SIMPLE IRA vs. SIMPLE 401(k): Knowing the Difference

SIMPLE IRA vs. SIMPLE 401(k): An Overview

Small business employers have a variety of choices if they want to offer a tax-advantaged retirement plan. It is essential to think about them carefully and review the options with financial and tax advisors.

For example, instead of a traditional 401(k) plan, a small business owner can opt for a SIMPLE 401(k). They sound similar, but there are important differences between them that employers need to review. Or an employer could choose between a SIMPLE 401(k) and a SIMPLE IRA. These plans share many similarities, but they also have differences that could provide enough reason to choose one type of SIMPLE plan over the other.

Key Takeaways

• Choosing a retirement plan is one of the most important financial decisions a business owner will make for their business.
• The retirement plan not only allows the employer to claim a tax deduction for contributions but also serves as a means of attracting highly competent employees.
• Some plans are an administrative burden and can be quite costly to maintain.
• A small business owner who wants to avoid complex administration and limit costs may find SIMPLE plans attractive.
• Before choosing, the owner may want to review certain specifics, including the average age of the business’s employees and whether they would prefer loans to be allowed under the plan.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) is a tax-deferred retirement savings account. SIMPLE accounts can be established by employers, including self-employed individuals.

To qualify, employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the previous year. An employer who chooses a SIMPLE IRA is not allowed to maintain any other plan while maintaining a SIMPLE IRA.

Note

Exceptions are allowed for employees covered under a collective bargaining agreement, and plans that cover these employees are disregarded for this purpose.

There is no age requirement for the SIMPLE IRA. Instead, any employee who earned at least $5,000 during any two preceding years and is reasonably expected to earn $5,000 in the current year must be allowed to participate in the plan.

For the SIMPLE IRA, an employer who elects to make matching contributions may choose to reduce the amount to one that is less than 3% but no less than 1% for two out of every five years. This option is not available for SIMPLE 401(k)s.

SIMPLE 401(k)

The SIMPLE 401(k) plan is a cross between a SIMPLE IRA and a traditional 401(k) plan and offers some features of both plans.

For both the SIMPLE IRA and the SIMPLE 401(k), eligible employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the previous year. Employers cannot maintain any other retirement plan for employees who are eligible to participate in the SIMPLE 401(k).

However, the employer can choose to maintain a second retirement plan to cover those employees who are not eligible to participate in the SIMPLE 401(k) plan. No non-discrimination testing is required for either plan, and both plans are subject to the 60-day annual notification requirement.

The deadline to establish either plan is from January 1 to October 1 of the year, and this deadline allows employees to make salary-deferral contributions before year-end. To be eligible to participate in the SIMPLE 401(k) plan, employees may be required to perform service for at least one year and reach the age of 21.

Because the SIMPLE IRA is an IRA-based plan, loans are not allowed. On the other hand, an employer may include loans as a feature in a SIMPLE 401(k) plan. For employees who need to tap into their retirement assets when they are ineligible to receive distributions from the plan, loans can be an attractive plan feature.

Important

For both the SIMPLE IRA and the SIMPLE 401(k) plans, all contributions are immediately 100% vested.

Special Considerations

Both plans permit the same type of contributions. Employees may make salary-deferral contributions, while employers may choose to make matching contributions to employees who make salary-deferral or non-elective contributions.

For the matching contributions, employers must contribute dollar for dollar up to 3% of the employee’s compensation. For the non-elective contributions, employers must contribute 2% of the employee’s compensation.

Workers age 50 or older by the end of the year can make additional catch-up contributions of $3,500, for a total of $19,500.

However, employer contributions for the SIMPLE IRA and the SIMPLE 401(k) are subject to different rules. As a result, the two plans will require/allow different employer contribution amounts. For instance, all employer contributions to a SIMPLE 401(k) are subject to the compensation cap (which is $330,000 for 2023, and $345,000 in 2024), while only non-elective employer contributions to SIMPLE IRAs are subject to the compensation cap. The following is an example of how this could affect the contributions that employees receive.

Example of a SIMPLE IRA

ABC Company established a SIMPLE for its employees and has elected to make a matching contribution to the plan for the 2023 calendar year. Jane, an employee, is eligible to participate in the plan. She receives compensation of $350,000 for the year from the company. Jane has decided to defer the maximum allowable amount of $15,500 ($16,500 for 2024) to the plan.

The amount Jane receives as an employer contribution is determined by the type of SIMPLE that ABC adopted:

• If ABC Company adopts a SIMPLE IRA, Jane may receive a matching contribution of $10,500 (3% of $350,000).
• If ABC Company adopts a SIMPLE 401(k), Jane would receive no more than $9,900 as a matching employer contribution. This is because ABC Company may consider no more than $290,000 of Jane’s compensation for plan purposes due to IRS limits (3% of $330,000).

As stated earlier, the non-elective contribution is subject to the same compensation cap for both plans. Therefore, if ABC Company had elected to make non-elective contributions, Jane’s contribution amount would be the same under both plans.

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