SIMPLE 401(k) Plan: What It Is and How It Works

Small business owners should know about this retirement-plan option

Reviewed by Eric EstevezFact checked by Suzanne KvilhaugReviewed by Eric EstevezFact checked by Suzanne Kvilhaug

What Is a SIMPLE 401(k) Plan?

A SIMPLE 401(k) is a retirement savings account offered by small business employers with 100 or fewer employees. The SIMPLE 401(k) works just like a regular 401(k) plan, combining it with the simplicity of a SIMPLE IRA with a few minor changes. Employees can defer some of their wages to the plan and employers must either make a matching or non-elective contribution of a certain amount of each employee’s wages.

Employers must meet certain eligibility requirements and the Internal Revenue Service (IRS) sets limits on how much can be contributed each year.

Key Takeaways

• SIMPLE 401(k) plans are retirement savings plans offered by small business employers or companies with 100 or fewer employees.
• This kind of plan combines the features of traditional 401(k)s with the simplicity of SIMPLE IRAs.
• Participants must be at least 21 and have one year of service before they can participate.
• Contributions to the plan are fully vested immediately and employees are allowed to borrow against their account balances.
• Employees who provide SIMPLE 401(k)s can’t offer their employees any other options and contribution limits are lower than traditional 401(k) plans.

How SIMPLE 401(k) Plans Work

As the name implies, the SIMPLE 401(k) is a simplified, stripped-down version of a regular 401(k) plan that is geared toward self-employed individuals and small business owners. And just like SIMPLE IRA accounts, only employers with a staff of 100 or fewer can establish SIMPLE 401(k) plans. Establishing businesses can be structured in any form, including sole proprietors, corporations, and partnerships.

SIMPLE 401(k)s work just like regular 401(k)s. Employees contribute with pretax dollars out of their paychecks, investing the funds in options provided by the plan administrator. The IRS limits annual contribution amounts, which are about two-thirds of those allowed for regular 401(k)s. Employees can contribute a maximum of $15,500 in 2023 and $16,000 in 2024. People 50 and over are allowed to deposit an additional catch-up contribution of $3,500 in 2023 and 2024.

All employer contributions to a SIMPLE 401(k) are subject to an employee compensation cap, which is $330,000 for 2023 and $345,000 for 2024. This is one way the SIMPLE 401(k) differs from a SIMPLE IRA. Unlike traditional 401(k)s, employers are required to make either a matching contribution to their employees’ accounts—up to 3% of each employee’s pay or a nonelective contribution of 2% of each eligible employee’s pay.

Important

Companies that offer their employees a SIMPLE 401(k) plan must file Form 5500 every year.

SIMPLE 401(k) Rules and Regulations

Employees who are at least 21 years old and completed at least one year of service must be allowed to participate in their employers’ SIMPLE 401(k) plans. They must also receive at least $5,000 in SIMPLE compensation from their employers for the preceding year in order to take part.

Funds in a SIMPLE 401(k) must be held in the account until the employee reaches age 59½. Withdrawals made before that point are subject to an early withdrawal penalty of 10%.

The employer must provide a deferral notice to each eligible employee for the year the plan is established and for each year the employer continues to maintain the plan. This notification must be provided at least 60 days before the employee becomes eligible to participate. It must include a statement of the employee’s right to make salary deferral contributions and to terminate their participation in the plan.

Note

The “SIMPLE” in a SIMPLE 401(k) plan is short for Savings Incentive Match Plan for Employees of Small Employers.

Advantages and Disadvantages of SIMPLE 401(k)s

There are a number of different benefits to participating in a SIMPLE 401(k) plan. But there are also several drawbacks. We’ve noted some of the major ones below.

Advantages

Contributions to a SIMPLE 401(k) are immediately 100% vested. An employee who meets the requirements to receive distributions from the plan may withdraw their entire account balance whenever they like and won’t lose it if they switch jobs after the money is in their account.

One of the simplified features is that SIMPLE 401(k) plans do not require nondiscrimination and top-heavy testing to ensure that the plan operates in compliance with IRS rules. Such testing must generally be done by professionals and can be quite costly.

Although withdrawals before the age of 59½ are subject to a penalty, employees can take out loans against their SIMPLE 401(k) balances. They also have the option of making hardship withdrawals from their plans if they need to do so.

Disadvantages

Unlike other retirement options, employer contributions are mandatory for those who offer SIMPLE 401(k) plans to their employees. Employers have one of two options available. They can contribute either 3% of each employee’s pay or they can make nonelective contributions of 2% of each eligible worker’s salary.

IRS rules prohibit a company from offering other types of retirement plans to employees already covered by a SIMPLE 401(k). That said, these companies may choose to maintain a separate retirement plan for other employees not covered by the SIMPLE 401(k).

Contribution caps to SIMPLE 401(k)s are smaller than those for traditional 401(k) plans. Employees can only contribute $15,500 in 2023 to a SIMPLE 401(k) plan with catch-up contributions of $3,500 per year for those 50 and older. Though these amounts increased to $16,000 of contributions with the same catch-up of $3,500 in 2024, these amounts are still lower than other retirement plans. For example, taxpayers can set aside $22,500 for their 401(k)s in 2023 and $23,000 in 2024. Catch-up contributions for these plans are $7,500 in both 2023 and 2024.

Pros

• Immediate 100% vesting for employees

• No discrimination testing for employer

• Loans and hardship withdrawals allowed

Cons

• Mandatory contributions (for employer)

• No other plans allowed

• Lower employee contributions than regular 401(k)

Who Is Eligible for a SIMPLE 401(k)?

A SIMPLE 401(k) is available for small businesses that have 100 or fewer employees who each earn more than $5,000 per year.

What Is the Difference Between a SIMPLE 401(k) and a SIMPLE IRA?

Both SIMPLE IRA and SIMPLE 401(k) plans are options for small business owners to provide retirement benefits to themselves and their employees. The key differences are that SIMPLE 401(k)s allow for loans while SIMPLE IRAs do not, and a SIMPLE 401(k) requires employees to be 21 years or older while SIMPLE IRAs have no age restrictions.

How Much Can You Contribute to a SIMPLE 401(k)?

A SIMPLE 401(k) limits employees to $15,500 in contributions for 2023 and $16,000 in 2024. This is in contrast to a regular 401(k), which has a $22,500 limit in 2023 and a $23,000 limit in 2024. Individuals may also qualify to make catch-up contributions for both plans: $3,500 for a SIMPLE 401(k) and $7,500 for a regular 401(k).

Can I Have a SIMPLE 401(k) and a Traditional IRA?

Yes, you can maintain and contribute to an individual retirement account (IRA) while also having and contributing to an employer-sponsored SIMPLE 401(k) plan.

The Bottom Line

Helping your employees save for retirement is a great way to keep turnover rates down and retention up. It doesn’t hurt to attract talent, either. It might help keep a small firm competitive with the perks offered by larger corporations.

While SIMPLE 401(k) plans have a lot of benefits, such as easy-to-manage rules, they do have some disadvantages when compared with other savings plans. The mandatory contributions and the paperwork, simplified though it is, can be a burden.

As a result, they’re not for every company but then, a few options are. Consult with 401(k) plan providers and your team of tax professionals to see if this retirement vehicle is the best suited for you and your staff.

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