Choosing the right retirement plan for your business is an important decision. It impacts employee satisfaction and how much you can save toward your own retirement.
SIMPLE IRAs are one of the easiest options for small businesses to offer. They tend to have lower fees and are easier to administer than 401(k) plans. But 401(k) plans have the advantage when it comes to contribution limits (they’re higher) and flexibility.
So which is right for your company? To help you decide, here’s a quick look at the differences between a SIMPLE IRA vs 401(k). After that, we’ll take a deep dive into the rules and benefits of each.
SIMPLE IRA vs 401(k): The Big Differences
There’s no one-size-fits-all plan when choosing between a SIMPLE IRA and 401(k). One might be a better fit for certain companies based on the business’s size, budget, and employee needs. Here are some of the major differences between the two so you can decide what’s best for your team.
SIMPLE IRA and 401(k) Explained
Now that we’ve answered all your burning questions about the differences between the two plans, let’s go back to the basics. What exactly is a SIMPLE IRA plan? How about a 401(k)? And what kinds of businesses can get them?
The SIMPLE IRA
A SIMPLE IRA is a retirement plan for businesses with 100 or fewer employees that lets them save for retirement while enjoying some tax benefits. Employees contribute pre-tax dollars (i.e. their pay before it’s taxed) to investment funds. This, in turn, lowers their taxable income.
Meanwhile, employers are required to contribute to the plan, and they can claim those contributions as deductible business expenses. Participants don’t pay taxes on contributions or investment growth, but they do have to pay taxes on those things when they take distributions in retirement.
Who Can Contribute to a SIMPLE IRA Account?
SIMPLE IRAs are available to self-employed individuals, small business owners, and any business with 100 or fewer employees that doesn’t have another existing retirement plan.
As far as eligibility is concerned, employees can contribute to the plan as long as they received at least $5,000 in salary or wages from the employer in any two preceding calendar years and are reasonably expected to earn at least $5,000 in the current year. There’s no minimum age to participate in a SIMPLE plan.
SIMPLE IRA Contribution Limits
As with other retirement savings options, there’s a limit to how much employees and employers can contribute to a SIMPLE IRA plan.
Employees can contribute up to $14,000 for the 2022 tax year. Employees age 50 and older can make an additional $3,000 in “catch-up” contributions, for a total of $17,000. The employer has 30 days from the end of the tax year—usually January 30—to deposit employee contributions into their accounts.
Employers are required to make contributions to the plan. They have two options for making contributions to employee accounts:
- Dollar-for-dollar match of employee contributions up to 3% of the employee’s annual compensation. For example, if an employee contributes 3% of their $50,000 salary ($1,500), the business would have to make a matching contribution of $1,500.
- A contribution of 2% of each employee’s annual compensation, whether or not they participate in the plan (and this applies to any salary up to $305,000). For example, say a team member participates in the plan and contributes 3% of their $50,000 salary. Meanwhile, another team member also makes $50,000 per year but doesn’t participate in the plan. The business contributes $1,000 (2% of $50,000) to both employees’ accounts.
Employer contributions are due by the due date of the business’s federal income tax return including extensions.
What is a 401(k)?
A 401(k) plan is a retirement plan offered by employers that takes money out of employees’ paychecks—and puts it in investment funds. Unlike with SIMPLE IRAs, employers get to decide if they want to match employee contributions (meanwhile that’s mandatory with SIMPLE IRAs).
Funds can be taken out of an employee's compensation pre- or post-tax (unlike with the SIMPLE IRA, which only lets you do pre-tax). If employees don’t want their contributions taxed when they’re taken out, that’s called a pre-tax contribution, and it will lower their taxable income. Why? Because money is going out before it’s even considered by the IRS. However, employees will have to pay taxes on those contributions and any investment growth come retirement time.
Employees can decide to do the post-tax option, which means they pay into their 401(k)s after payroll taxes have already been taken out of their paychecks. Since those contributions have already been taxed, they won’t need to pay taxes on them again when it comes time to withdraw retirement funds. They also don't need to pay taxes on any investment growth (i.e., dividends, capital gains, or other investment returns), as long as they're 59 and a half or older and their first contribution to the account was at least five years earlier.
Who Can Contribute to a 401(k) Plan?
Employees can participate in a 401(k) plan if they meet both of the following requirements:
- Are at least 21 years old
- Have worked for the company for at least one year
401(k) Contribution Limits
A 401(k) plan has a higher contribution limit than a SIMPLE IRA. Again, another place where there’s more flexibility.
For 2022, eligible employees can contribute up to $20,500 to their 401(k). Workers who are age 50 or older can make an additional $6,000 in catch-up contributions for a total of $26,500.
The Department of Labor (DOL) has strict deadlines for depositing employee contributions to the plan. Businesses must deposit employee contributions as soon as possible, but no later than the 15th business day of the following month. For plans with less than 100 participants, the DOL offers a “safe harbor” requirement allowing the business to deposit employee contributions within seven business days.
Like we mentioned earlier, employers are not required to contribute to employees’ 401(k) accounts. However, they can choose to match employee contributions, either dollar-for-dollar or partially. According to the Bureau of Labor Statistics, the average 401(k) match is 3.5%.
The total annual contribution to each employee’s account—including the employee portion and employer matching—cannot be more than $61,000 ($67,500 if age 50 or older) per year.
If the employer elects to make matching contributions, the deadline to make those contributions is the due date (including extensions) of the business’s federal income tax return. For calendar-year taxpayers, that generally means:
- March 15 for partnerships, LLCs taxed as partnerships, and S corporations (September 15 if the company requests a six-month filing extension)
- April 15 for C corporations, LLCs taxed as C corporations, and sole proprietorships (October 15 if the company requests an extension)
SIMPLE IRA vs 401(k): Costs and Administration
So now that we have all the basics down, you’re probably wondering what the price tag is to set all this up. So, let’s circle back to that ever-important point of comparison: cost. We’ll also touch on admin too, since you’ll have to decide if you have the time to implement the more time-consuming plan (hint: the 401(k)).
Cost
A 401(k) plan gives you higher contribution limits and more flexibility than a SIMPLE IRA. So they’re also subject to more complicated rules, which typically means they take more time and money to administer.
Starting a 401(k) plan can require a lot of paperwork, so providers usually charge a setup fee ranging from $500 to $2,000. They may also charge a fee per participant each year, ranging from $15 to $60 per year.
Setting up a SIMPLE IRA is usually quite a bit cheaper. Many financial institutions don’t charge a setup fee at all. Annual maintenance fees range anywhere from $10 to 25 per participant.
In either case, businesses can take advantage of a tax credit to offset those costs. The Retirement Plans Startup Costs Tax Credit gives eligible employers a tax credit of up to $5,000 for three years to help cover the cost of starting a SEP IRA, SIMPLE IRA or 401(k) plan and educating employees about the plan.
You may be eligible for the credit if:
- You had 100 or fewer employees who received at least $5,000 in compensation during the previous year
- At least one plan participant is a non-highly compensated employee
- You didn’t sponsor a different retirement plan in the prior three years
You can claim the credit by including Form 8881 with your federal income tax return.
Administrator Requirements
Businesses that sponsor 401(k) plans must:
- Send notices and enroll new employees as they become eligible
- Deposit contributions into employee accounts every month
- Perform annual “nondiscrimination testing” to ensure the plan doesn’t favor highly compensated employees
- File Form 5500 with the IRS each year
- Have a CPA audit the plan each year (if the plan has more than 100 employees)
- Approve loans and hardship withdrawals
- Prepare and issue Form 1099-R to participants when necessary
Plan sponsors usually outsource several of these tasks to a third-party administrator.
Because of the complexity and costs involved, small businesses with few employees usually find it easier to offer a SIMPLE IRA to employees. As the business grows or the employer wants to offer more flexibility and features in their workplace retirement plan, they can later replace the SIMPLE IRA with a 401(k) plan.
Another Option: SIMPLE 401(k) Plan
If you’re interested in offering a little more flexibility than a SIMPLE IRA but not quite ready to shoulder the administrative burden of a 401(k) plan, a SIMPLE 401(k) may be the answer. A SIMPLE 401(k) is a mix between a SIMPLE IRA and a 401(k) plan. It has some of the features of a regular 401(k) plan, but it’s easier to administer and less expensive.
SIMPLE 401(k) plans are available to businesses with 100 or fewer employees.
Employee contribution limits are the same as those for a SIMPLE IRA: $14,000 for 2022 plus an additional $3,000 in catch-up contributions for employees 50 or older.
Employers are required to make either:
- A matching contribution of up to 3% of each employee’s pay, or
- A non-elective contribution of 2% of each employee’s pay.
Employees are 100% vested in all contributions.
While employers that offer SIMPLE 401(k) plans need to file a Form 5500 tax return for the plan each year, they offer some advantages over SIMPLE IRAs.
SIMPLE 401(k) Advantages:
- Can offer loans and hardship withdrawals. These features aren’t available from SIMPLE IRAs, but they can be helpful for employees who need to borrow or withdraw money from their retirement accounts to pay for a child’s education, buy a home, or cover other unexpected costs.
- Can require participants to be 21 years or older and be employed with the company for at least one year. Businesses can waste a lot of time and money managing small retirement accounts for employees who only work for them for a short period of time. Setting minimum age and employment terms helps prevent these issues.
So Which One Is Really Better?
The high contribution limits and flexible design options of a 401(k) plan make them a better choice for employees that want to maximize their retirement savings and businesses looking to attract sought-after talent.
But if you’re looking for a lower-cost and easier retirement plan option, a SIMPLE IRA or SIMPLE 401(k) might be the right one for you.
Whichever plan you choose, thoroughly research your options, paying close attention to administration fees and investment costs. Then you and your employees can start reaping the tax benefits of retirement savings.
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