Small businesses that are looking to offer retirement benefits for their employees often look at two different options: a SIMPLE IRA and a 401(k). The common question, of course, is: what’s the difference?
In general terms, the difference is that a 401(k) maximizes the ability to build retirement wealth, while SIMPLE IRAs are easier to administer. And depending on the situation, either may be appropriate for the small business.
However, in my perspective, a 401(k) has four big advantages over a SIMPLE IRA. These are:
- High level of employee and employer contributions
- Employee eligibility restrictions
- Loans permitted
- Vesting schedules for certain employer contributions. In some cases, the SIMPLE IRA may be much more expensive to implement.
Let’s take a look at both investment vehicles in more detail to clarify the differences between them and further unpack which might be the best fit for your small business.
An Overview of SIMPLE IRAs
These retirement plans offer a reasonably easy way to get started with retirement benefits. However, they lack many of the robust features of a 401(k), which may reduce the amount an employee can save for retirement.
Additionally, these plans are only available to companies with less than 100 employees. The maximum that an employee can defer into these plans is $13,000 in 2019, and the maximum employer match can range between 1-3% of compensation (depending on the circumstance). Therefore, the maximum that could be contributed to a SIMPLE IRA account by both the employee and employer is $21,400 in 2019 ($13,000 + (3% * $280,000) = $21,400).
On the plus side (for employees, at least), this plan has a low eligibility threshold and most everyone who works at the company would qualify for the plan.
Loans are not available for the plan.
An Overview of 401(k)s
The key selling feature of a 401(k) is a higher contribution limit, and there are more robust features that allow employees to save significantly more money for retirement than they’d be able to within a SIMPLE IRA.
An employee can defer up to $19,000 of their 2019 salary and up to $25,000 if they are over 50 years old. In addition, these employees are also eligible for tax-free employer contributions, which could take the total employee and employer contributions to $56,000 in 2019 ($62,000 if the employee is over 50 years old).
Because the benefit package is significantly richer, the government allows businesses more flexibility in restricting access to this benefit to employees that are 21 years or older and have worked at least 1,000 hours in a previous year. From an employer’s perspective, this allows the business to exclude part-time employees from the plan.
Loans and hardship withdrawals can be permitted under these plans. Some employer contributions to the plan may be subject to vesting schedules, which will give the employee a financial incentive to stay at the firm (an added benefit for employers).
A Detailed Comparison of SIMPLE IRAs vs. 401(k)s
According to data from the US Department of Labor’s guide to retirement plans for small businesses, here’s a more detailed breakdown of how SIMPLE IRAs and 401(k)s compare to each other across a range of factors.
|Key Advantage(s)||Little administrative paperwork.||(1) Permits high level of salary deferrals and employer contributions (up to $56,000-62,000); (2) Employee eligibility restrictions; (3) Loans permitted; (4) Vesting schedules for some employer contributions.|
|Employer Eligibility||Employer with <100 employees and does not maintain another retirement plan.||Employer with one or more employees.|
|Maximum Annual Contributions – Employee||Employee: $13,000 in 2019. ($12,500 2015-2018)||Employee: $19,000 in 2019. ($18,500 in 2018). Participants aged 50 or older can defer an addition $6,000 for a total of $25,000.|
|Maximum Annual Contributions – Employer||Match contributions of 100% of first 3% of compensation (but can be lowered to 1% in any 2 out of 5 years); or 2% of each eligible employees compensation (does not require employee deferral).||Employer & Employee Combined Contribution: Up to the lesser of 100% of compensation or $56,000 in 2019 ($55,000 in 2018) or $62,000 if the employee is over 50 years old.|
|Contributor’s Option||Employee can decide how much to contribute. Employer MUST make matching contribution or contribute 2% of each employee’s compensation.||Employee can decide how much to contribute. Depending on plan design, the employer may or may not be obligated to match an employees deferral.|
|Minimum Employee Coverage Requirements||Must be offered to all employees who have compensation of at least $5,000 in any prior 2 years or may earn this in current year.||Generally, must be offered to all employees at least 21 years old who have worked at least 1,000 in a previous year.|
|Withdrawals, Loans & Payments||Withdrawals subject to Federal tax; early withdrawals subject to an additional tax. Loans NOT available.||Withdrawals permitted in certain circumstances and are subject to Federal taxes. Early withdrawals subject to an additional tax. Loans and hardship withdrawals permitted.|
|Vesting||All contributions are 100% vested.||Employee salary reductions and safe harbor contributions are 100% vested. Other employer contributions may be subject to a vesting schedule.|
Ready to Choose the Right Plan for Your Small Business?
Hopefully, this information has been helpful as you consider the benefits options available to your small business.
If you’re looking for additional guidance toward the right one, let’s talk.
At Sapling Wealth, I work closely with plan sponsors and strategic vendors to design thoughtfully-structured retirement benefit plans for your small business and help you minimize fiduciary risk. Together, we can take into consideration the objectives of your company – employee retention, personal retirement wealth creation, profit sharing methodologies – in selecting from the myriad of choices available.
Ready to choose the right plan? Get in touch for a free consultation today.