Retirement Planning: 401(k) vs. SIMPLE Plan

There are many types of retirement plans and not one is fit for everyone. Small businesses may use a different type than an employee of a large corporation. We are going to break down the different types of retirement plans and discuss which one is best for you. 

401(k) Plans

401(k) traditional accounts allow employees to contribute up to $19,500 (or $26,000, if they are at least 50 years old anytime during 2020) on a pre-tax basis. Employees can also put money into a Roth 401(k) plan up to the same limit on a post-tax basis (either partly or entirely). What makes these plans great for employees are the benefits the employer gives by matching benefits. Employers will match both traditional and Roth accounts. These matches are done on a pre-tax basis so although you may have a Roth, you may still have to pay additional fees if you take that money out early.

Another option for Retirement

However, keeping up with paperwork such as Form 5500, record-keeping, reporting obligations and other duties without the help of a third-party administrator can be a very daunting task for a small business. SIMPLE IRAs are a great plan to turn to for businesses with 100 employees or less. SIMPLE stands for "Saving Incentives Match Plan for Employees Individual Retirement Accounts". This allows the employee to set up their own individual IRA in their name. A SIMPLE IRA and a traditional IRA are different.

SIMPLE IRA

A SIMPLE IRA does not require record-keeping or updating Form 5500. They are less expensive to administer than a SIMPLE 401(k) or a traditional 401(k). SIMPLE IRAs contributions are made on pre-tax basis, those taxes are due the year the money is distributed, and the individual cannot attain that money until they are at least 59 and a half years old or they are subject to a 10% tax penalty for taking it out too early.

 

The caps on SIMPLE IRAs are much more limited than 401(k)s. Employees can contribute $13,000 into a SIMPLE IRA. If they are more than 50 years old, they can contribute $3,000 more for “catch up” contribution. However, employees are required to contribute to employees’ accounts. These contributions can either be two percent flat rate, a dollar for dollar match, or three percent of their salary. A unique aspect of the SIMPLE IRA matching is that employees are always 100% entitled to keep the full amount contributed, no tenure requirements attached. In return, the employer does not undergo nondiscriminatory testing unlike with the 401(k) plan. 

SIMPLE 401(k)

SIMPLE 401(k)s are not much different from SIMPLE IRA plans. To participate, businesses need to be small, reporting obligations are limited, and contributions are pre-taxed. However, SIMPLE IRA plans will have employees eligible if they have received at least $5,000 in compensation from the previous year. The difference is that SIMPLE 401(k) plans make employees wait until they are 21 years old and completed one year of service before they can participate. While employees are required to match contributions, only $285,000 are available to be matched by an employee. Even then, the most the employee can match is up to three percent of that cap which is $8,550.

When your business begins to expand, you have the ability to switch from SIMPLE IRA to a 401(k). 

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