Comparing Simple IRA and Simple 401(k) For Business Owners

Now, this one is a big call, whether you’re just trying to double-check your decision or you haven’t even started looking at options yet. 

The financial stability of everyone connected to your company could be radically changed depending on the type of plan you choose. 

In a domain saturated with options, it can be difficult to sort through all the jargon and fine print to find the plan that is ideal for your business.

That’s why we’ll be taking a more holistic approach in this SIMPLE IRA vs SIMPLE 401(k) comparison.

I’ll go over their key differences and lay down some pros and cons. I hope that by the time you finish this article, you will have a firm grasp on the specifics of the plan that best suits your needs.

Let’s begin. 

How a SIMPLE IRA and SIMPLE 401(k) Work

The first step is to recognize the commonalities between these plans. 

Both plans enable workers to have a predetermined amount of money set down in a retirement account each pay period. 

This payment (called an “elective deferral” by the IRS) is exempt from income taxation both at the time of deposit and in the event of growth. 

All growth is exempt from taxation until the funds are withdrawn from the account by the retiree.

Both plans permit (or even mandate, in the case of a SIMPLE IRA) employers to contribute a tax-deductible contribution to their employees’ accounts.

401(k)s and SIMPLE IRAs are, thus, quite comparable in their essential features.

Defining a SIMPLE IRA 

Individual Retirement Accounts (IRAs) can be set up for employees under a Simplified Employee Pension (SIMPLE) plan, which permits both employees and employers to make contributions. 

Smaller businesses can still offer a valuable perk to their employees by setting up a SIMPLE IRA plan, even if they may be too small to meet the requirements of a standard retirement plan.

The company contributes to each employee’s individual IRA. To save for their golden years in retirement, workers contribute a portion of their income to the plan. All of the worker’s contributions are immediately invested.

Employers must contribute to the plan and may choose to contribute at least 2% of income for all qualified employees earning at least $5,000. 

They are also allowed to contribute a matching amount of at least 100% up to the first 3% of their salary.

Defining a SIMPLE 401(k) 

Enterprises with fewer employees can take advantage of the SIMPLE 401(k) plan to provide retirement benefits to their staff.

As a qualified plan, it is bound by the regulations governing minimum distributions. Still, SIMPLE 401(k) plans are not required to undergo annual nondiscrimination testing. 

Suppose an employee meets the criteria for receiving distributions from the plan. In that case, they may withdraw the whole amount of their account at any time, and the contribution will be fully vested. 

Moreover, the maximum amount that can be contributed each year to a SIMPLE 401(k) plan is less than the maximum amount that can be contributed to a standard 401(k) plan.

Some requirements must be met by both employers and employees in order for a SIMPLE 401(k) plan to be valid.

For an organization to qualify, it must have fewer than 100 workers. The annual salary that an employee receives from the company must be $5,000 or more.

When an eligible employee is up for the SIMPLE 401(k), their employer may not offer them another qualifying retirement plan. Employees who do not qualify for the primary plan may be offered a secondary plan.

Employers are obligated to make a payment equal to either 2% of an employee’s base salary or 3% of their salary as a matching contribution.

Pros and Cons of a SIMPLE IRA 

PROS 

• Match compensation is not subject to the maximum. Any amount beyond the annual salary cap ($290,000 in 2022) will be eligible for a matching contribution to the employee’s compensation.

• It’s not subject to testing. While 401(k) plans are subject to top-heavy and nondiscrimination testing standards, SIMPLE IRAs are not. 

No employee will be prevented from contributing the maximum allowed by the deferral limit. The company will not have to worry about an unexpectedly large top-heavy contribution.

• It lessens the administrative load. Loans and other distributions that require the employer’s approval are not permitted in a SIMPLE IRA. 

The administrative burdens (and costs) of running a SIMPLE IRA may also be lessened because there is no need to file a Form 5500 annually.

CONS 

• Employers must always contribute to their employer’s retirement fund. In contrast to the discretionary nature of company contributions in a regular 401(k) plan, businesses with SIMPLE IRAs are obligated to make annual contributions.

• Lower cap on contributions. In 2022, the highest amount an employee can contribute to a SIMPLE IRA is $14,000 (plus an additional $3,000 catch-up for those over 50). 

The maximum amount an employee can contribute to a standard 401(k) plan is $20,500 (with an additional $6,500 catch-up for those over 50). If an employee is 50 or older, that extra $10,000 might make a huge difference in their ability to save for retirement.

• No Roth contributions. As part of their financial and legacy planning, many employees value the option to make Roth contributions to their standard 401(k) plans. 

With that said, contributions to a SIMPLE IRA can only be made before taxes are taken out.

• Stringent size restrictions. The 100-employee threshold places a ceiling on how large a SIMPLE IRA can become over time for a given business. 

The SIMPLE IRA plan structure may soon be inadequate for a rapidly expanding business. 

New retirement plan decisions may need to be made by an employer sooner than expected, which may eat into more resources.

• Employer contributions don’t adhere to a vesting schedule. Employees immediately receive 100% of their employer’s contribution. 

The lack of a vesting schedule for the employer contribution provides no incentive for the 

employee to continue in their position for any length of time.

• Other qualified plans aren’t allowed. 

The “exclusive plan rule” limits an employer’s ability to provide retirement benefits by prohibiting them from also sponsoring another qualifying plan, like a profit-sharing plan.

• Limited withdrawals. Unlike traditional IRAs, participants in a SIMPLE IRA cannot access their money through loans. 

Participants are free to take distributions whenever they like, but they will be subject to an additional 25% penalty if they do so within the first two years of opening their IRA account. 

This is in addition to the 10% excise tax for early withdrawal before the age of 59 1/2. 

• Terminations are strictly timed. It’s important for businesses to know that the end of the calendar year is the only time a SIMPLE IRA may be closed, and the employer’s obligation to make contributions can be released. 

If an organization is not going to make a contribution for the upcoming year, it must inform the bank that it wants to dissolve the arrangement and stop receiving contributions. 

Companies with at least 100 full-time employees are required to inform their staff by November 2 that the SIMPLE IRA will no longer be offered.

Pros and Cons of a SIMPLE 401(k) 

PROS 

• No testing. Unlike traditional 401(k) plans, SIMPLE 401(k)s are not subject to the same nondiscrimination and top-heavy testing requirements. 

Employees are free to put in as much as they can afford into employee salary deferrals, and businesses don’t have to worry about a surprise top-heavy contribution from their workers.

• Lenient eligibility. SIMPLE 401(k) plans offer the same flexibility in terms of participant eligibility as standard 401(k) plans. In comparison to the SIMPLE IRA, this could lower the cost of employer contributions.

• Flexible distribution. Unlike traditional 401(k) plans, SIMPLE 401(k) may permit loans and in-service distributions.

CONS 

• Compulsory employer contributions. When it comes to employer contributions, a SIMPLE 401(k) plan is more stringent than a standard 401(k) plan as it mandates that companies put money into the plan each year.

• Lower contribution limits. In 2022, the maximum employee deferral to a SIMPLE 401(k) will be $14,000 (plus an additional $3,000 catch-up for those over 50). 

The maximum employee deferral to a standard 401(k) will be $20,500 (with an additional $6,500 catch-up for those over 50).

• Stringent size restrictions. The SIMPLE 401(k) plan structure may not be able to keep up with the needs of a growing company. 

It may be more efficient for the company to convert the SIMPLE 401(k) to a standard 401(k) rather than establish an entirely new retirement plan, as is the case with a SIMPLE IRA.

• No vesting schedule. The entire amount of the employer’s contribution is instantly invested. Employees are not compelled to remain on staff for extended periods of time in order to have access to the employer contribution through vesting.

• Other qualified plans aren’t allowed. The “exclusive plan rule” limits an employer’s ability to offer a wide variety of retirement benefit options by prohibiting them from also sponsoring a qualified plan. 

Which One Is Better For Your Business?

Employer-provided retirement plans can be a powerful tool for attracting and retaining top talent. Therefore, as a business owner, your interests coincide with those of your staff.

If your company pays above-average wages, you may find it worthwhile to contribute to the more expensive 401(k) plan. 

Workers who earn a higher income are more likely to wish to beef up their retirement savings account.

When compared to the mandatory employer contributions of a SIMPLE IRA, the matching contribution structure of a 401(k) may set you up to save more money in the long run. 

However, a competitive 401(k) employer match is an important factor for many workers when weighing job offers.

Employees’ propensity to save money can be satisfied by a SIMPLE IRA, even if salaries are low. 

The $13,500 annual contribution limits are still high in comparison to other retirement savings alternatives, especially for those earning a middle-range wage. 

Keep in mind that employees can still contribute to their personal IRAs in addition to their employer-sponsored 401(k) or SIMPLE IRA. However, their ability to deduct those contributions may be limited if their income is too high.

The primary advantage of a SIMPLE IRA is the reduced initial and ongoing costs associated with establishing and maintaining the plan. 

You should consider switching to a SIMPLE IRA from a 401(k) if it better suits the needs of your employees (k). A 401(k) is more expensive, but it’s well worth it if you need a lot of leeway in choosing investments and making contributions.

How To Set Up A SIMPLE IRA 

A SIMPLE IRA can be up and running in a matter of hours. Basically, everything boils down to these three steps:

Write a written agreement. 

To establish the plan’s parameters, merely complete and sign IRS Form 5304-SIMPLE or Form 5305-SIMPLE. Then you don’t have to file it with the IRS; just retain it in your records.

Set up a SIMPLE IRA account for your employees. 

Simply put, you’ll need to sign into the provider’s platform and set up an account for each of your workers. The time required to complete this task will vary depending on the number of staff members, but in most cases, it will be quick and easy.

Notify your eligible employees. 

Eligible employees must be given the necessary information when they first become part of the plan and annually thereafter. Sending a completed Form 5304 or 5305 is all that’s required.

That’s it! 

How To Set Up A SIMPLE 401(k) 

It’s not surprising that 401(k)s have more stringent regulations than SIMPLE IRAs, given how much more versatile the former is. 

There is a fiduciary duty on the part of employers to guarantee compliance with these standards.

A plan fiduciary, as you might expect, is responsible for a wide range of back-end tasks. They consist of the following:

• Enroll new employees and notify them when they become eligible. 
• Deposit contributions into your employees’ accounts in a timely manner. 
• Conduct nondiscrimination testing every year to ensure the plan doesn’t favor higher earners. 
• File a form 5500 with the IRS at the end of every year. 

Unfortunately, the list doesn’t end there. A reliable 401(k) service will handle the most complex and time-consuming duties while giving you clear instructions on how to handle the rest.

This might take as little as 16-20 hours per year, depending on the following:

• The size of your company 
• The frequency with which you recruit new employees 
• The frequency with which you process payroll
• The 401(k) provider with whom you operate

If you’d rather not get bogged down with plan administration, a SIMPLE IRA could be the way to go.

Related Reading: 401a vs 401 K – Check Them out Here

Final Thoughts 

The distinctions between these retirement plans should now be evident, and you should have a solid notion of which one is right for you.

Once again, to review:

401(k) plans are a valuable resource for amassing financial security for one’s future. The higher contribution limits and customizable nature of these plans are a huge draw for both high-quality employees and employers who are eager to optimize their personal investments.

On the other hand, SIMPLE IRAs are incredibly easy to understand and use. As a result of their low costs and few administrative needs, they are a great option for companies looking to provide a retirement benefit to their employees with fewer inconveniences.

Pay special attention to the investing charges of any plan you consider, and make sure to engage with a provider who does not impose sales loads or hidden revenue-sharing fees. 

Retirement security for you and your staff will be greatly enhanced if you follow these steps. After all, this is what we’re striving for.