SIMPLE IRA & SIMPLE 401(K) vs 401(K) – Which is Better for Your Small Business?

May 19, 2020

SIMPLE 401(k) plans and SIMPLE IRAs are often a popular choice for many small businesses. They’re low cost and easy to set up and maintain, making them an attractive option for small businesses wanting to offer a retirement plan without all of the compliance testing and reporting requirements typically found in retirement plans. But is a SIMPLE plan really the best option for your small business?

We’ll take a look at SIMPLE 401(k) plans, SIMPLE IRA plans, and traditional 401(k) plans to see which one is the right fit for your company.

 

What is a SIMPLE Plan?

Savings Incentive Match Plan for Employees, or SIMPLE plans, are designed to simplify ways for employers and employees to contribute to retirement savings. SIMPLE plans can be attributed to either an IRA or a 401(k) plan and are exempt from many of the compliance and reporting requirements that traditional 401(k) plans are subject to. Small businesses looking to offer retirement plans at a lower cost often gravitate towards SIMPLE plans, since they’re generally less expensive than a traditional 401(k) plan and easier to administer since they often lack many of the more advanced features offered in 401(k) plans.

 

SIMPLE 401(k) Plans

A SIMPLE 401(k) plan is similar to a traditional 401(k) plan, but with a few distinctions.

Like a traditional 401(k) plan, employee deferrals are made on a pre-tax basis and only taxed in the year a distribution is taken. However, contributions are limited to $13,500 in 2020. For participants 50 and over, catch-up contributions up to $3,000 are available.

Employer contributions are also mandatory. The employer is required to make a matching contribution up to 3% of compensation or a 2% nonelective contribution based on compensation. In a SIMPLE 401(k), employer contributions are capped – only the first $285,000 in compensation is considered when calculating the matching contribution. So an employee cannot receive more than $8,550 in matching contributions (3% of $285,000).

One benefit to a SIMPLE plan is that contributions (both employer and employee) are 100% vested, so the participant is always free to keep the full account value.

Participants must be at least 21 years old and have one year of service to be eligible to participate.

An employer is not permitted to offer any other retirement plan to employees eligible for the SIMPLE 401(k) plan. They may, however, offer another retirement plan for ineligible employees.

One notable feature of a SIMPLE 401(k) plan is the option for loans. This is often an attractive feature for employees who are not eligible to take a distribution but need to access their retirement plan funds.

 

SIMPLE IRAs

Similar to a SIMPLE 401(k), a SIMPLE IRA is another retirement plan option for small businesses with fewer than 100 employees. Each employee has an individual retirement account established for them where they can make deferrals that are matched by the employer. Like a SIMPLE 401(k) plan, deferrals are limited to $13,500, catch up contributions are available, and employer contributions are required.

There is no age requirement for participants, however, the employee must have earned at least $5,000 in compensation in the previous year and be reasonably expected to earn $5,000 in the current year to be eligible to participate in the plan.

Unlike a SIMPLE 401(k), an employer is not permitted to offer another retirement plan for ineligible employees – with the exception of employees covered by collective bargaining agreements. Additionally, loans are not permitted in a SIMPLE IRA like they are in a SIMPLE 401(k).

There is a 10% penalty for withdrawing funds early from a SIMPLE IRA, and it may be increased to 25% if funds are withdrawn within the first two years.

 

Traditional 401(k) Plans

A traditional 401(k) plan is a qualified retirement plan offered by an employer to the employees. It’s designed for businesses of all sizes – both small and large.

The employees contribute to the plan through pre-tax salary deferrals that may, but are not required, to be matched by the employer. Employers have greater control over the type of matching contributions that are available to participants in a traditional 401(k) plan. If an employer does choose to offer a match (which many do), there are tax advantages available to the employer as well.

A 401(k) plan has a higher contribution limit than a SIMPLE 401(k) or a SIMPLE IRA plan – up to $19,500 in 2020 and $26,000 for those who are catch up eligible. The total contribution limit (including both employee and employer contributions) is $57,000 for 2020. These high contribution limits help ensure that participants are well prepared for retirement when the time comes.

Traditional 401(k) plans also permit vesting schedules for employer contributions (all employee contributions are 100% vested). A small business looking to attract and retain talent may want to consider setting up a traditional 401(k) plan since designing a vesting schedule can be one way of retaining top talent – many employees are incentivized to stay with the employer while their matching contributions vest. Additionally, non-vested forfeitures remain with the plan assets which may be used to cover some of the plan expenses in some circumstances.

Although 401(k) plans are subject to annual nondiscrimination testing to ensure Highly Compensated Employees (HECs) are not benefitting disproportionally from the retirement plan compared to the Non-Highly Compensated Employees (NHCEs), the right plan design can make passing these tests a breeze.

 

Which One Is Right For My Small Business?

When choosing a retirement plan, it’s important to find one that fits your company. SIMPLE plans are specifically designed for businesses with less than 100 employees, so it’s important to reconsider the type of retirement plan your company offers as it grows.

SIMPLE 401(k)s and SIMPLE IRAs have their advantages – lower costs, no nondiscrimination testing, and fewer compliance requirements. However, they may not meet the needs of a growing company in the way that a traditional 401(k) plan can.

Traditional 401(k) plans are very dynamic and offer a lot of flexibility in plan design that can adapt to a growing company and can be managed cost effectively and efficiently through a Plan Administrator. A 401(k) plan allows you to customize several features of your retirement plan including eligibility, matching, automatic enrollment, loans, and vesting provisions. Having the ability to customize these features will allow you to offer a retirement plan that works for both your company and employees.

If you’re thinking of starting a retirement plan but not sure where to start, let us help.

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