SIMPLE IRA vs SIMPLE 401K: What’s the Difference? What Should I use for my Small Business?
As a small business owner, you want to keep your employees happy and doing good work. One of the best ways to provide and give back to your employees, even if you are only employing yourself, is to provide them with an opportunity to save for retirement.
While it may seem out of reach, it is possible to provide a plan that will benefit both you and your employees. There are few options available, but two are considered the “simple” way to save for retirement: Simple IRAs and Simple 401Ks. Depending on what you are looking for in a plan, either can be a great choice, but which is better for your employees?
What is a SIMPLE IRA?
Simple IRA stands for saving incentive match plan for employees of small employers. It is a tax-deferred retirement savings plan where employees make elective contributions. Like a traditional IRA, the funds will grow tax-deferred until retirement age. The Simple IRA is established by the employer and this arrangement works for self-employed individuals. So, if you are a freelancer looking for a retirement plan, this may benefit you as well.
Simple IRAs have specific qualifications. The employer must have no more than 100 employees who have received at least $5,000 in compensation from the employer the previous year. Also, an employer cannot maintain any other plan whatsoever when opening a Simple IRA. There is an exception to this rule; employees covered under a collective bargaining agreement can disregard this rule.
There is no age requirement for Simple IRAs. As far as who can participate in the plan, any employee who has earned at least $5,000 during any two preceding years and is expected to earn $5,000 in the current year are allowed to participate.
On the employer side, when matching contributions, an employer may choose to reduce the amount contributed to less than 3%, but no less than 1% for two out of every five years. Also, one pain point of Simple IRAs is that loans are not allowed. If an employee wished to borrow from the fund, he would not be able. If you are looking for that additional option, a Simple 401K may be a better choice for you.
What is a SIMPLE 401K?
A Simple 401K is a cross between a Simple IRA and a traditional 401K plan. The two have many similarities. Both the Simple IRA and SIMPLE 401K need employers to have less than 100 employees who have received at least $5,000 in compensation. Additionally, employers are allowed only to maintain Simple 401K. However, in this case, the employer can choose to maintain a second retirement plan to cover employees who are not eligible.
Unlike the Simple IRA, the Simple 401K does have an age requirement. Employees must be at least 21 years of age to participate in the company retirement plan. Also, eligible employees are required to perform the service for at least one year. A positive change for the Simple 401K is that employees can take out money on loan from the fund. Before making a selection, the best course of action is deciding which features you would like to offer your employees, and what may benefit you as well.
Similarities in Savings
Simple IRAs and Simple 401Ks have many similar features. Both funds have a 60-day annual notification. The deadline to establish is between January 1st and October of the same year. No non-discriminator testing is required; nearly everyone is eligible as long as they fall within the guidelines. Both permit the same contributions – this includes any catch-up contributions as well.
One of the best benefits for employees is that for either plan, all contributions are immediately 100% vested. Employees may make salary-deferral contributions while employers choose to make matching contributions to employees who make salary-deferral or non-elective contributions
When matching, employers must contribution dollar for dollar up to 3% of the employee’s compensation. For non-elective selection, employers must contribute 2%. What it comes down to is what would be the best fit for your company.
Which plan is right for you?
Selecting the right retirement plan for yourself can be tricky but picking one for your small business can be incredibly difficult. Consider what both plans have to offer and what would work to benefit both you and your employees. Remember, a retirement plan is a good way to keep employees and keep them happy. Of course, before opening an IRA or 401K, discuss the different opportunities with your financial advisor. Be the helping hand and help your employees, and yourself, save for the future.
For additional information, contact one of our trusted investment experts.