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. 

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. 

Two choices for small businesses

The main difference between the two retirement vehicles is that the SIMPLE IRA is simpler. 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 more expensive and more complex to set up and administer. 

Additional duties of 401(k) sponsorship include annual tax filings (i.e., IRS Form 5500) and discrimination testing. Retirement plan service providers and plan consultants routinely perform these functions in conjunction with other offered plan services. Plan sponsors can avoid testing altogether on certain 401(k)s by selecting safe harbor status and making required matching contributions. 

Table of differences

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 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. 

 

 

The content of this document is for general information only and is believed to be accurate and reliable as of posting date but may be subject to change. John Hancock does not provide investment, tax, or legal advice. Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

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