SIMPLE IRA vs. 401(k): Which is Better for Small Business?

When compared to a SIMPLE IRA, a 401(k) plan is the smarter solution for small businesses, ultimately providing greater value for owners and employees.

The Savings Incentive Match Plan for Employees (SIMPLE) is a type of Individual Retirement Account (IRA). Typically a 401(k) retirement savings account offers a broader range of investment options than a SIMPLE IRA. Here are some other key differences:

Contributions Limit

The higher contribution limit of the small business 401(k) paves the way for bigger tax relief today and bigger returns tomorrow.

For employers and employees 49 and under:

• SIMPLE IRA Contribution Limit 2023: $15,000
• Small Business 401(k) Contribution Limit 2022: $22,500

For employers and employees 50+:

• SIMPLE IRA Contribution Limit 2023: $19,000
• Small Business 401(k) Contribution Limit 2022: $30,000

Consider that an extra $6,000 per year will compound into $180,000 over 30 years (assuming the average 8% annual return). This figure doesn’t take into consideration matching employer contributions, so the pot of gold at the end of the rainbow is even brighter for your employees when you offer a small business 401(k).

Scalability

Today you may be a small business with a handful of employees, but what if you meet with quick success and need to scale up your operations? Do you want to add the headache of switching to a new retirement plan? A small business 401(k) plan has the flexibility to accommodate your business as it grows.

• SIMPLE IRA: Only for businesses with 100 or fewer employees, though not ideal for self-employed individuals
• Small Business 401(k): Anyone is eligible, whether you have 1 or well over 100 employees

Some 401(k) plan providers charge per-participant administrative fees, so if you are concerned about scaling up in the future, be sure you find a flat-fee service provider like Ubiquity!

Employer Contribution Requirements

Employers with a SIMPLE IRA are required to match employee contributions. They can choose to make a non-elective contribution of at least 2 percent of compensation for all eligible employees earning at least $5,000, or they may opt to make a dollar-for-dollar matching contribution up to the first 3 percent of compensation.

• SIMPLE IRA: Requires employer matching or nonelective contributions for all eligible employees
• Small Business 401(k): Employers decide whether or not to match

The employer match is completely optional for small business 401(k)s. Most employers choose to make a matching or profit-sharing contribution up to 25% to a maximum of $61,000 (combined employee/employer).

Vesting

Employee retention is a fundamental goal for many small businesses. One way employers hang onto core employees during the early years is to make their 401(k) plans “vested.” Employers can choose to vest employees immediately, on a cliff, or in a graded fashion.

A cliff vested plan allows employees to begin contributing to the 401(k) immediately, but they do not receive the employer matching contributions until a specific amount of time elapses (such as five years.) If employees leave before the vesting schedule, they can still keep the money they put into the retirement account, but they will not receive the match.

A graded vesting schedule may give employees 20% of the employee match after two years, 40% after three years, 60% after four years, 80% after five years, and 100% after six years.

• SIMPLE IRA: Employees must vest immediately
• Small Business 401(k): Employers can vest immediately, on a graded schedule, or on a cliff schedule

Choosing a small business 401(k) provides the freedom to choose which type of benefit works for you.

Setup and Maintenance

The main reason small businesses would choose a SIMPLE IRA is that setup and maintenance are considered easier than with a 401(k). While certain annual employee notifications must be made by November 1, there is no employer tax filings necessary. There is no IRS-mandated testing required to ensure that highly compensated executives are not receiving favorable treatment.

• SIMPLE IRA: Less expensive and complicated to set up and maintain, with no testing requirements.
• Small Business 401(k): Form 5500 is due to the IRS annually, and testing may be necessary.

ERISA requires every 401(k) plan to complete certain tests to confirm they do not exceed IRS contribution limits or discriminate in favor of Highly Compensated Employees (HCEs).

Tax Advantage

You may be able to roll a SIMPLE IRA into a Roth IRA, but you must participate in the SIMPLE IRA for at least two years before removing funds to avoid the 25% penalty. Even if you wait long enough to evade the penalty, you will still owe taxes on the entire balance converted to a Roth IRA, so it still feels like a penalty of sorts.

• SIMPLE IRA: There is no Roth version of a SIMPLE IRA
• Small Business 401(k): Control over when taxes are paid on retirement assets (pre-tax vs. Roth)

Most people will go for the traditional 401(k) and pay tax on the assets when they are withdrawn in retirement. However, high earners or those who plan to live more lavishly in retirement may opt to pay the taxes upfront and pay no tax later by signing up for a Roth 401(k).

Loan Access

With a SIMPLE IRA, you can withdraw your money at any time, but you’ll be subject to a 25% penalty if you take a withdrawal within the first two years and a 10% penalty if you are under the age of 59.5.

• SIMPLE IRA: No option to take a loan from retirement savings
• Small Business 401(k): Option to take a loan from retirement savings

By contrast, employers and employees can borrow from their own 401(k) accounts if necessary. Disability and termination of employment are common reasons to dip into a 401(k). Hardship withdrawals may be available, but a 10% penalty applies to those under the age of 59.5

Learn More About Small Business 401(k) Plans

With a budget-friendly, easy-to-use 401(k) solution from Ubiquity, business owners and employees enjoy substantial benefits. Offering a 401(k) is an optimal way to:

• Attract and retain employees
• Provide access to a broad range of investment options
• Encourage older workers to retire comfortably at the appropriate age to reduce businesses expenses and increase morale
• Save for your own future as well

With generous tax benefits, high contribution limits, and maximum flexibility, a small business 401(k) may be just what you need to make your enterprise more competitive. Contact Ubiquity for 401(k) resources and to learn more about our low-cost, flat-fee, high-value plan administration.