Comparing SIMPLE IRA and 401(k) Plans | Paychex (2024)

​Choosing the right retirement plan for your employees is an important decision, and requires thorough research. To evaluate different options, such as SIMPLE IRA vs. 401(k) plans, here are some key preliminary questions to ask:

• Who and what type of employees are you trying to benefit?
• What benefits do you want to offer the selected group of employees?
• What benefits administration costs are you able to pay?
• Will you provide these benefits to part-time employees?

Once you've answered these questions, it's time to investigate the different retirement plan choices.

SIMPLE retirement plans for small businesses

Savings Incentive Match Plan for Employees (SIMPLE) plans are designed for businesses with 100 employees or fewer who earn $5,000 or more per year. A SIMPLE plan can apply for both 401(k) and IRA plans. SIMPLE plans are easy to set up, with lower initial and ongoing costs than other retirement savings options, but they don't offer all the features found in a traditional employer-sponsored 401(k).

What is a SIMPLE 401(k) plan?

The SIMPLE 401(k) plan offers a cost-effective way for small businesses to offer retirement benefits to employees. It is a qualified plan and must follow the rules for required distributions. However, SIMPLE 401(k) plans are not subject to annual nondiscrimination testing. Contributions are immediately vested (100 percent), which means that an employee who meets the requirements to receive distributions from the plan may withdraw their entire account balance at any time. Also, the annual contribution limits are lower for a SIMPLE 401(k) plan than for a traditional 401(k) plan.

SIMPLE 401(k) plans have a few stipulations that employers and employees must follow:

• Eligible employers must have no more than 100 employees.
• Employees must have received at least $5,000 in compensation from the employer for the previous year.
• Employers cannot maintain any other qualified retirement plan for employees who are eligible to participate in the SIMPLE 401(k). A second plan may be offered to employees who are not eligible.
• Employers must make either a matching contribution of up to 3 percent of an employee's pay or a 2 percent non-elective contribution based on employee's pay.

What is a SIMPLE IRA and how does it work?

A SIMPLE IRA plan allows employees and employers to make contributions to Individual Retirement Arrangements (IRAs) set up for employees. SIMPLE IRA plans allow smaller employers to avoid the more complex structure and regulations surrounding traditional retirement plans and still provide a desired benefit to their staff.

Under a SIMPLE IRA plan:

• The employer makes contributions to an individual account set up for each eligible employee;
• Employees defer a part of their salaries into the plan for retirement;
• The plan is funded both by employer and employee contributions; and
• Each employee is always 100 percent vested.

An employer is required to make a contribution to the plan and can choose to:

• Make a non-elective contribution of at least 2% of compensation for all eligible employees earning at least $5,000; or
• Make a matching contribution of at least 100% up to the first 3% of compensation.

SIMPLE 401(k) vs. SIMPLE IRA: Which is better for small business?

Both SIMPLE plans allow small employers to provide employees with a retirement savings option. They both permit employees to contribute to a retirement savings account via salary reductions and allow for catch-up contributions to participants over 50 years old. Some key differences include the following:

• SIMPLE 401(k) plans may permit loans, while a SIMPLE IRA doesn't allow this feature.
• Companies with a SIMPLE IRA may not sponsor another plan with one exception: employees covered by collective bargaining agreements.
• There is no minimum age requirement for SIMPLE IRA eligibility, while SIMPLE 401(k) plan participants must be at least 21 years old.

What is a traditional 401(k) plan?

A traditional 401(k) plan is a retirement investment option offered by an employer. Compared with SIMPLE plans, traditional 401(k) plans offer more features and greater flexibility, which often comes with increased administrative expenses. Most plan providers offer different levels of prototype plans or varying options available under a particular plan, such as an automatic enrollment option or varied vesting schedules. With a traditional 401(k), you are not required to make employer contributions, and your employees can contribute up to an annual maximum as set by the IRS.

A traditional plan is subject to reporting obligations and tests:

• Average Deferral Percentage (ADP) test: Compares employee deferrals of highly compensated versus non-highly compensated employees.
• Average Contribution Percentage (ACP) test: Compares employer matching contributions and employee after-tax contributions of highly compensated versus non-highly compensated employees.
• Top-Heavy Test: Compares the overall benefits in the plan of key employees such as owners and officers to non-key employees.

These compliance tests must be performed annually, and failing a test may require additional contributions or highly compensated employee distributions to bring the plan into compliance.

The differences between a 401(k) and a SIMPLE IRA

When evaluating a SIMPLE IRA vs. 401(k) plan option, it's important to acknowledge that each plan may be a better fit for certain companies, based on factors such as business size as well as the wants or needs of employees. Understanding the differences between 401(k) plans and IRAs help companies make sound decisions about their benefit plans.

• A 401(k) plan can be offered by any type of employer, but a SIMPLE IRA is designed for small businesses with 100 or fewer employees.
• Contribution limits for SIMPLE IRA plans are lower than traditional 401(k) plans.
• SIMPLE IRAs require an employer contribution. 401(k) plans do not, although many employers do choose to make contributions.
• With SIMPLE IRAs, employees are always 100 percent vested, while 401(k) plans may have different vesting rules for employer contributions.

How much can I contribute to a 401(k) and SIMPLE IRA?

In 2023, the contribution limit for traditional 401(k) plans is $22,500, with an additional catch-up contribution of $7,500 for plan participants who are age 50 and older.

The contribution limit for SIMPLE IRA plans is $15,500 for 2023. Participants who are age 50 and older may make catch-up contributions up to $35000, if the plan permits it. If an employee participates in any other employer retirement plan during the year, the total amount of contributions that they can make to all plans is limited to $22,500.

Deciding which retirement plan is better for your business

Choosing a retirement plan is one of the most important financial decisions a business owner can make. Understanding the advantages of different plans and how employees will use the benefits can help employers tailor their offerings. Company culture and workforce demographics may also play a part in the final selection. For example:

• A smaller company with fewer employees may find it more beneficial to offer a SIMPLE plan rather than bear the administrative costs of a traditional 401(k).
• Companies located in a state where employers are mandated to provide access to a retirement savings account may offer a SIMPLE plan to meet these requirements.
• A small business may qualify for a SIMPLE plan, but may ultimately decide that the extra flexibility and features of a traditional 401(k) plan are a better fit for their workforce.
• Depending on the retirement plans traditionally offered in a particular industry, a company may choose to provide a certain level of benefits to employees to remain competitive.

Your financial or employee benefits advisor can assist you when evaluating a SIMPLE IRA vs. 401(k) plan. Those familiar with the latest tax laws and retirement plan structures can guide you toward the best options available, so you can choose a plan that meets your needs.