Choosing the right retirement plan for your business is an important task. The right plan will help attract high quality talent, ensure employee satisfaction, and help you save towards your own retirement. Both 401(k) plans and SIMPLE IRAs allow employees to contribute part of each paycheck to a retirement investment account. We will cover both SIMPLE IRA and 401(k) in detail to help you decide which one is right for your small business.
What is a SIMPLE IRA?
SIMPLE stands for Savings Incentive Match Plan for Employees. A SIMPLE IRA is for small businesses with fewer than 100 employees. It is an easy way to set up a retirement plan within a business without having to worry about many of the costs and time associated with some other retirement plans.
What are the 3 steps to set up a SIMPLE IRA plan?
- Execute a written agreement to provide benefits to all eligible employees.
- Give employees certain information about the agreement.
- Set up an IRA account for each employee.
Pros of SIMPLE IRA
- Easy to establish.
- Easy and inexpensive to maintain: no filing requirements.
- There is no discrimination testing required.
Cons of SIMPLE IRA
- The employer cannot have another retirement plan.
- The employer is required to contribute either a 3% match or 2% nonelective contribution for each eligible employee.
- The employee is always 100% vested in SIMPLE IRA money; the employer cannot force a vesting plan on an employee.
- Lower contribution limits than other retirement plans.
- If the company increases to over 100 employees, they are no longer eligible for a SIMPLE IRA plan.
- Does not allow Roth; contributions are always traditional.
What is a 401(k)?
A 401(k) is an employer-sponsored retirement plan for companies of any size. A 401(k) is versatile and can be offered to employees with or without a company match or contribution. There are limits to how much can go into a 401(k) each year, but these limits are much greater than with a SIMPLE IRA. A 401(k) can offer a Roth component for employee contributions. This means that employees can set aside after-tax money each year that then can grow tax-free.
Pros of 401(k)
- If the small business turns into a large business, there is no need to change plan types. 401(k) plans are for all business sizes.
- Higher contribution limits.
- Vesting is allowed, employees do not have to be 100% immediately vested in employer contributions.
- There is no matching or nonelective deferral requirement. The 401(k) plan can be set up solely for employees to contribute to their own retirement.
- Allows for a Roth provision.
Cons of 401(k)
- More paperwork is involved in the setup and maintenance of a 401(k) plan.
- Higher maintenance costs.
- Eligibility testing must be performed annually.
What’s the difference between a SIMPLE IRA and a 401(k)?
A SIMPLE IRA is a retirement plan for small businesses with fewer than 100 employees. A 401(k) is a retirement plan for businesses of any size. The key differences are the method of setting up the plan, the amount an individual can contribute, and the amount the employer can/must contribute.
Can an employer have a SIMPLE IRA and a 401(k) in the same year?
No. According to IRS rules, a SIMPLE plan must be maintained for the entire calendar year. A SIMPLE plan cannot be terminated mid-year. This means if a company wants to change from offering a SIMPLE IRA to a 401(k), they must end the SIMPLE plan at the end of the calendar year and begin the 401(k) at the beginning of the following year.
Employers must also notify employees by November 2nd if the plan is going to terminate at the end of that year. So if a company decides to terminate a plan in mid-November, they then must keep the SIMPLE in place for another full calendar year before termination.
Can I move my SIMPLE IRA to a 401(k)?
Yes. As long as your 401(k) accepts rollovers from prior plans, you can roll a SIMPLE IRA into your current 401(k) plan. One rule on this is that you must keep your SIMPLE IRA where it is for 2 years from when you first participated before rolling the money to any account other than another SIMPLE. If you do roll the money out before 2 years, it will be treated as an early withdrawal and this comes with income tax as well as a 25% additional tax.
This could be a costly mistake. So, ensure you have had your SIMPLE plan in place for a full 2 years before rolling it out.
What is better a SIMPLE IRA or a 401(k)?
This depends on the goals and the company. If your main goal is to keep administrative costs low and the maintenance of a plan easy, a SIMPLE might be a good start for your small business. If you plan to grow your business over the next few years and plan to have more than 100 employees, you may want to consider going straight to a 401(k) plan.
Look at the pros and cons for both a SIMPLE IRA and a 401(k) and then decide what is best for your company.
SIMPLE IRA vs 401(k)
|Availability||Small business with fewer than 100 employees.||Companies with 1 or more employees.|
|Employee contribution limit (2023)||Employee: $15,500 limit|
Employer contribution: unlimited for 2% nonelective and for the 3% match the limit is up to $305K salary.
|Employee: $22,500 limit|
Employer contribution: combined employer and employee contributions: $61,000 per year.
|Employee catch-up contribution (50+)||3000||6500|
|Employer contributions||Employers must contribute 2% non-elective or 3% matching contribution to each eligible employee’s account.||No mandatory employer contribution.|
|Vesting||All contributions are immediately 100% vested.||Companies can set up a vesting schedule for employer contributions.|
|Tax benefits||Employer contributions are deductible.||Employer contributions are deductible.|
|Can be combined with other retirement plans?||No||Yes|
|Costs/administration||Minimal costs and low administrative responsibilities.||Higher setup costs and administrative requirements.|
|Who is an “Eligible Employee”||Employees who earned at least $5,000 in compensation during any 2 preceding calendar years and who are expected to earn $5,000 during the current calendar year.||Employees who are at least 21-years-old with at least 1 year of service.|
What is a SIMPLE 401(k) plan? Is this a good option?
A SIMPLE 401(K) is a hybrid plan that has many similarities to a SIMPLE IRA with a few key differences. SIMPLE 401(k)s are meant for small businesses with fewer than 100 people, just like the SIMPLE IRA.
SIMPLE 401(k) plans still have the employer contribution rules. Employers must either do a 3% match or 2% non-elective contribution. Employees may also contribute. A SIMPLE 401(k) also does not allow for a vesting schedule. Employees are always 100% vested in employer contributions, just like a SIMPLE IRA. The annual contribution limit is also the same for SIMPLE 401(k)s as it is for SIMPLE IRAs.
The key differences between SIMPLE 401(k) plans and SIMPLE IRAs is that the SIMPLE 401(k) may allow for loans, and SIMPLE IRAs do not. The other difference is for SIMPLE IRAs, there is no age limit to determine who is an eligible employee. For the SIMPLE 401(k), an eligible employee is at least 21 years of age with at least 1 year of service.
Choose a SIMPLE IRA or a 401(k) for your small business
A SIMPLE IRA or a 401(k) are great retirement savings options for your small business. Whichever plan you choose, make sure that you thoroughly research your options and know the administration fees and investment costs. If you’re interested in a comprehensive financial plan, for yourself and your small business, schedule a free discovery call today.
Kayla Welte, AFC®, ChFC®, CFP®, has been helping clients maximize their finances since 2009. With a background in financial education & counseling, Kayla is passionate about helping people prioritize & reach their financial goals. Kayla is a Financial Planner at District Capital Management, a financial planning firm designed to help professionals in their 30s & 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, & maximizing their money. Schedule a free discovery call today.