Q: We are evaluating which retirement plan to implement for our business. What are the advantages and disadvantages of a SIMPLE IRA retirement plan versus a 401(k) retirement plan?
The Problem: Understanding the Differences Between SIMPLE IRAs and 401(k) Retirement Plans
Many small and midsize businesses delay implementing a retirement plan because they don’t understand the key differences between two of the most common plan types.
The Solution – Learning the Differences
Number of employees
Businesses with 100 or fewer employees may offer a SIMPLE IRA plan (Savings Incentive Matching Plan for Small Business Employees). Companies that have one or more employees may offer a 401(k) plan.
Employee contribution limits
A SIMPLE IRA allows employees to contribute up to $11,500 in pre-tax salary deferrals or $14,000 if they are age 50 or older. A 401(k) allows employees to contribute up to $16,500 in pre-tax or subsequent salary deferrals or $22,000 if they are age 50 or older.
Like a Roth IRA, the Roth version of the 401(k) allows after-tax contributions (with significantly higher limits than a Roth IRA). Unlike a Roth IRA, employees with relatively high incomes can still make contributions.
Employer contribution limits
A SIMPLE IRA requires employers to match employee contributions at 100% of the first 3% of compensation (can be reduced by up to 1% in 2 out of 5 years) or contribute 2% of each employee’s compensation eligible (limited to $245,000).
A 401(k) does not require employers to match or contribute. A 401(k) allows, on a combined employee and employer basis, contributions up to 100% of compensation (capped at $245,000) or $49,000, whichever is less. With a 401(k), employers can deduct amounts not to exceed 25% of aggregate compensation for all participants and all salary reduction contributions.
New Comparability, also known as Age-Weighted, is a type of 401(k) plan design that maximizes the amount contributed to a select group (usually the business owner and other key employees) while minimizing the total cost of contributions of the employees.
Clothing
A SIMPLE IRA requires employee salary reduction contributions and employer contributions to be vested immediately at 100%. A 401(k) requires that employee salary reduction contributions be vested immediately at 100%. With a 401(k), employer contributions can be vested over time according to the terms of the plan. Employers can use a 401(k) vesting schedule to control employee turnover and reward dedicated employees.
Management
A SIMPLE IRA is a low-cost or no-cost plan for the employer that does not require an annual filing with the IRS. A 401(k) is a low-cost employer plan that requires an annual IRS filing, which is often provided by the 401(k) provider. Depending on plan design, a 401(k) may require evidence of employee discrimination.
Resume
Since each plan offers certain advantages and disadvantages, talk to a retirement plan expert before making a decision.
action steps
Implement a SIMPLE IRA or 401(k) retirement plan. It will offer a powerful benefit in recruiting new employees and retaining existing employees.