As a small business owner, perhaps you’ve been contemplating the best type of retirement plan to implement at your company. When looking to set up a company retirement plan for the first time, the amount of choices can completely overwhelm you. In fact, there are over 20 different types of plans that you could potentially implement. And with that amount of choices you will likely be so overwhelmed that you will take no action at all.
When it comes to choosing a company retirement plan, there is rarely a “one size fits all” approach. All small business owners and companies have different goals, different levels of profitability, different numbers of employees, different levels of cash flow, etc. Therefore, it’s wise to do a thorough analysis to explore all your options. But in my experience, when implementing a company retirement plan for the first time, you will likely be weighing the pros and cons of the SIMPLE IRA vs 401k.
SO, WHICH IS BEST?
Let’s take a look at some of the basic differences between both types of plans.
The 401k allows for greater contributions than the SIMPLE IRA. Therefore, if a big priority of yours is to give employees the ability to contribute as much as they possibly can, then you will likely lean toward the 401k. Additionally, any participant age 50 or older can save even more via a catch up contribution.
A SIMPLE IRA requires the employer to match up to 3% of an employee’s salary. A 401k, on the other hand does not require a company match; however, you can implement one if you desire. If you have concerns that you may not be able to afford a company match during low or no profitability years, then a 401k may be best for you. Although, there is a provision within the SIMPLE IRA that allows you to reduce the company match periodically if you need to.
Within a 401k, an employee is allowed to borrow up to 50% of their vested balance or $50,000, whichever is less. This option is not available with SIMPLE IRAs. If you absolutely must have a loan feature, then choose the 401k. Having a loan provision is usually not a big priority for business owners.
A profit sharing provision allows an employer to contribute up to 25% to each employee’s account. If you desire to motivate your employees with profit sharing contributions, then you would choose a 401k over a SIMPLE IRA. It’s important to note; however, that employers may opt to motivate their employees with a bonus instead of a profit sharing plan. Reason being is that the bonus is immediately available to the employee, whereas the profit sharing contribution is generally not available until age 59 1/2.
When an employee makes a Roth 401k contribution, it is done with dollars that have already been taxed. In exchange, all money in the Roth 401k can be withdrawn completely tax free in the future. If this feature is a must for you and your employees, then choosing a 401k will be your best option since Roth contributions aren’t allowed in a SIMPLE IRA.
Owner Fiduciary Liability
When a business owner implements a 401k, they have an inherent legal responsibility to their employees. SIMPLE IRAs do not subject the business owner to this risk since each employee technically sets up their own SIMPLE IRA thru a particular financial institution (a 401k is technically set up by the business owner).
Annual Admin Cost
If you’re implementing a 401k for the first time, then the business will be paying an annual “out of pocket” administration fee (to cover the cost of all recordkeeping and legal compliance matters). The business can expect to pay an annual base fee of around $2,000 + approximately $50 per employee per year. These types of fees are not present with a SIMPLE IRA.
The 401k is slightly more complex than the SIMPLE IRA due to the fact that there are legal compliance issues to deal with. But in reality, neither the 401k or SIMPLE IRA is all that complex – especially if you are working with knowledgeable companies.
If you are looking to implement a company retirement plan for the first time, hopefully this comparison of the SIMPLE IRA vs 401k has been helpful.
In summary, if you want employees to have the ability to contribute as much as possible, have a Roth feature, have the ability to take loans, and /or potentially receive profit sharing contributions, then the 401k is likely your best option. Additionally, many business owners feel that having a 401k plan carries more appeal than a SIMPLE IRA when trying to attract and retain high quality employees. Otherwise, if none of those things matter to you then you will likely find the simplicity and lower cost nature of the SIMPLE IRA to be best.
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Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™
CHARTERED RETIREMENT PLANS SPECIALIST℠
2 thoughts on “Simple IRA vs 401k – Which Should A Company Implement?”
As someone who has a simple IRA at the moment, I can attest to how beneficial it is. As you’ve stated here, the process itself is simple, hence the name, and the fact that companies contribute to their employees’ plans makes it all the more worthwhile.
Completely agree Rob. Thanks for sharing!