401K Vs SIMPLE IRA: Which Plan Is Best for My Company?

Retirement plans are one of the most sought-after employee benefits. If you’re considering adding one of these, you know that it’ll make you more competitive and boost employee satisfaction. While there are various plans that can enhance your benefits package, the two most common are 401(k)s and SIMPLE IRAs. 

For the last 17 years, Complete Payroll Solutions has assisted thousands of businesses in designing comprehensive and cost-effective benefits packages. We’ve come to know quite a bit about retirement plan options. We’ve helped businesses like yours understand the differences between a 401k and SIMPLE IRA so they can make the right choice.

In this article, we’ll compare the 401(k) and SIMPLE IRA in several categories:

• Eligibility
• Costs
• Contributions
• Vesting
• Plan design
• Administrative burden
• Tax advantages

After reading this, you’ll have the information you need to decide if a 401(k) or SIMPLE IRA may be a good fit for your business. 

What is a 401(k)?

A 401(k) plan is a retirement savings plan that allows workers to make pre-tax contributions from their paychecks. That means they won’t have to pay taxes on the money they set aside until it’s withdrawn. Many plans also offer a Roth contribution option. This allows employees to make contributions from money that’s already been taxed so that employees don’t pay taxes upon withdrawal.

What is a SIMPLE IRA?

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a tax-deferred plan that allows employees and employers to contribute to IRAs set up for employees. Your employees elect to defer part of their salary and you as an employer make either a matching contribution or non-elective contribution, which we’ll explain a little bit later.

Can I Offer A 401(k) Or SIMPLE IRA?

One of the big benefits of a 401(k) is that employers of all sizes can offer one. So even if you’re an owner-only business, only have a handful of people, or operate with hundreds, you can always offer a 401(k). 

In terms of your employee eligibility, employees must be age 18 to take part in a 401(k), although you have the ability to raise the minimum age to 21. While you can allow employees to take part immediately, you also have the flexibility to require a certain length of service before they can participate. This time period can be up to a year. 

SIMPLE IRAs are designed for smaller companies. Unlike a 401(k), a SIMPLE IRA is available only to businesses with 100 or fewer employees that offer no other retirement plan. 

For employees to take part in a SIMPLE IRA, there typically is no age restriction. However, there could be a minimum earnings requirement. Essentially the employee must have made up to $5,000 per year over the last two years and be  expected to earn up to $5,000 in the current year. 

How Much Will A 401(k) Or A SIMPLE IRA Cost Me?

401(k) plans are more costly to offer than SIMPLE IRAs. That’s because you not only have start-up costs for the plan, that can be between $500 and $2,000, but also third-party administrator (TPA) fees to cover the day-to-day management of the plan. These administration fees range depending on the TPA, but you can generally expect to pay $750 to $3,000 per year plus a per-participant annual fee anywhere from $15 to $60 a year.

With a SIMPLE IRA, you generally don’t have to pay any of the start-up or operating costs of a conventional retirement plan. Primarily, that’s because there aren’t the same compliance testing requirements, filing of the Form 5500 annual report, or other responsibilities. However, some SIMPLE IRA plans may charge a low set-up fee and/or a per employee fee of around $10 to $25 a year. 

What Are The Maximum Employee Contributions For A 401(k) & A  SIMPLE IRA? 

With a 401(k), employees can contribute more in a given year, which can help them build greater wealth over the long term. For 2020, the maximums are as follows:

• $19,500 for employee contributions
• $6,500 for catch-up contributions for employees aged 50 and over
• $57,000 for the total contributions from both the employee and employer (or $63,500 for those over 50) if you decide to offer an optional match and profit sharing contribution

Employee contributions can be either pre-tax or post-tax if you offer a Roth contribution option. With Roth after-tax contributions, your employees get tax-free distributions when they retire.

The contribution limits for SIMPLE IRAs for 2020 are a little lower than for 401(k)s. For 2020, they are:

• $13,500 for employee contributions
• $3,000 for catch-up contributions for employees aged 50 and over

When it comes to contributions for SIMPLE IRAs, the big difference is that instead of an optional match with 401(k)s, you must make a contribution to your employees’ accounts every year. You can either contribute 2% of an employee’s compensation or a dollar-for-dollar match of up to 3% of the employee’s contribution. If you choose the match, you are allowed to contribute less than 3% for up to two years within a five-year period. 

How Do Vesting Rules Differ for a 401(k) Vs SIMPLE IRA? 

With both 401(k)s and SIMPLE IRAs, the amount of an employee’s contributions are fully vested immediately – meaning they’re owned by the employee. But employer contributions can be treated differently under the two plan types.

With a 401(k), you have the flexibility to design your plan with a vesting schedule to encourage employee retention. So, for example, an employee may vest in 20% of the match amount after one year of service, 40% after two years and so on. You can also opt to have a safe harbor match, which means employees would be fully vested in your contributions immediately.

With a SIMPLE IRA, employees are always 100% vested in your contribution immediately.  

How Many Plan Options Do 401(k)s And  SIMPLE IRAs Offer?

Depending on the needs of your employees, 401(k) plans offer a little more options in plan design. For example, with a 401(k), you can set up your plan to allow loans. Loans are not allowed, however, with SIMPLE IRA plans. So if you think employees may want the opportunity to borrow money from their accounts, which many have done during the COVID-19 pandemic, that could be an important difference.

With a 401(k), you also have the opportunity to make profit sharing contributions. That means you as a business owner can make large contributions to yourself or other key employees. SIMPLE IRAs, on the other hand, don’t allow profit sharing contributions. For owners or high earners who want to maximize the amount they’re saving for retirement, you may want this feature.

How Does The Administrative Burden Of A 401(k) Compare To A SIMPLE IRA?

401(k)s are a little more complex so you’ll want to consider the time required to handle the administrative tasks to make sure you’re meeting the requirements. These include:

• Sending eligibility notices
• Depositing contributions
• Annual compliance testing
• Filing the Form 5500 annual report every year

Most of these steps will likely be handled by your TPA, but you’ll still need to spend time overseeing the administration because of your fiduciary duty.

The SIMPLE IRA is fast and easy to set up. You just have to:

1. Complete a SIMPLE IRA adoption agreement
2. Set up an account for each employee

Since there’s not the same level of regulation with SIMPLE IRAs as there is with 401(k)s, there’s very little required from you in terms of administration. For example, there’s no annual compliance testing or filing requirements. All that you’ll really need to do once your plan is up and running is issue a notice to employees each year informing them of the election period.

Comparing The Tax Advantages Of A 401(k) Vs A SIMPLE IRA

Both 401(k)s and SIMPLE IRAs are tax-advantaged plans that allow employees to make contributions from their salary that are excluded from taxable income. Both are taxed once money is withdrawn. A Roth contribution option allows employees to also make after-tax contributions and make withdrawals in retirement tax-free.

There’s also a tax benefit for you as the employer: with either a 401(k) or SIMPLE IRA, your contributions as an employer are deductible.

So What’s Better, A 401(k) Vs SIMPLE IRA?

Both 401(k)s and SIMPLE IRAs are great ways to expand your benefits package to appeal to workers. Even though there are a lot of similarities between the plans, there are also distinct differences that may make one or the other a better fit for your company.

If you’re a small business and want to offer a retirement plan but want it to be easy and cost-effective, then a SIMPLE IRA may be the way to go. Keep in mind, however, that since employer contributions are required, these plans may not be ideal if your profits fluctuate. 

For added flexibility for you and maximum savings for your employees, a 401(k) may be a better fit. But the added features and customization also come with greater complexity and cost so you’ll need to consider whether you can afford the higher fees. 

Complete Payroll Solutions can help you decide on the right plan for your company so you can start reaping the benefits for your organization. Visit our benefits page for more information.