Simple IRA or 401(k): What’s Better for Small Business?

SIMPLE IRA and 401(k) are retirement savings options that businesses can offer their employees to retain talent. This article explains the difference between the two plans and the benefits that each can offer to help you select the plan most suitable for your business.

Understanding Simple IRA and 401(k)

SIMPLE IRA is the Savings Incentive Match Plan for Employees. It is a form of an Individual Retirement Account. Compared to SIMPLE IRA, a 401(k) plan offers more significant retirement benefits and investment opportunities to small businesses.

Here are the key differences of each plan as provided by plan provider Ubiquity:

Contributions Limit

Small business 401(k) plans have higher contribution limits compared to a SIMPLE IRA plan. Through a small business 401(k), you can make a maximum contribution of $19,500 each year while SIMPLE IRA allows a maximum contribution of $13,500. Both employers and employees above 50 years can contribute $26,000 to small business 401(k) while they can only contribute $19,500 to SIMPLE IRA. Higher contribution limits offered by small business 401(k) plans provide greater tax relief and better returns in the future.

Scalability

SIMPLE IRA is restrictive in terms of scalability as it allows only up to 100 employees. In contrast, anyone right from self-employed individuals to businesses with over 100 employees can adopt a small business 401(k) plan.

Employer Contribution Requirements

Employers who adopt the SIMPLE IRA plan are expected to match the employee contribution through a non-elective contribution of at least 2% of all eligible employees’ compensation. Or they can also opt for a matching contribution of up to the first 3% compensation. Such employer contribution is optional if you select a small business 401(k) plan.

Vesting

SIMPLE IRA demands immediate vesting to the employees. While with a small business 401(k) employers can either vest immediately or adopt a cliff schedule where the employees will receive the employer matching contribution after a specific pre-defined period has elapsed.

Setup and Maintenance

SIMPLE IRA has easy setup and maintenance procedures as compared to a 401(k) plan. As there are no tax filings necessary or mandated IRS annual testing requirements to be fulfilled, SIMPLE IRA proves to be less expensive and complicated. Small business 401(k) plans, on the other hand, demand annual IRS testing to ensure that there is no discrimination between employees and require Form 5500 submission.

Tax Advantage

SIMPLE IRA requires you to participate in the program for at least 2 years before removing funds to avoid penalties. Besides, you still owe taxes on your balance. While through a small business 401(k) plan you have more control over when you pay the taxes on your assets.

Loan Access

SIMPLE IRA does not have any provisions for borrowing a loan from the savings fund. On the other hand, small business 401(k) allows you to take out a loan from your retirement savings in case of an emergency.

Selecting the Right Plan

A small business 401(k) is an excellent option if you are looking for higher contribution limits, substantial tax benefits, and higher flexibility. Likewise, you may choose a SIMPLE IRA if you are looking for an easier setup and exemption from IRS-mandated testing. Ultimately, businesses should consider each plan’s offerings and select a plan that fits their financial ability and business goals.