but not for more than two years in a five-year period Mediocre contribution limits - SIMPLE IRA contribution limits are $13,000, which is higher than the $6,000 allowed for a Traditional IRA but still lower than a 401(k). Can’t borrow against - Unlike a 401(k), you can’t borrow against IRAs including a SIMPLE IRA. SIMPLE IRA Alternatives If you work at a company, you don’t decide whether you have access to a SIMPLE IRA. Your employer decides whether to offer a SIMPLE and you decide to participate or not. However, there are also accounts that you can use in addition to a SIMPLE. There are also other accounts that business owners can choose to offer instead of a SIMPLE. Three of the most common SIMPLE IRA alternatives are: 1. SEP IRA A SEP IRA is an employer-sponsored retirement plan that allows tax-free contributions up to 25 percent of employer income or $56,000, whichever is less. Using a SEP, employers choose whether to contribute to their account each year. However, whenever employers contribute to their own account, they’re required to make contributions for employees that are proportional to their own contributions based on annual compensation. SEP IRAs have extremely high contribution limits, making them ideal for businesses with high profitability. However, because a SEP IRA requires employers to fund contributions for their employees in addition to themselves, these plans are better for self-employed individuals and businesses with about five employees or fewer. For more information, be sure to check out our ultimate guide to SEP IRAs. 2. Traditional IRA A Traditional IRA is a very simple and straightforward retirement account. Traditional IRAs aren’t set up by employers. Instead, anyone who’s eligible for a Traditional IRA can set one up. Using a Traditional IRA, investors can contribute up to $6,000 pretax. A Traditional IRA is a great account for freelancers and independent business people who don’t have a lot of revenue. The contribution limits for Traditional IRAs are very low, but account holders can make contributions whenever they choose and businesses don’t have to make contributions for employees. 3. 401(k) A 401(k) plan is the gold standard in employer-sponsored retirement benefit plans. Using a 401(k), employees can make up to $19,000 in pretax contributions to their account through salary deferrals. Employers then have the option of matching these contributions, but can adjust their match as necessary. 401(k) plans are ideal for companies that have 15 to 18 employees or more. Using a 401(k), these businesses can facilitate employee saving and give employers the option of matching employee contributions or even provide profit-sharing contributions up to $18,000. For a low-cost, full-featured 401(k) plan that is able to grow as you do, consider . Their advisors and customer success managers will help you determine the right plan design, conduct employee education, and answer all your 401(k) questions. The one-time setup fee is $750 and administration costs start at just $100 per month. Get started at ShareBuilder 401k. Bottom Line A SIMPLE IRA is a great account for small business owners who want to provide retirement benefits that incentivize employee saving. Using the SIMPLE IRA calculator above, you can see how much you’ll contribute to a SIMPLE IRA during a year, the mandatory minimum employer matching, and how fast your account will grow over five years. If you’re a small business owner and you think a SIMPLE IRA may be a good option for your company, you should read more about the process of setting up a plan.

A fiduciary financial advisor is an investment professional who is licensed with the United States Securities and Exchange Commission (SEC) or state regulators. Fiduciary advisors are important for clients because they are legally required to put clients’ interests ahead of their own. Using a fiduciary is important if you want an advisor to manage your money or make unbiased investment recommendations. What Is a Fiduciary Financial Advisor? A fiduciary financial advisor is required to represent clients objectively and sell clients products without regard for their compensation. Many services are the same for fiduciary vs. financial advisors including investment management and portfolio recommendations. There are two big differences in using a fiduciary advisor — compensation structure and legal requirements that advisors put your interests first. Financial advisors who aren’t fiduciaries often receive commissions on the investments they sell. While nonfiduciaries must sell investments that are appropriate — or suitable — based on individual client circumstances, they are not required to put their clients’ interest first. A fiduciary advisor is important if you plan to give an advisor discretionary control of your account if you aren’t sure what you need and want sound, objective advice. Fiduciary vs. Financial Advisors The biggest difference between fiduciary vs. financial advisor is the standard they're held to when advising clients. Most financial advisors have to sell investments that are suitable for clients, but fiduciaries must act with a higher standard of care. As a result, fiduciary advisors are often less expensive because client accounts aren’t charged commissions. Some ways to distinguish a fiduciary vs. financial advisor include: Registration: If your financial advisor is registered with the SEC or state securities regulators, they are required to act as fiduciaries in at least some situations Series 7: A financial advisor who holds a FINRA Series 7 license doesn’t act as a fiduciary all the time — they may never be a fiduciary Series 65 or 66: Advisors who hold investment advisor licenses from Financial Industry Regulatory Authority (FINRA) are typically held to a fiduciary standard at least some of the time Certified financial planner (CFP): Whether a financial advisor is a CFP provides no indication whether they’re a fiduciary Trade associations: Membership in some trade association like the Investment Advisors Association (IAA) can indicate that a financial advisor acts as a fiduciary at least some of the time Suitability Standard vs. Fiduciary Financial Advisors When working with a typical financial advisor, the advisor is held to a standard of suitability. This standard requires that advisors understand their client’s circumstances and sell them investments that are appropriate. Fiduciary financial advisors, however, are held to a different standard. Under a fiduciary standard, advisors are legally required to put their clients’ interests first. If you’re wondering which standard your advisor is held to, you can always ask them directly and have them provide an answer in writing. However, there are also some red flags that should indicate whether your advisor is a fiduciary vs. financial advisor. Some red flags that your advisor doesn’t always act as a fiduciary include: Series 7 license: If a financial advisor has a Series 7 license they are allowed to collect commissions from the sale of investments, which means they don’t always act in a fiduciary capacity Series 63 or 66 license: A Series 63 or 66 is another license that a financial advisor needs to collect commissions, but if they collect commissions on product sales that means they don’t always act as fiduciaries Website Disclosures: Many financial advisory firms include disclosures including “securities offered through ...” or “representatives licensed with …” that are red flags that these firms collect commissions from the sale of securities — meaning they don’t always act as fiduciaries “While there are indicators, the only real way to tell whether an advisor is a fiduciary is to check their advisor agreement. It's especially important to work with a fiduciary advisor if you're giving discretionary control of your account to an advisor or if you aren't familiar with the investment world and need help. There aren't any situations where a client is better off working with someone who isn't required to act in their best interest. Another good way to tell whether an advisor is a fiduciary is to check their SEC or state registration. If your advisor has a Form ADV on file, that's a sign that they act as a fiduciary at least some of the time. If they also periodically in a nonfiduciary capacity, that will be disclosed in their ADV.” — Patrick Cote, chartered financial analyst (CFA), CFP, Founding Partner, Cote went on to say “Other red flags that someone doesn't always act as a fiduciary include Series 7, 63, or 24 licenses. If your advisor is a member of the IAA, that typically indicates that they act as a fiduciary at least some of the time. However, there's no one designation that a client can look at to know whether their advisor is a fiduciary — CFAs, CFPs or CPAs [certified public accountants] may or may not be fiduciaries.” When to Use a Fiduciary Advisor Clients are almost always better off using a fiduciary. In fact, there’s rarely a reason not to use a fiduciary. However, you may not need a fiduciary if you don’t want an advisor to manage your account on your behalf or even make recommendations. However, if you want an advisor to execute transactions or to buy insurance, there’s no need to use a fiduciary. If you want a financial advisor who will manage your money for you, then it’s important for you to use a fiduciary advisor. Even if you just want to ensure that you get unbiased investment recommendations, then it’s a good idea to use a fiduciary vs. a financial advisor. “In most cases, any SEC-registered investment advisor must serve as a fiduciary. To ensure this, it's best if the advisory agreement specifically states the adviser accepts it will be held to the standard of a fiduciary under SEC/ERISA definitions. Any time you're delegating investment advice to a third party (even if you will still ultimately make the decision to buy and sell securities based on that advice). In addition, especially in the case of employee retirement plans, hiring a professional fiduciary can reduce your own personal fiduciary liability.” — Christopher Carosa, CTFA [certified trust and financial advisor], President, Types of Fiduciary Financial Advisor Not all financial advisors are fiduciaries, but those that qualify as fiduciaries are required to act in their client’s best interest. All fiduciaries are held to this standard, even though different of fiduciary advisors do different things. Some manage money for clients while others help guide investment decisions or helping choose 401(k) investment options. Some of the most popular types of fiduciary financial advisors include: Discretionary Investment Advisor Some fiduciary financial advisors assume discretionary control of clients’ investment accounts. These fiduciaries manage their clients’ assets on their behalf, executing trades when they deem necessary. These advisors typically collect investment management fees. They’re registered with the SEC or state regulators and required to act in clients’ best interest in their capacity in managing client portfolios. The most common type of fiduciary financial advisor is a discretionary investment manager. These are advisors who have management agreements with individual clients and make investment decisions on their clients’ behalf. Advisors typically charge monthly or quarterly fees for this service which are either flat fees or based on the size of client accounts. Portfolio managers for mutual funds are also qualified fiduciaries. Nondiscretionary Fiduciary Financial Advisor There are some financial advisors who don’t have decision-making authority for client accounts but make recommendations for clients’ investments. If these advisors are registered as investment advisors with the SEC or various states, they are held to a fiduciary standard when making recommendations for clients. A nondiscretionary fiduciary advisor is most commonly seen advising on employer employer-sponsored retirement plans like 401(k)s. These advisors help plan participants make decisions but don’t make investment decisions on their behalf. Nondiscretionary fiduciary advisors can also serve as financial managers who want to advise but not make financial decisions for clients. Certified Financial Planner A CFP is an advisor who has gone through additional training and gotten their designation from the Financial Planning Association. A CFP may or may not be as a fiduciary, depending on the licenses and registrations they hold. If they have a Series 7 license, that means they don’t always act as a fiduciary. “When a financial advisor sells a product, the costs are buried in the product cost and not readily discernible by the client. Most fiduciaries are paid by engagement or on a monthly or quarterly retainer. With these forms of payment, the client agrees to either have fees deducted from an investment account or they choose to receive an invoice and write a check. The all-in costs to the client are no more when the client is aware of the fee when it’s deducted from an investment account or paid by the client than when the comp is buried in the investment contract.” — Randy Brunson, AIF [accredited investment fiduciary], CEO, A CFP acting as a fiduciary may serve in either a discretionary or nondiscretionary capacity. The CFP designation indicates that an advisor has undergone additional training in order to provide more comprehensive help to clients’ finances. These advisors are particularly helpful if you may also need insurance, annuities or other special products. Retirement Plan Fiduciary Advisor If you have a 401(k) at work, your employer is a fiduciary for your retirement plan. However, many employers hire a financial advisor to share in those responsibilities. There are two main types of retirement plan fiduciary advisors — those that help select 401(k) investment options those who make investment decisions for plan assets. “If you're looking for an advisor for a business, there are several different types of fiduciaries for retirement plans. The higher the level of fiduciary, the more responsibility the advisor takes on. However, plan sponsors never give up their fiduciary responsibility to the plan. One level of fiduciary to retirement plans involves the advisor helping to choose the fund lineup for a plan. Another level of fiduciary — the 3-38 fiduciary — is sometimes used by smaller companies to serve as an investment manager, making investment decisions directly and investing plan assets on behalf of the firm.” — Susan Powers, CFA, CPA, CFP, Partner, Most employer-sponsored retirement plans have an advisor who serves the plan. This is particularly important for businesses that have more than four or five employees. Business owners typically need help setting up a retirement plan and only get limited guidance from a plan administrator. These advisors are typically paid from plan assets. Fiduciary Financial Advisors for Small Business Owners In addition to advising on retirement plans, some fiduciary financial advisors can help small business owners in other ways. These include objective advice on succession planning and providing guidance on insurance products. So many different insurance products are available that it can be helpful to have a fiduciary provide objective advice based on specific needs. Fiduciary advisors who work with small business owners serve as trusted advisors. Many act as financial managers for company owners who are focused on running their own businesses. Often, these services are part of a larger relationship such as a private banker or CPA. Fiduciaries who service small business owners usually have certain specialties like succession planning or financing solutions for business needs. Fiduciary Financial Advisor Duties There are many different kinds of fiduciary financial advisors, although they’re all held to the same fiduciary standard. Fiduciaries are required not only to provide investments that are suitable for the clients but also always put their clients’ interests first when managing money for a client or helping them make decisions. Some fiduciary financial advisor duties may include: Managing money: Some fiduciaries manage money on their clients’ behalf Recommending investments: Clients may make their own investment decisions but get objective advice from a fiduciary 401(k) guidance: Fiduciary advisors can help choose investment options available to 401(k) plan participants Manage retirement plan assets: Some fiduciaries make investment decisions and manage money on behalf of a retirement plan Financial Advisor Fees Fiduciary financial advisor costs vary based on provider and the services they’re providing. Depending on the firm, fiduciaries may charge fees for managing client portfolios, subscription fees, hourly consulting fees or other costs. However, fiduciary advisors are typically less expensive than the costs clients pay through nonfiduciary advisors. Fiduciary financial advisor fees may include: Advisory fees: 0.25% to 2.00% of account assets per year The most common fee structure among fiduciary advisors is to charge a fixed percentage of the value of the account(s) they’re advising on. Fees can be up to 2 percent per year and are typically deducted from the account quarterly. Consulting fee: $20 to $200 per hour Rather than charge account management fees, some fiduciaries charge flat hourly fees for helping to guide clients. Clients can then make their own investment decisions after getting objective advice from a fiduciary. Subscription fee: $0 to $5,000 per quarter Some fiduciaries provide investment advice that clients can use to make their own investment decisions. Rather than billing per hour, they simply charge invoice clients each month or quarter in exchange for giving clients access to their advice. Retirement plan administration fee: 0.15% to 1.5% of plan assets per year Fiduciary financial advisors who help guide employer-sponsored retirement plans typically charge an advisory fee that’s based on the number of assets in the plan. Financial advisors charge different fees that vary in structure and in level. These fees depend in large part on the services an advisor is providing to clients. However, before you work with a financial advisor (fiduciary or not), it’s important to understand how an advisor is going to be paid. “Not using a fiduciary advisor opens you up to paying a lot of extra fees, usually in the form of commissions. For example, if you are an investor with $100,000 to invest, a nonfiduciary advisor may allocate your investment into a fund that pays large commissions. It is not uncommon for nonfiduciary advisors to invest clients' money in a fund that charges a front-end sales fees of 5 percent or more and expense ratios of 1 percent or higher. For an investor with $100,000 invested in a fund with a 5.75 percent front-end sales fee and a 1 percent annual expense ratio, they pay $5,750 in upfront sales fees (most of which are paid to the advisor as commissions), followed by $942 in the fund's expense ratio (1 percent of $94,250).” — Matt Hylland, President, Hylland Capital Management Hylland went on to say that “a fiduciary advisor will invest you in a fund that has no upfront sales fees and has a much lower expense ratio. Even after accounting for their management fee, they can be significantly cheaper.” How to Identify Fiduciary Financial Advisors There are many ways to tell that a financial advisor isn’t a fiduciary. Fiduciary financial advisors have to be registered with the SEC or state regulators, but it can be hard to tell how an advisor is registered. Luckily, in addition to the SEC, there are other ways that you can tell with an advisor is a fiduciary. Four ways to identify fiduciary financial advisors include: Search investment advisor public disclosure: Investment advisers registered with the SEC or states are all searchable in the SEC’s database. You can also see if advisors have broken rules or a firm’s Form ADV with fees and assets under management. Advisor website: Look for advisors who are “fee-only.” Fee-based advisors may act as fiduciaries, but the fiduciary standard always applies for fee-only advisors. Mention of commissions or the sale of securities also means an advisor isn’t a fiduciary. Just ask: One of the best ways to find out if a financial advisor is a fiduciary is to ask them directly. When you ask about their fee structure or whether they act as a fiduciary financial advisor, it can be a good idea to get answers in writing. Search directories: Another way that you can try to find financial advisors is to search directories for trade associations. The IAA, for example, has many members that serve as fiduciary financial advisors. “Whether an advisor is acting as a fiduciary or has fiduciary obligations can be very difficult for the layperson to determine. Because duties apply to different advisors depending how they are regulated or even by their title or other designation, perhaps the best way to identify whether an advisor has fiduciary obligations is to ask the financial advisor. Those who hold themselves out as a fiduciary should be able to clearly articulate how they are prepared to act in accordance with their fiduciary obligations and to describe the impact their actions or requirements have or will have on their clients.” — Kathleen A. Stewart, JD AIF, Senior Director, Family Wealth Strategist,   If you want to work with a fiduciary financial advisor, you should also make sure that they have adequate insurance. This includes fiduciary liability insurance, which helps protect you if your advisor makes a mistake when administering your account or managing your assets. 5 Top Fiduciary Financial Advisors Many fiduciary financial advisors are smaller, lesser-known firms. However, there are also some large firms that operate as fee-only fiduciary advisors or who serve as fiduciaries in some roles but not in others. It’s critical for clients to inquire whether their advisor will act as a fiduciary or be collecting commissions or other compensation on investments. Five of the best-known of firms that offer fiduciary financial advisor services are: Fidelity offers a number of banking, brokerage, and advisory services. While Fidelity representatives don’t always act as fiduciary financial advisors, they do have some advisors who can act as fiduciaries. However, investors need to be cautious of what services they’re buying and make sure that their advisor will act as a fiduciary and their account won’t be charged commissions. BNY Mellon Wealth Management is part of an extremely large and storied financial institution that has a dedicated fiduciary services unit. Not all reps within the wealth management department are fiduciary advisors, but clients of the fiduciary services unit can rest assured that they have a fiduciary financial advisor watching over their account. Fisher Investments is one of the world’s largest fee-only advisor and manages about $100 billion. Financial advisors with Fisher Investments always act as fiduciary financial advisors because of how the firm is structured, so the firm is ideal for clients who don’t want to worry about whether their advisor will act as a fiduciary. Vanguard is the largest mutual fund company in the world. As a very large and well-established company, Vanguard focuses on providing management services to dozens of mutual funds and exchange-traded funds (ETFs). The company also offers fiduciary services to select clients, which is a great option for individuals who want to focus on cost-efficient passive investing. Charles Schwab is a huge diversified financial services company. The firm offers retail banking, brokerage and investment advisory services including in a fiduciary capacity. Schwab is ideal for clients who want a partner to help grow their business with products like checking accounts and business loans in addition to offices all over the country. Fiduciary Financial Advisors Frequently Asked Questions (FAQs) If you still have questions about fiduciary financial advisors, here are some of the most frequently asked questions about fiduciary advisors. What Is the Fiduciary Rule? Registered investment advisors are held to a fiduciary standard when advising client accounts. This fiduciary standard requires fiduciary financial advisors to put their clients’ interests first. The fiduciary rule was also a rule proposed by the U.S. Department of Labor to limit advisor compensation from retirement accounts, but the rule’s no longer being enacted. How Do Financial Advisors Make Money from Mutual Funds? Nonfiduciary advisors are paid commissions when they sell shares in mutual funds. Advisors can also share in 12b-1 fees that are paid annually by most mutual funds. Fiduciary financial advisors can’t collect commissions or other compensation directly from mutual funds but are limited to independent management or advisory fees that they charge to clients. Is a Trustee a Fiduciary? A trustee is a person or entity that holds legal title to a property. In a trust, a trustee has certain duties to perform on behalf of the trust’s beneficiaries. However, a trustee is not a fiduciary. A fiduciary is a person or firm that is legally required to exercise reasonable care in managing a client’s assets. Can You Sue a Fiduciary Advisor? If you’ve suffered losses as a result of fraud or negligence by a financial advisor, you may have grounds for filing a lawsuit against a financial advisor. If you can prove that your advisor was fraudulent or negligent in their guidance or management of your account, you may be able to claim your losses as damages. The Bottom Line Fiduciary financial advisors are investment professionals registered with the SEC or state securities regulators. Fiduciary advisors can’t collect commissions from selling investments and must put their clients’ interests first. If you aren’t sure what investments you need or want an advisor to manage your account, make sure your financial advisor is held to a fiduciary standard.

An employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit plan that provides the employees of a business an ownership interest in that business. An ESOP is used by employers to either reward employees or as an exit strategy from business ownership. If owned by an ESOP, the business can receive great tax benefits. How an ESOP Works An ESOP is an employee benefit plan that’s established by the owners of a company. Using an ESOP, the plan either borrows funds or receives contributions from the company, which are used to purchase shares in the business. This allows business owners to transfer full or partial ownership of their company to employees and enjoy numerous tax benefits. When business owners establish an ESOP as a retirement benefit for their employees, they use a plan document to outline the structure of a plan and its governing policies. They also appoint a trustee or committee to oversee the plan in accordance with the plan document. One of the company’s employees is usually appointed to represent employees’ interests. When a plan document is structured for an ESOP, it often includes certain limits or restrictions. Business owners can transfer full or partial ownership of their company to employees with either voting or nonvoting shares. Using this structure, business owners can keep control of the company until the ESOP buys all of their shares. ESOP Benefits for Employees An ESOP is a great benefit for eligible employees. ESOP eligibility is outlined in the plan document. According to the IRS, the maximum age an employer can impose to be eligible for an ESOP is 21 and employees must be eligible for the ESOP within a year of joining the company. An employer can restrict eligibility to employees with two years of service but only if the plan has immediate vesting. One of the biggest ESOP benefits for employees is that an ESOP enables employees to accumulate shares in the business without contributing any of their own money. Instead, the company makes contributions every year that are used to buy shares or to repay a loan that was used to buy shares. “The main use of employee ownership is business transition. An owner (or owners) can sell to a third party (sometimes) or just gradually take money out of the company and shut it down, but neither of these preserves the legacy the owner has worked so hard to build. By using an ESOP, the company can continue, and the owner can play any role they want going forward. The owner gets a fair price and can defer taxation on the gain by reinvesting in other securities.” — Corey Rosen, Founder, National Center for Employee Ownership Rosen went on to say that “owners don't have to sell all at once. They can sell out some now and some later, or one owner can sell and another not. But ESOPs only work for companies that have enough profit to purchase the shares and still run the business, and they generally are not worth doing in companies under about 20 employees because of the costs and complexity.” Types of ESOPs There are three main types of ESOPs that employers can use to transfer full or partial ownership of a company to their employees. The plan document governs the plan including the plan type. Most of this article focuses on unleveraged ESOPs as the most straightforward type of plan, but there are other types as well. The three primary types of ESOPs are: 1. Unleveraged ESOPs Unleveraged ESOPs are the most basic type of ESOP and the focus for most of the rest of this article. Using an unleveraged ESOP, a company makes periodic contributions to the plan, which are then used to buy shares in the company from current owners. An unleveraged ESOP is ideal for business owners who want to be bought out over time. These plans are also great ways to reward employees who stay with the company over extended periods of time instead of the employees who are with the company at a single point in time. 2. Leveraged ESOPs In a leveraged ESOP, a plan takes out one or more loans from a bank or other lender. These borrowed funds are used to buy shares in the company from its current owners. The company then makes regular contributions to the ESOP which are used to repay the loans. Leveraged ESOPs are also very common and are usually a much better option for business owners who want to be bought out quickly. Using a leveraged ESOP, these business owners can structure a loan for the ESOP to buy large numbers of shares in the company all at once rather than in little pieces over time. 3. Issuance ESOPs Issuance ESOPs are the least common form of ESOP. A company using an issuance ESOP makes regular contributions to the plan comprised of newly issued shares of company stock rather than cash. An issuance ESOP is a great choice for business owners who don’t want to contribute profits to the plan but instead want to issue new shares to the plan. Using this structure, current owners of the business have their ownership shares diluted over time as the number of outstanding shares increases.   ESOP Benefits for Business Owners ESOPs are especially beneficial for companies whose owners want to worry about finding a buyer for their business. Instead, business owners can use an ESOP to create a built-in buyer for their company. ESOPs are also a great feature to help attract talented employees and to reward long-time employees for their service. Some scenarios when ESOPs are useful include: Attracting talented employees: An ESOP is a great benefit that doesn’t cost employees anything to participate, which is a powerful recruiting tool Rewarding employees with stock: If you have employees that have been with your business for years, an employee stock plan is a terrific way to reward them for their service Eventually transferring control of a business: ESOPs allow business owners to create a built-in buyer for the company Low-cost benefit to employees: Employees don’t have to pay to participate in an ESOP, unlike in a 401(k) where part of their contributions are used to pay plan expenses; instead, businesses cover the costs of an ESOP and make the contributions to buy company stock from the current business owners Using an ESOP, business owners can make contributions to the plan each year that are tax-deductible up to 25 percent of the company’s payroll. Business owners can also have the ESOP borrow money to buy shares in their business. “Employers of private companies should consider the costs to establish and administer an ESOP. There are benefits, including increased productivity, that must be considered. ESOP advantages include employee ownership and increased productivity. They're also a flexible way to sell all or part of a business. Disadvantages include diluted ownership and tax implications for participants who need to sell their shares prematurely.” — Levar Haffoney, Principal, Fayohne Advisors One of the biggest benefits of an ESOP for small business owners is tax treatment. If your business is structured as a C-corporation, any profits paid to the ESOP as dividends are tax-deductible to the company. Once an ESOP owns 100 percent of a business, the business is exempt from corporate income taxes. When Not to Use an ESOP ESOPs are a great benefit for many small businesses, but they aren’t always good to use. ESOPs often don’t work for very large companies that cost too much to buy, super small businesses with few employees or businesses that have trouble retaining employees. Some cases when an ESOP may not be helpful are: Large valuable companies: Very large or publicly-traded companies are often too valuable for ESOPs to purchase even over time Very small companies: Super small businesses with low revenue or few employees often aren’t worth the cost of setting up an ESOP Multigenerational businesses: If you have a company that has been family-controlled for generations, you may want to make sure that stock ownership stays within the family Retirement asset businesses: If you’re depending on the sale of your business to finance your retirement an ESOP may not be a good choice because it uses company profits to finance a buyout One of the biggest ESOP benefits is tax treatment. Using an ESOP, businesses can make contributions to the plan that are tax-deductible for the employer. This allows business owners to reward employees while also reducing their tax burden. For more information on the benefits of ESOPs, be sure to check out the Pros & Cons section below. How ESOP Vesting Works Employers offering ESOPs choose the schedule for vesting shares that employees own through an ESOP. Vesting schedules are outlined in the plan document, and if you leave the company before you’re fully vested, you forfeit some stock. The IRS requires that employees be fully vested after no longer than six years depending on the type of vesting. Under Section 411 of the Internal Revenue Code, employers who use ESOP vesting can choose from two different types of vesting schedule. Under graded vesting, employees are vested in even amounts over several years, but they must be fully vested within 6 years. Employees with a cliff vesting schedule vest all at once within no more than 3 years. ESOP Vesting Minimum Requirements Employees whose plans are subject to ESOP vesting schedules may vest faster than these minimum requirements, but according to IRS rules, they can’t vest slower. It’s also worth noting that vesting does not occur for each year individually but all at once. For example, if an employee covered by cliff vesting leaves in the fourth year, he or she gets to keep 100 percent of his or her stock holdings in the ESOP — not just their stock purchased within the first 2 years. ESOP Immediate Vesting There are minimum vesting requirements that businesses must meet to use an ESOP. However, business owners can include faster vesting schedules in their plan document. Some ESOPs immediately vest stock owned by employees through an ESOP. Those shares can be sold at any time or kept if an employee leaves the plan. ESOP Tax Benefits ESOP taxes for employees are very low. Employees don’t pay any taxes on employer contributions to the plan, and there’s no tax implication as the employees accumulate ownership through the ESOP. The only taxes that employees pay in an ESOP are on profit distributions, and individual retirement account (IRA)-eligible participants can sometimes roll distributions into an IRA to grow tax-free. Employee ESOP tax considerations include: No taxes on employer contributions: Employer contributions of cash or stock are tax-deductible to the employer up to 25 percent of the company’s total payroll; contributions also aren’t taxable to employees No taxes on contributions to repay ESOP loans: If your ESOP borrows money to buy shares in the business, contributions used to repay the loan are not taxable for employees; they’re also tax-deductible for employers No taxes on accumulated ownership percentage: As employees build ownership in the business through the ESOP, there are no taxes on this increased ownership Taxes on profit distributions: Employee distributions from an ESOP are taxable but may be taxed as capital gains instead of income or rolled into an IRA with all taxes deferred ESOP distributions are subject to some of the same rules as IRA distributions. This means that in addition to income or capital gains taxes on ESOP distributions, employees may also be subject to a 10 percent penalty if they take distributions before age 59 1/2. ESOP Tax Benefits for Small Business Owners ESOPs offer numerous tax benefits for small business owners. Using an ESOP, employers can contribute either cash or stock which is tax-deductible for the company. The biggest tax advantage of an ESOP is that if a business is fully owned by an ESOP, then it is exempt from corporate income tax. In addition to tax-deductible ESOP contributions, business owners can also get additional tax benefits from selling their stock to an ESOP. For example, business owners can often defer capital gains from their sale of stock to an ESOP, once the plan owns more than 30 percent of the company. To do this, company owners must reinvest any money they earn when the ESOP buys their shares. ESOP Rules If your employer offers an ESOP, there are certain rules that need to be followed to ensure that your plan isn’t disqualified. When structuring an ESOP, employers must offer vesting schedules that meet certain minimum standards. Businesses must also be sure to enroll all employees who become eligible for the plan. If you have an ESOP through work, be sure that your employer is following these rules carefully in their administration of the plan. Failure to follow these rules can cause your plan to be disqualified or your employer to incur penalties. ESOP Rules for Business Owners In order to use an ESOP, employees need to ensure that their employers are following certain ESOP rules. For example, business owners must enroll all eligible employees. Employer ESOP contributions are also limited based on a company's revenue. Contributions are capped at 30 percent of earnings before interest, taxes, and depreciation amortization (EBITDA). Some important ESOP rules to follow include: ESOP contribution limits: Employer contributions to an ESOP can’t exceed 30 percent of EBITDA Enroll all eligible employees: Employees who are eligible for an ESOP can’t be excluded unless they opt-out Follow vesting guidelines: If you include an ESOP vesting schedule in your plan document be sure to follow it just like a 401(k) vesting schedule Pay ESOP taxes: There are taxes on employee ESOP distributions, but employer contributions are tax-deductible up to 25 percent of the company’s payroll Employee representation: An ESOP must have a trustee appointed to represent the interests of employee participants Meet ESOP vesting requirements: Employers can use either cliff or graded vesting, but employees must be vested after no longer than a 3-year cliff or 6-year graded vesting period; for more information, be sure to check out the How ESOP Vesting Works section above If you work for a company that offers an ESOP, it’s critical that your employer follow ESOP rules. If your employer violates these rules, your plan can encounter penalties or unexpected tax liability. This is why it’s important that employees choose someone knowledgeable and trustworthy to represent their interests in the ESOP. ESOP Costs ESOPs can be very expensive to set up and administer. However, one of the biggest ESOP advantages for employees is that they pay almost none of the costs. The biggest cost that employees may incur from an ESOP is that their stock ownership plan may take the place of cash bonuses or profit sharing. ESOPs are expensive but have almost no direct cost for employees. However, as an owner, the plan eats into potential dividends or value of ownership. Businesses also pay the costs of recordkeeping, financial advisors who help structure the transaction, and costs for contributions. The costs must all be paid before either the company owners or the ESOP get profit distributions from the company. Some ESOP costs include: Setup costs: $75,000+ Businesses must pay legal fees and appraisal costs to set up an ESOP, which drastically increase the first-year costs of the plan Ongoing administration: $20,000+ annually Maintaining an ESOP requires annual reviews as well as representation by a trustee whose job is to protect plan participants Recordkeeping: $2,000 to $5,000 plus $25 to $50 per employee Details records must be kept of contributions to the plan as well as stock purchases and allocations and vesting for each employee Contributions: Discretionary for employer Most employers set up ESOPs with regular contributions each year for a set period of time, but ESOP contributions are decided by the employer Taxes: None ESOP contributions are tax-deductible up to 25 percent of total payroll and aren’t taxable to employees. Employee distributions are taxable, but those taxes can often be deferred if employees roll their distributions into an IRA. Financial advisor fees: 1 to 3% of transaction size This cost is optional, but many employers retain financial advisors to guide and structure buyouts with ESOPs While employees don’t pay these costs directly, it’s important to be aware of how they work. As an ESOP builds assets and owns more of the company, more of these costs will be borne indirectly by employees as shareholders in the company. Understanding these costs is also important for employees to ensure that the plan is run properly and for their benefit. ESOP vs. ESPP In an employee stock purchase plan (ESPP), employees contribute to the plan through salary deductions similar to a 401(k). Those contributions are then used to purchase stock in their employing company, often at a discount. Unlike ESPPs, ESOPs don’t have employee contributions. Instead, employers make tax-deductible contributions to buy company owners’ stock for the plan. Employees don’t get a choice between an ESOP or an ESPP. Instead, an employer chooses one and sets it up. However, employers are better off using an ESPP if they want to incentivize employee saving and have employees pay them for part of the company, rather than financing their own buyout with an ESOP. Employers who choose an ESPP should also be willing to accept lower plan participation since ESPPs require contributions from employees or be willing to sell only a part of their company. Using an ESOP, company owners essentially have to contribute the money for their employees to buy their companies, but they can control the pace and structure of their company sale. Pros & Cons of an ESOP ESOPs are a great benefit for employees. Employees get to build an ownership stake in a business with almost no personal costs. Costs are high but are borne almost entirely by the business. However, business owners also get to make tax-deductible contributions and can use an ESOP to attract very talented employees. Pros of an ESOP For employees, the advantages of an ESOP are numerous. Employees get free shares in the company which they can later sell. Employees can also eventually take over running the company when the buyout is complete. ESOPs are also great recruiting tools for employers, but the biggest benefit of an ESOP for business owners is tax treatment. Some ESOP pros include: No taxes for employees: There are no taxes on ESOP plan contributions - only on distributions which may be deferred if you roll into IRA No cost to employees: Employees pay none of the costs of an ESOP, unlike a 401(k) where some of their contributions are used to cover plan administration costs Built-in buyout: Employees who have access to an ESOP plan don’t have to wonder if or when they may be able to buy the business — it’s all set up for them Employees can eventually take over the business: After an ESOP completes a buyout of a company, the employees can take over management of the business Tax-deductible contributions: ESOP contributions are tax-deductible for business owners, which helps them reduce their tax liability Great for attracting other top employees: If your employer offers an ESOP plan, they can use it to recruit other strong employees to help grow your business and build the value of the company, part of which you will own Cons of an ESOP There are virtually no ESOP drawbacks for employees except that their ESOP may take the place of cash bonuses or profit sharing. Employees also may not have any way to protect their investment in the company if their plan doesn’t give them the ability to make management decisions for the company. The biggest drawback for ESOPs is the high cost for employers. Some cons of an ESOP plan include: Employees may not have control: Even though employees will be invested in a business through their stock plan, their plan may not grant them any rights to make decisions for the company, making it difficult or impossible for employees to protect their investment Have to make sure business is run for benefit of the plan: Owners of businesses with stock plans owe a fiduciary duty to their shareholders including the plan, which means that they must run the company for the plan’s benefit and can’t take too much compensation Expensive for employers: ESOPs are very expensive for businesses to implement and administer 4 Steps for Business Owners to Set Up an ESOP Setting up an ESOP doesn’t typically require any input from employees — employers decide whether to set up an ESOP and employees have the option to participate. If your employer does offer an ESOP, it’s up to you to familiarize yourself with enrollment qualifications and make sure that you enroll when you’re eligible. For business owners, however, there are several steps that you’ll need to take to set up and use an ESOP. In order to set up an ESOP plan, you’ll want to work with an attorney for a company that specializes in designing and implementing plans. You’ll also need to make sure all eligible employees are enrolled and that you make contributions to the plan. The four steps for business owners to set up an ESOP are: 1. Employer Chooses an ESOP Provider Setting up an ESOP requires hiring a lawyer and appointing a trustee to represent the employees in the plan. While some business owners can set up ESOPs using their attorney and financial advisor, it can be a good idea to use a specialty company to help set up an ESOP. A few good providers that can help business owners set up an ESOP plan include: Principal Financial is a large financial services company that provides advising services to large institutions. One of Principal’s specialties is in providing employee benefits including 401(k)s, insurance plans, and ESOPs. Principal is a great provider for businesses that offer other employee benefits in addition to employee stock plans. The provider is also great for business owners who need help with succession planning or insurance needs. E-Trade is known as a discount online brokerage firm. The company offers cost-effective trading platforms for many types of accounts including IRAs, simplified employee pension plans (SEPs), and Solo 401(k)s. However, E-Trade has also expanded their offerings to include many employee benefit plans like ESOPs. Businesses looking for a cost-effective provider for their employee stock plan should consider working with E-Trade. E-Trade is also an ideal ESOP provider for companies or business owners that already have an account with E-Trade. Greenberg Traurig is a huge international law firm. The firm is extremely reputable and very knowledgeable in many areas of law including employer-sponsored retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). Greenberg Traurig is a great law firm for midsized businesses who want to work with a high-quality law firm to set up their ESOP. Business owners who work with Greenberg Traurig can expect great legal advice if they can absorb the high cost. 2. Draft & Adopt ESOP Document Once you choose a provider, businesses must work with their attorney or ESOP provider to prepare an ESOP document. ESOP plan documents outline information about the plan including eligibility criteria and employee vesting schedules. The plan document must also designate a trustee to represent employees in the plan. 3. Enroll ESOP Eligible Employees After the ESOP plan document is drafted and adopted, employers need to enroll all employees who are eligible to participate in the ESOP. Qualifications for participation are outlined in the plan document, and employers must be careful not to exclude any employees who are eligible for the plan. 4. Make Cash or Stock ESOP Contributions When the plan document has been formed and employees have been enrolled, the last thing left for employers to do is to administer their ESOP. This can be done by having the ESOP borrow money to purchase stock in their company and then making tax-deductible contributions to repay the loan. Alternatively, employers can contribute stock directly to the ESOP or contribute cash which is used to purchase their shares. If you choose to use a leveraged ESOP these steps are basically the same except for the actual administration of a plan. Under a typical unleveraged ESOP, a company makes contributions that are used to purchase shares over time. In a leveraged ESOP, the process is reversed as the plan borrows money to buy shares and the company makes contributions over time to repay the loan. ESOP Frequently Asked Questions (FAQs) If you still have questions about ESOPs after reading this article, here are some of the frequently asked questions about ESOPs. If you still don’t see an answer to your question, you’re welcome to post it in the comment section. Is an ESOP the Same as a 401(k)? An ESOP is very different from a 401(k). In a 401(k), employees contribute through salary deductions which they invest in stocks, bonds, or mutual funds. They may also receive employer matching or profit-sharing contributions. An ESOP is a 401(a) plan that gradually shifts ownership in a company to its employees. What Is an ESOP Distribution? An ESOP distribution is a withdrawal that employees take from their ESOP accounts after they vest. ESOP distributions are usually taxed as ordinary income but can be taxed as capital gains in some cases. ESOP distribution taxes can also sometimes be deferred if the employee rolls their distributions into an IRA. What Is an ESOP Vesting Period? An ESOP vesting period is a timeframe that employees must wait until their stock in their employing company vests. ESOP vesting is similar to 401(k) vesting schedules, which are outlined in plan documents and can force employees to give up part of their stock if they leave before they’re fully vested. What Is a Leveraged ESOP? A leveraged ESOP is an ESOP that takes out a loan in order to purchase company stock from the business owners. Under a leveraged ESOP, employer contributions are used to repay the ESOP loan over time. However, employer contributions are still tax-deductible up to 25 percent of total payroll. The Bottom Line ESPPs are great benefits that some businesses offer to their employees. ESOPs have virtually no cost for employees and are a great recruiting tool. Business owners looking to sell their business over time should consider an ESOP for financing their own buyout through tax-deductible contributions. Some business owners want to provide retirement benefits to their employees without giving up stock in their company. Using other types of retirement plans, business owners can incentivize employee saving or offer profit-sharing.

A limited liability partnership (LLP) agreement is a professionally licensed partnership that protects partners from personal liability of business decisions. These legal entities serve as pass-through entities for tax purposes and are organized to specifically help certain licensed professionals such as lawyers, accountants or architects. An LLP is easy to set up and administer. You can find the free template of an LLP agreement below. However, if you’d like a state specific agreement and personalized legal advice, check out . In just 10-15 questions, their software will build you an LLP agreement that’s ready to sign. They also offer consultations from real attorneys at a low cost. Limited Liability Partnership Template Agreement Every LLP needs an LLP agreement that formally organizes the various partners into a legal partnership. This document sets forth the rights and obligations of partners, respective ownership stakes and the procedures for governing the partnership. We’ve put together a template agreement for your reference but also recommend getting your own legal advice. This free template offers all of the core needs of any strong partnership agreement, including: Defining the scope of the partnership Setting each partner’s contribution Listing ownership stakes Outlining management roles and responsibilities Providing general governing provisions Using a partnership agreement template like the one provided meets the needs of most small- to medium-sized partnerships. Some large or specialized firms should definitely engage a lawyer for help. The requirements of a limited liability partnership agreement vary by jurisdiction, so you should consult with an attorney and your state’s secretary of state website to learn specific requirements in the state where you intend to organize. Download Free Template Now LLP Advantages and Disadvantages 4 Advantages of an LLP Many professionally licensed practitioners in fields like law, accounting or architecture choose to organize as an LLP. Like limited liability companies (LLCs) and other formally organized businesses, LLPs help to shelter partners against personal liability. They’re easy to create and administer, make it easy to raise money from new partners and aren’t required to pay corporate income tax. The advantages of an LLP agreement include: 1. Limit Personal Liability In an LLP, the personal assets of partners are protected from risk from creditors or other obligations of the partnership. LLPs are especially beneficial to protect personal assets of partners against the risk that arises from the actions (including negligence or malfeasance) of other partners. However, partners are still personally responsible for partnership bills or loans. A limited liability partnership agreement helps to protect partners from personal liability arising from things including: Unpaid company bills Debts taken on by the partnership (unless personally guaranteed by partners) Damages resulting from operating the business Debts taken on by other partners This liability protection available in an LLP agreement is similar in other legal entities including: LLCs: Members of LLCs sometimes expose themselves to personal liability if they’re actively engaged in the management of the company S-Corporations (S-Corps): Shareholders are typically sheltered from personal liability to the same degree as partners in a partnership C-Corporations (C-Corps): Shareholders have similar liability protection Limited liability limited partnership (LLLPs): Partners have an added layer of personal liability protection by defining their partnership as a limited partnership Another advantage of limited liability protections in LLPs is that partners in an LLP don’t forfeit personal liability protection if they’re actively engaged in the management of the partnership. This isn’t the case in, for example, a limited partnership (not to be confused with a limited liability partnership). However, there are some instances where the "corporate veil" or a partnership can be pierced and partners may be open to personal liability. These cases include: Fraud: If you or your business defraud customers, vendors or investors, you can be open to unlimited personal liability. Failure to meet LLP requirements: If you fail to meet statutory requirements to administer your LLP. These typically include annual meetings with formal minutes, filing annual reports, and so on. Mixing personal and partnership finances: If you keep business and personal funds together in the same accounts, you can open yourself up to additional liability. To help keep finances separate, it’s a good idea to open a dedicated business checking account. Using personal money to meet partnership obligations: Paying business bills with personal money can leave you open to additional liability. Insufficiently capitalizing your partnership at startup: If you don’t have form your partnership with enough money to meet its obligations early on, you run the risk of being held personally liable for its bills and debts. To learn how you can use retirement assets to fund a new business, be sure to read about using your 401(k) to start a business. 2. Easy to Create and Administer LLPs can be more difficult to establish in some states than in others. However, LLPs are simpler to create and administer than corporations. LLPs can typically be created online through states' secretary of state websites. If you want dedicated financials (or a business checking account) for the partnership, you can get an employer identification number (EIN) through the IRS website. The specific steps you need to take in order to create an LLP include: Choose where you want to register your partnership File with that state’s secretary of state Obtain an EIN from the IRS Thankfully, you can use a service like or hire a lawyer to help you through this process. Rocket Lawyer can help you through the steps to establish and administer your LLP or pair you up with a legal expert to answer specific questions as they arise. If you’re unsure what steps to take next in establishing your LLP, be sure to consult with Rocket Lawyer. 3. No Business Income Tax All partnerships are pass-through entities for tax purposes. There are no taxes paid at the partnership level — all tax liability is passed on to individual partners according to their percentage ownership. While you will need to pay a 15.3% self-employment tax on income derived from a partnership, this is far cheaper than paying 21% corporate income tax plus additional personal income tax on profit disbursements. The takes you’re required to pay on income earned in a partnership income include: Personal income tax (10%-30.6%): Depending on how much income you earn, you need to pay income tax for the appropriate tax bracket Self-employment tax (15.3%): If you’re self-employed through a partnership, you are required to pay full FICA tax on any income received as opposed to half of FICA tax paid by most W-2 employees Franchise or excise taxes (vary by state): Depending on the size and nature of the business, some states or municipalities require partnerships to pay franchise or excise taxes 4. Can Raise Money From Outside Sources In less formal organizations like sole proprietorships or even LLCs, it can be nearly impossible to raise additional capital. With no equity or partnership shares to sell, potential investors have nothing to buy and no way to protect their investment. This isn’t the case in an LLP. In a limited liability partnership, you can take on new limited partners at any time. What’s more, you can require that new partners buy-in to your partnership, which is very common among law firms. This helps you to not only build the business by adding valuable new talent but to raise new capital potentially as well. In some cases, new partners don’t even need to be directly involved in the operations of a business. While it’s generally easier to find outside investors for C-Corps, some LLPs bring in money from more passive investors who take a less active role in the operations of the partnership. 4 Disadvantages of an LLP In addition to their benefits, LLPs have disadvantages to consider. The limited applications of LLPs or their relative difficulty to establish in some states may make other business structure better for your specific circumstances. If you’re a business in an industry that doesn’t have traditional partnerships like attorneys or accountants, then you’ll be better served with another business structure. Some disadvantages of limited liability partnership agreements include: 1. Limited Applications The typical professions that are eligible to use LLPs include: Accountants Architects Attorneys The biggest drawback of LLPs is that they can only be used by certain types of businesses. In most states, LLPs can only be formed to practice certain licensed professions including accounting, law and architecture. If you aren’t engaged in one of these businesses, you may not even be eligible to set up an LLP in some states. 2. More Difficult to Form Than an LLC Most small businesses will find it easier to use an LLC than an LLP. This is because LLCs are typically easier to qualify for and set up. They also offer a greater degree of flexibility. LLPs are typically only used by firms practicing law, accounting or architecture. In some states, LLPs can only be used for these purposes. Aside from their limited use to practice in certain professions, there are additional requirements of LLPs that can make them less attractive business structures. For instance, limited liability partnerships must be just that — partnerships. You can’t usually set up an LLP with just one partner. LLPs also typically require more paperwork than other business structures like LLCs, in part to prove you have the requisite licenses to practice your profession. Once you set up an LLP, as in an LLC, you are also required to have annual meetings, keep minutes and submit regular filings. There are certain steps you need to follow if you want to set up an LLP. If you want help setting up or administering your partnership, you can always engage knowledgeable professionals to help you. One of the best providers of these services is . They can help you draft a partnership agreement, file with the state of your choosing and keep your partnership current going forward. 3. Less Flexible Tax Structure The disadvantage of LLPs is the lack of flexibility in the tax structure. In an LLC, for example, owners can choose how they want to be taxed. They have to pay self-employment tax but LLC owners can be taxed as pass-throughs like partnerships. Alternatively, they can choose an S-Corp election or other distinction to file taxes at the company level. Owners of some companies like LLCs get to choose a tax structure that’s best for their individual circumstances. Partners in LLPs don’t have these choices. They have to be taxed as pass-throughs (and pay self-employment tax, of course). However, LLPs offer a distinct advantage over some types of companies like C-Corps, which are taxed 21% on company profits. LLPs, do not pay income tax at the partnership level as all tax liability is passed on to individual partners. Each year, partners receive Schedule K-1 forms and report their share of the partnership income on personal tax returns. 4. Extra Licensing Fees As with other companies, various states charge fees to set up LLPs. Formation fees are often $50 to $500 with additional fees assessed when you submit required annual filings. Filings are typically submitted online through state websites but filing requirements and fees vary widely. Annual filing fees for an LLC, for example, can range from $0 to $820. The typical state fees you’ll pay for an LLP include: Formation fee: $50 to $500 Annual filing fee: $0-$820 The fees to establish and maintain an LLP, which can be high, are separate from the fees you may need to pay for professional licensing to practice as an accountant, architect or attorney. These fees are also separate from the self-employment tax you need to pay and other potential franchise or excise taxes charged by some states. Some states also require a local agent to act on behalf of the business. If you’re filing in a different state, you may need to hire a local agent who will charge his or her own fee. Because of the required fees for the formation and annual filings, an LLP may not be the cheapest option for you to organize your business. Depending on your circumstances and type of business, it may be better for you to establish your business as a sole proprietorship initially. Once the business grows, you can always convert to an LLP or other structure later. Alternatives to an LLP Before deciding if an LLP is right for you, be sure to consider some alternatives. Some other options may be easier and more cost-effective to establish or administer. Others like LLCs, S-Corps and C-Corps are more available to people outside certain licensed professions, have more flexible tax structures or lack the partner restrictions of an LLP. Some alternatives to an LLP include: 1. LLC vs. LLP Both LLPs and LLCs offer personal liability protection for owners. In some cases, LLC owners forgo some protections when they’re actively engaged in the management of the business, which isn’t the case for LLPs. LLCs have similar filing fees and administration requirements, including annual meetings and minutes. However, LLC owners get to choose how they’re taxed. 2. S-Corp vs. LLP Where LLPs are a form of partnership, S-Corps are more akin to traditional corporations with shareholders. S-Corps do not have the requirements that LLPs have for use in practicing licensed professions. S-Corps also have the same tax structure as LLPs with no taxes paid on corporate profits. This gives S-Corps the same advantages over C-Corps that LLPs share. 3. C-Corp vs. LLP Of all company structures, the C-Corp is the most robust. It is the most costly and time-consuming to form and administer. C-Corps are also far-and-away the most expensive from a tax perspective. Before any company profits are distributed to shareholders in C-Corporations, those profits are taxed at 21% by the federal government. Once those profits are distributed, they are taxed again at the personal level. 4. LLLP vs. LLP Limited liability limited partnership is a relatively new creation. The differences between LLPs and LLLPs are relatively nuanced but center on liability protection. Essentially, partnerships have two different classes of partners — general partners and limited partners. LLPs do not have limited partners — all partners are considered "general partners." LLLPs, in contrast, have limited partners which have additional liability protection. 5. Sole Proprietorship vs. LLP Of the alternatives listed, a sole proprietorship is the only option that is not a formally organized business. You do not need to register to form a sole proprietorship nor do you need to submit to annual filings except for reporting your self-employed income on Form 1040 of your Schedule C and obtaining any necessary licenses. However, sole proprietorships do not offer their owners any liability protection whatsoever, which is much different than an LLP. Who an LLP is Right For An LLP is best for groups of attorneys, accountants or architects who want to work together in partnership while not being held liable for each other’s mistakes. Whether you opt for a centralized or decentralized management structure, LLPs are also best if you want your business to be pass-through tax responsibilities to individual partners. To have an LLP, you need to have more than one partner, but LLPs are also advantageous if you expect to have a fluid group of partners. Under a limited liability partnership agreement, you can give people the option of joining and buying in, which incidentally helps you raise money, and also leave later on. LLP Frequently Asked Questions (FAQs) What’s the Difference Between an LLP and LLC? An LLP is a partnership formed for licensed professionals like lawyers, accountants or architects. An LLC can be formed for to operate almost any kind of business or to hold property. LLPs are treated and taxed as partnerships while LLCs get to choose how they will be taxed. Also, LLC members often give up personal liability protection if they’re actively engaged in the management of the business. For more information on the how a limited liability partnership agreement compares to an LLC, check out our article on LLPs vs. LLCs and how to choose between the two. What is an LLLP? An LLLP is a limited liability limited partnership. LLLPs are relatively new and have been found to offer partners a greater degree of liability protection in some cases, but an LLP will be the better option for most small business partnerships. What’s the Purpose of an LLP? LLPs are formed by two or more people who want to work together in the practice of law, accounting or architecture. More people starting businesses in other industries find it easier to qualify for and set up an LLC instead of an LLP. How is an LLP Taxed? LLPs are taxed as partnerships — the tax responsibility for partnership profits each year flows through to individual partners based on their individual ownership stake. Partners are also required to pay personal income tax and self-employment tax on any income they earn through the partnership. What Should Be Included in a Partnership Agreement? Partnership agreements should include everything you need to define the nature of your partnership and its purpose. The agreement should also include a list of all the partners, their respective ownership contribution levels and ownership stakes. Management roles should be clearly defined along with any rules or restrictions on partner behavior or company oversight. In short, anything you would need to have proof of in the event of a partnership dispute. The Bottom Line LLPs are great for forming partnerships to practice certain licensed professions. Like S-Corps and some LLCs, LLPs are treated as pass-throughs for tax purposes. They are easy to set up, allow for new partners and limit the personal liability of partners. LLPs also have drawbacks you should consider before deciding if an LLP is right for you. If you want help setting up an LLP, can serve as an excellent resource. They offer detailed template documents customized for your industry and state and can walk you through any industry-specific issues you need to address or resolve any questions that arise. They also offer one-on-one guidance and discounted rates on attorneys.

A sole proprietorship is a single-member business that’s never formally incorporated with a state filing. Sole proprietorship pros and cons include that It’s easy to set up, but there’s no distinction between business and owner and no liability protection. Sole proprietorships minimize startup costs but won't help you limit your personal liability. Regardless of how you structure your business, it’s important to separate your business and personal finances. Commingling funds can create huge accounting, tax, and liability headaches. Our review of the best business banking options put at the top. New customers can qualify for a $300 bonus. Sole Proprietorship Pros and Cons 5 Pros of a Sole Proprietorship A sole proprietorship is the easiest type of business to implement. It requires no formal setup, no annual administration, no dedicated business taxes, and no formal record keeping. In a sole proprietorship, you simply start selling goods or services - all bills and debts are your personal responsibility. All business income is considered pass-through and filed on your personal tax returns. The five pros of a sole proprietorship include: 1. Easy Setup & Low Cost Because a sole proprietorship is not a formal business structure, there are no filings or paperwork for you to complete before you get started. You simply start operating and don’t have to pay any incorporation or filing fees. Depending on your industry, you may need to obtain a special license, permit, surety bond, or business insurance policy, but you don’t need to complete filings with the state. This ease of setup and low cost of administration/management makes sole proprietorships great for cottage industries and seasonal businesses. If you’re just starting out in a new venture - especially one that doesn’t have substantial liability - it can be great to use a sole proprietorship until your business is established and growing. The reason why sole proprietorships are easy to set up is that owners aren’t taking the steps to formally incorporate - steps that would provide liability protection and other advantages. Sole proprietors don’t have to take these steps, but therefore give up the liability protection that comes with a formal business structure. If you’re interested in protecting your liability, it might be best to incorporate as an LLC with a service like Rocket Lawyer. They’ll help you with all state and federal filings, which allows you to legally separate yourself from your business. 2. No Corporate Business Taxes or Double Taxation As a sole proprietor, you don’t pay 21% in corporate taxes on business profits the way you would in a C-corporation. Instead, you just keep filing your personal tax returns and claim any new income from the operation of your business as pass-through taxes, meaning all income is taxed at your ordinary income tax rate. Sole proprietors are also often exempt from state franchise or excises taxes. These exemptions make taxes far simpler - and cheaper - for sole proprietorships than companies like C-corps, where revenue is taxed at the company level and then a second time when profits are distributed to shareholders in the form of dividends. The dividend tax rate is currently between 15-20%, meaning that you can pay as much as 41% on your taxable business profits, which doesn’t include the income tax you pay on your salary. However, sole proprietorships aren’t the only business structures that offer pass-through tax benefits. LLCs and S-corps are both considered pass-through entities and avoid double taxation and the corporate tax rate on profits. However, even LLCs are usually charged franchise or excises taxes, depending on where and how they operate, meaning that taxes can still be higher than a sole proprietorship, depending on level of profits. The typical taxes you may incur as a sole proprietor include: Ordinary income tax - As a sole proprietor, you don’t pay yourself a salary. Instead, all profits are filed on your personal tax return and taxed at your ordinary income tax rate. Self-employment tax - If you run your own business you will need to pay self-employment tax on any income from that business, which is the employer-portion of FICA tax. This means you pay an additional 7.65% in taxes or the full 15.3-16.2% in FICA taxes. Sales tax - Depending on nature of the business, if you’re selling goods, you may need to collect and pay sales tax that varies by state but typically ranges from 6-9%. 3. No Annual Reports or Filings Sole proprietorships do not require annual reports or filings with the state in order to stay current. In fact, you don’t have to file anything other than your personal tax returns. This is in contrast to LLCs, S-corporations, or C-corporations, which are generally required to file annual reports after they’re formed. These reports typically require updating lists of members or managers. If you decided to use an LLC, LLP, S-corp, or C-corp instead of a sole proprietorship, you would be required to prepare many more filings, including: Initial filing - When you formally establish a company Annual filing - Charged by most states to keep your company current Change of manager - If you change managers or directors, you have to notify the state List of members - Many types of companies must notify the state when members change Annual audit - Some companies are required to submit annual audits Company tax returns - Certain types of companies are required to prepare corporate tax returns and pay separate taxes on business profits The absence of an annual filing for sole proprietorships is helpful not just because it avoids the headache and saves you time, but also because most states charge a fee for these annual filings that range from $50-$200 or more. Sole proprietors, on the other hand, just have to file their annual tax returns. 4. Not Restricted by Formal Business Structure Other, more formally structured businesses face certain limits on operations in addition to requirements they have to meet. Sole proprietorships are not subject to these requirements. If you’re a sole proprietor, it’s just you - you can make whatever business decisions you want, as long as it’s legal. There’s no formal review or approval process. Some requirements of other types of business that you get to skip as a sole proprietor include: Annual meetings - Companies such as LLCs are required to hold annual meetings to review lists of managers and members Board meetings - Some companies are required to have some business decisions formally approved by directors of the company Recorded minutes - Formal minutes need to be kept for these meetings for LLCs and corporations Shareholder votes - Any formal actions of the company, including appointing managers or admitting new members, need to be voted on Formal reviews - Certain actions of the company need to be formally reviewed, and managers re-appointed 5. Easy Record Keeping In an LLC or other formally-structured business, you’re required to segregate your business and personal finances. Otherwise, you run the risk of opening yourself up to unlimited liability - this is called “piercing the corporate veil.” Among other pros and cons of a sole proprietorship, though, is that this unlimited liability is ever-present. Since sole proprietors have unlimited liability, many sole proprietors don’t segregate their financials. They deposit business income right into personal accounts, pay bills and debts personally, and handle the business basically as an extension of their personal finances. This might make operating a sole proprietorship easier than an LLC or something similar. However, while simpler, keeping business and personal finances together is not typically recommended. Keeping separate records helps you to more closely monitor cash flow in your business. The first step in separating finances is to open a business checking account. In a sole proprietorship, separating finances won’t protect you from liability, but it can help with bookkeeping as the business grows. It will also make it easier if you decide to transition to an LLC or other formal business structure. We reviewed the best business checking accounts and put Chase at the top. New customers can qualify for bonuses. 5 Cons of a Sole Proprietorship It's important to consider sole proprietorship pros and cons. The biggest drawback is unlimited liability for a business owner, who can be held personally responsible for obligations of the business. You also won’t be able to hire W2 employees (only 1099 contract workers), which could create a significant problem if you plan on growing your business. Major disadvantages of sole proprietorships include: 1. Unlimited Liability If you’re a sole proprietor, you don’t have any of the limited liability protections offered in an LLP, LLC, S-corporation, or C-corporation. You are personally liable for all business expenses and debts, if someone’s hurt on your property, or is harmed by a product of your business or a mistake you make. This means that there is no legal difference between you and your business. Some liabilities in a sole proprietorship that you’ll be personally responsible for include: Expenses incurred by your business Business-related debts Product-related liability Property-related injury Civil damages if you provide inappropriate or insufficient service Because you have unlimited personal liability in a sole proprietorship, a vendor, customer, or lender can come after your personal assets to satisfy any obligations of the business. This is in contrast to LLCs, S-corps, and C-corps, which create a liability shield between a business and its owners. In an incorporated entity such as an LLC or C-corp, the personal assets of company owners are protected. They can’t be taken by lenders, customers, or vendors to satisfy the obligations of a company unless the business owners do something that allows the corporate veil to be pierced or if the business owner knowingly signed a personal guarantee. If you need to protect yourself legally, then a sole proprietorship isn’t right for you. Use a service like Rocket Lawyer to help you incorporate as a single-member LLC. This should protect you from the liabilities of your company. Visit them today and you could have legal documents in a matter of minutes. “An LLC is a limited liability company, meaning that your personal assets are protected from creditors and lawsuits against the company. Other entities like sole proprietorships, most general partnerships, and other unincorporated businesses are unlimited liability companies. Under these businesses, the company and the owner are the same, so you’re liable for any debts of the company, even if another partner took them on.” - Josh Zimmelman, President, Westwood Tax & Consulting 2. No Ongoing Business Life If you structure your business as an LLC, C-corp, or other formal structure, and something happens to you (like death or a planned exit), the business survives. In fact, as long as you keep your business filings current and maintain proper licensing, your business can survive in perpetuity. If you’re a sole proprietor and something happens to you, however, that’s the end of the business. In a sole proprietorship, there is no structure for ensuring continuity. An employee or family member may continue in your business, but they would essentially be starting a new company from scratch - they wouldn’t really be continuing your operations. This makes it harder to plan long-term and create succession plans around your eventual business exit, if any. Further, sole proprietorships can’t hire any full-time or W2 employees. While you can still hire 1099 freelancers to do work for you, you won’t be able to run payroll and retain employees long-term. If you expect to hire employees in the future, you’ll need to incorporate as an S-corp or C-corp. To learn more, check out our article on hiring W2 vs 1099 employees. 3. Difficult to Raise Capital Structuring your business as a sole proprietorship is not a good idea if you may need to raise money from outside investors. This is because there’s no real business to sell, so it’s almost impossible to raise money unless you have tangible assets or intellectual property that investors can buy into. Sole proprietorships don’t have equity shares, nor are they formally-licensed businesses. There is no formal review process for business decisions or approval process. “Shareholders” in a sole proprietorship have essentially no rights. Because of these concerns, investors generally don’t invest money in a sole proprietorship. In fact, even an LLC makes it hard to raise capital, although you can make an S-corp election, which makes it easier. Still, if you want to raise money, especially investor funds from an angel investor or venture capital firm, a C-corporation is your best bet. 4. Can’t Take on Business Debt Because a sole proprietorship isn’t a formally-established company, it’s not possible to take out a business loan. Instead, all debt - even funds you borrow to grow or operate your business - is personal debt. Lenders will require that any loans be personally guaranteed by a sole proprietor, meaning they can go after your personal assets in case of default. This is because a sole proprietorship is not a standalone business entity - you are the business. By personally guaranteeing debt for a sole proprietorship, you are committing to lenders that you will repay any loans taken for business purposes, even if the business fails. However, this might not be so different from other types of business structures. For example, even if you incorporate as an LLC, there’s a good chance you’ll need to personally guarantee any type of business loan, including an SBA loan. Be sure you fully understand your personal liability when taking on business debt. 5. Perceived Lack of Professionalism Customers and business partners often view sole proprietors as lacking professionalism. For people who just want to run a small business out of their house or make some extra money in their spare time, this may not be a problem. However, when deciding what kind of business structure you want to use, it’s worth considering the pros and cons of a sole proprietorship. At the other end of the spectrum of sole proprietorships, C-corporations are used by many of the largest companies in the world and are generally considered to be the most professional. These types of entities have the most rigid organizational structure and oversight requirements, but they also provide the greatest liability protection and are the best for raising outside capital. Sole proprietorships, on the other hand, do not provide any formal oversight or management structure. A sole proprietorship is simply someone selling goods or hiring themselves out for work. When sole proprietors collect income, it often goes to them personally. Bills are frequently paid from their personal accounts. Some of this unprofessionalism can be dismissed by establishing a small business checking account in the name of your business. Many providers will allow you to use an alias for your business or a “doing business as” (DBA). However, this will vary by institution. For more information, check out our article on the Best Small Business Checking Accounts.  Sole Proprietorship Examples Sole proprietorships pros and cons make them ideal for small-scale entrepreneurs who are just starting out in low-cost, low-liability ventures. It’s also better for business owners who don’t have substantial assets that a creditor might go after if a business fails. Some good examples of sole proprietorships include: Amazon Businesses Many people create Amazon businesses that white label existing products. You can easily do this as a sole proprietor. For more information, read our article on how to sell on Amazon. Etsy Shops Many sellers on the online platform Etsy operate as sole proprietors to avoid the cost of setting up and administering a formal business entity. For more information, you can read our article on how to sell on Etsy. Other Personal Businesses Sole proprietorship can also work for a number of other types of businesses. Independent service providers like massage therapists and consultants on platforms like or can be well suited for sole proprietorships. Even a small neighborhood lawn mowing or snow shoveling operation can be a good candidate for a sole proprietorship. However, in these cases, you’d want to transition to a business with liability protection before buying trucks or other equipment. Moving to an LLC or S-corp, for instance, would help protect you from personal liability resulting from injury. Some small business owners choose to remain sole proprietors if their business never grows beyond a part-time pursuit or small weekend operation. That way, they can avoid the costs of registering or administering an LLC or other company. Those that grow, however, eventually choose a more formal structure that provides more liability protection. Alternatives to a Sole Proprietorship There are several business structures that are alternatives to a sole proprietorship, including: Limited Liability Company (LLC) LLCs are the easiest company to form and administer. They can be created in most states online in just 5-10 minutes at a cost of $150-$200. LLCs provide limited liability protection to company owners but also require annual filings, updated member lists, tax filings with K-1s issued to members, and more formal administration. Limited Liability Partnership (LLP) Limited Liability Partnerships are only available in many states for use in practicing a licensed profession. For tax purposes they are considered pass-through entities, with tax liability being passed on to owners based on their respective ownership stake. LLPs operate much like LLCs, but can only be used in certain industries, including: Accounting Architecture Law S-Corporations S-corps are closely-held corporations that are generally treated as pass-throughs but also receive special tax treatment in certain areas. For instance, while the IRS does not recognize the right of LLC owners to pay themselves a salary, S-corp owners may pay themselves a salary and deduct that expense from corporate profit. For more information, read our article on S-corps and C-corps. C-Corporations Of the various business structures, a C-corp is the most robust and also the most costly. This is largely because C-corps are subject to double taxation, with corporate profits being taxed at 21%. Those profits are then taxed a second time once they are distributed to company owners in the form of dividends, this time at the owner’s individual income tax rate. For more information, read our article on C-corps and S-corps. Who a Sole Proprietorship Is Right For Sole proprietorship pros and cons make them good for a new business owner who’s just starting. Preferably, they should be entering a field that doesn’t have much liability or require much startup capital. They shouldn’t need to borrow for the business or have a risk of injury. A cottage industry would be ideal. Sole proprietorships are also best for business owners who don’t have major assets that could be taken by vendors, creditors, or customers due to debts or liabilities from the operation of the business. This type of business is best for an entrepreneur who just wants to get their business going and then plans to transition to a more formal business structure. Frequently Asked Questions (FAQs) 1. What Advantages Does an LLC Have Over a Sole Proprietorship? The biggest advantage of an LLC vs a sole proprietorship is that an LLC limits your liability as a business owner. A sole proprietor is responsible for all debts and obligations of their business. In an LLC, business assets are segregated from personal finances, and you are only personally liable for business obligations if you provide a personal guarantee or do something to allow “piercing the corporate veil.” 2. Why Is It Good to Be a Sole Proprietor? Sole proprietorship pros and cons can make them very advantageous for certain small or new businesses because they're very easy to get started and very inexpensive. The unfortunate truth is that a lot of businesses fail, so starting as a sole proprietorship can be a good idea until you see whether your business is going to succeed. This is especially true if you’re starting a business that doesn’t require a ton of outside investment or entail a lot of potential liability. 3. Do You Have to Register as a Sole Proprietor? No, you do not need to register as a sole proprietor. You may, however, need to register for certain licenses, depending on your specific industry. 4. How Do I Pay Taxes as a Sole Proprietor? If you structure your business as a sole proprietorship, all you need to do is keep paying your personal taxes. If you generate any income from your business operations, claim that income and pay self-employment tax. You may also need to collect and pay state and local sales tax on any goods sold, depending on where your business is located. Bottom Line A sole proprietorship is a great, informal structure that has many benefits for small business owners. When deciding on a type of business structure, it’s important to consider the pros and cons of a sole proprietorship. While these businesses do not offer their owners liability protection and make it difficult to raise money, they’re also incredibly easy to establish and administer. As a sole proprietor, you can create tax and liability issues in the future if you mix business and personal funds. We recommend you get a business checking account from , which offers competitive fee structures to other providers and a bonus. Get started today with no minimum deposit!