SIMPLE IRA vs 401(k) Plans

Retirement plans are financial tools designed to help individuals save for their golden years. They offer various benefits, such as tax advantages and employer contributions, to help employees build a nest egg for retirement.

There are different types of retirement plans, each with its own rules and regulations, so choosing the right one is crucial. The wrong choice may lead to insufficient retirement money or getting penalized for early withdrawals.

This blog post will discuss SIMPLE IRAs and SIMPLE 401(k) plans, two popular retirement plans for small businesses and/or self-employed individuals running their own businesses. We’ll also provide an overview of traditional 401(k) plans and compare them to SIMPLE IRAs and SIMPLE 401(k) plans.

By understanding these different types of plans, you can make an informed decision about which best fits your needs.

What is a SIMPLE 401(k) Plan?

A SIMPLE 401(k) Plan, or Savings Incentive Match Plan for Employees 401(k), is a type of retirement plan designed specifically for small businesses with 100 employees or fewer.

These plans merge the benefits of a 401(k) with a SIMPLE IRA. Unlike traditional 401(k) plans, SIMPLE 401(k) plans do not require nondiscrimination testing (similar to safe harbor plans) which makes them more accessible to small businesses.

Here are some key features of a SIMPLE 401(k) plan:

• Employee contributions can be made on a pre-tax basis, reducing taxable income (and therefore income taxes) in the year of contribution. A Roth option is also available in certain plans.
• Employers must make either a mandatory 3% matching contribution or a 2% non-elective contribution to employee accounts. These amounts are based on an employee’s pay.
• As of 2023, the maximum employee contribution limit is $15,500, with a catch-up contribution of $3,500 for those 50 and over.

• Eligibility is contingent on meeting minimum requirements for hours worked in the previous year.
• Loans are typically permitted in the same way they are for traditional 401(k) plans.
• Employees are 100% vested in their SIMPLE 401(k) plan balances.

Setting up a SIMPLE 401(k) plan involves completing specific paperwork, selecting a financial institution to hold the plan assets, and informing eligible employees about the plan.

Employees are eligible to use various investment options (i.e. mutual funds) in their SIMPLE 401(k)s, and have the opportunity to see their account balances grow over time.

However, there are potential drawbacks to a SIMPLE 401(k) plan, such as the administrative responsibilities that come with it and the relatively low contribution limits.

What is a SIMPLE IRA Plan?

A SIMPLE IRA account, or Savings Incentive Match Plan for Employees Individual Retirement Account, is a retirement plan designed for small businesses and self-employed individuals.

Like the SIMPLE 401(k) plan, it is specifically tailored to businesses with fewer employees (less than 100).

Some key features of a SIMPLE IRA plan include:

• Annual contribution limits and eligibility requirements are similar to SIMPLE 401(k) plans.
• Employer contributions are mandatory, similar to SIMPLE 401(k)s, and contributions are 100% vested at the time of deposit.
• Only non-elective employer contributions (rather than an employer match) are subject to the compensation cap as delineated by the IRS.
  • In other words, a SIMPLE IRA with a 3% uncapped employer matching contribution will result in higher total employer contributions than if a non-elective employer contribution were made.
• Like traditional or Roth IRAs, and unlike SIMPLE 401(k) plans, loans are not permitted.
• A SIMPLE IRA plan is known for its simplicity and ease of administration.

However, it also has limitations compared to other retirement plans, such as a lack of tax-free Roth option.

SIMPLE 401(k) vs. SIMPLE IRA

Choosing the right retirement plan options is crucial for small business owners, and they often find themselves deciding between the SIMPLE 401(k) and the SIMPLE IRA.

Both SIMPLE plans are designed for small businesses, but there are key differences in contribution limits and administrative requirements.

Both employer-sponsored accounts can accommodate employer matching and take into account employee compensation and pay, allowing for tax-deductible elective deferrals and employee catch-up contributions.

To help you make an informed decision, here’s a comparison of the pros and cons of each retirement benefits plan below:

SIMPLE 401(k)

Pros

• Roth contributions available (Roth 401(k) contributions)
• Not subject to traditional 401(k) plan nondiscrimination testing

• Option for loans available

• More complex vesting schedules

Cons

• Heavy plan administration burden relative to SIMPLE IRAs
• No other qualified plans permitted (see the “exclusive plan rule”)
• Mandatory employer contributions (a con if you’re the employer)

SIMPLE IRA

Pros

• Employer match does not have a compensation limit
• Not subject to traditional 401(k) plan nondiscrimination testing
• Less administrative hassle

Cons

• Mandatory employer contributions (a con if you’re the employer)
• No Roth option to make after-tax contributions
• No vesting schedule (a con if you’re the employer)
• No other qualified plans permitted (see the “exclusive plan rule”)
• Limited withdrawal/loan opportunities

Which plan is better for a small business?

There is no one-size-fits-all answer when it comes to choosing the best retirement plan for your business. To determine the best option, consider factors such as the number of plan participants as well as the degree to which you’re able to manage the administrative burden around employee retirement plans.

Regardless of the plan you choose, both SIMPLE 401(k) and SIMPLE IRA plans can provide valuable retirement benefits to your employees.

What is a Traditional 401(k) Plan?

A traditional 401(k) plan is a type of retirement plan offered by many larger, private, and for-profit employers. It differs from SIMPLE 401(k) and SIMPLE IRA plans in several ways, including having higher contribution limits for employees.

Some key features of a traditional 401(k) plan include:

• Employees can make pre-tax deferrals, reducing their taxable income in the year of contribution.
• Employers may offer dollar-for-dollar matching contributions up to a certain percentage of the employee’s salary.
• More complex vesting schedules than SIMPLE plans, with employer contributions typically becoming fully vested over several years.
• High contribution limits, with employees eligible to contribute up to $22,500 in 2023 and $7,500 available in catch-up contributions for those 50 and older. Note that current year contribution limits apply to the calendar year, and all contributions must be made by December 31st.

• Nondiscrimination testing to ensure the plan isn’t top-heavy, or geared to its highly-compensated employees.

The Differences Between a 401(k) and a SIMPLE IRA

While 401(k) and SIMPLE IRA plans can help employees save for retirement, they cater to different types of businesses. SIMPLE IRA plans are designed for small businesses with fewer employees, while 401(k) plans are more suitable as retirement accounts for larger organizations.

Before choosing a retirement plan, weigh the pros and cons of each option to consider how they align with your business’ needs, retirement savings goals, and capacity to manage administrative requirements.

Need Help Deciding Which Retirement Plan is Better for Your Business?

Choosing the right retirement plan is crucial, but it can be overwhelming for small business owners. It can help to get feedback from your employees about what they would like to see in a retirement benefits package.

Take time to weigh the pros and cons of potential offerings before making a decision. Ultimately, providing a retirement benefit to employees is an excellent option and a smart idea for small business owners.

If you’re looking for help finding and rolling over your old 401(k) into a new retirement account, partner with a company like Capitalize. We make building for retirement stress-free.

Learn more about how we can help you today.