When SIMPLE isn’t best: why a 401(k) may beat the SIMPLE IRA
Sponsoring a retirement plan can help you attract, retain, and reward employees. Two popular participant-directed options that allow for tax-deferred contributions are the SIMPLE IRA and the 401(k). Choosing the right retirement plan for your small business comes down to your goals and your employees’ needs.
Updated article; original publish date October 2, 2019
401(k) or SIMPLE IRA for a small business retirement plan?
Both the SIMPLE IRA and the 401(k) are covered under the Employee Retirement Income Security Act of 1974 (ERISA), the federal law governing employer-sponsored retirement plans. The SIMPLE IRA and 401(k) are also both defined contribution plans, which means that the plan allows employee and employer contributions, including tax deferrals on both the contributions and associated earnings, but certain tax incentives may be available.
Two retirement plan choices for small businesses
The main difference between the two retirement vehicles is that the SIMPLE IRA is ... simple. It’s easy to establish, maintain, and, if necessary, terminate; in fact, the SIMPLE IRA isn’t a single plan, it’s multiple IRAs. There’s one IRA set up for each employee, and the IRA doesn't have to be closed just because the business closes. Drawbacks to a SIMPLE IRA include relatively low contribution limits, exclusivity (i.e., when the employer isn’t allowed to sponsor other retirement plans), and inflexible design.
A 401(k), on the other hand, allows for much larger annual contribution amounts, and its design is quite flexible—an important consideration for growing businesses. The drawbacks are that it’s generally more expensive and more complex to set up and administer, but certain tax incentives may be available (as detailed later in this article).
Additional duties of 401(k) sponsorship include annual tax filings (e.g., IRS Form 5500) and nondiscrimination testing. Retirement plan service providers and plan consultants routinely perform these functions in conjunction with other offered plan services. Plan sponsors may be able to avoid certain nondiscrimination testing on certain 401(k)s by selecting a safe harbor design and making required safe harbor matching contributions or safe harbor nonelective contributions.
| SIMPLE IRA (2024 rules) | 401(k) (2024 rules) | |
| Setup | Short prototype document; can't be customized | Choice of preapproved defined contribution plan or individually designed document; can be customized |
| Company size limit | No more than 100 employees | No limit |
| Restrictions on other plans | No other plans allowed | No restrictions |
| Employer contributions | Mandatory (matching up to 3% or nonelective [automatic] of 2%) | Optional (if profit-sharing feature offered, contributions must be "substantial and recurring") |
| Employee deferral limit (combined pretax and Roth) | $16,000 annually, plus $3,500 annual catch up for employees over 50 | $23,000 annually, plus $7,500 annual catch up for employees over 50 |
| Overall contribution limit | Employee deferral limit (including any catch up), plus mandatory employer contributions as described above | $69,000 ($76,500, including catch-up contributions for employees over 50) |
| Vesting | 100% immediate vesting | 100% immediate vesting for employee money; variable vesting for employer contributions (up to six-year graded or three-year cliff) |
| Loans permitted? | No | Yes |
| Subject to nondiscrimination testing? | No | Yes (unless it's a safe harbor plan) |
| Filing requirement | None | IRS Form 5500 |
Choosing a retirement plan for a small business
SIMPLE IRAs and 401(k)s both provide small businesses with a tax-deferred retirement plan option for employees, but they’re each suitable under different circumstances, including the growth prospects of the business and the resources it can devote to the retirement readiness of its employees.
Despite its limitations, a SIMPLE IRA may make sense for a smaller business that has uncertain growth potential and tight resources. It’s easy to establish and maintain, and it offers a modest retirement readiness solution for employees.
The 401(k)’s design flexibility, higher contribution limits, and services for participants make it a natural choice for an employer seeking to improve employee financial wellness and the retirement readiness of a growing workforce.
Help from the SECURE Act and SECURE 2.0
The SECURE Act of 2019 and SECURE 2.0 Act of 2022 encourage eligible small employers to establish SIMPLE IRAs or 401(k) plans. They do this by providing an increased three-year tax credit to defray administrative expenses, an additional tax credit for eligible plan contributions made to eligible employees, and a $500 tax credit if the new SIMPLE IRA or 401(k) is established with an automatic enrollment feature.
Important disclosures
This content is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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