SIMPLE IRA vs. 401(k): Evaluating retirement options for your clients

Both SIMPLE IRA and traditional 401(k) plans help businesses offer retirement benefits to their employees, but which is the right choice for your clients?  

What is a 401(k)? 

The 401(k) is one of the more common employer-offered retirement plans. This type of plan allows employees to contribute money directly from their paycheck. 

401(k) plans have annual contribution limits set each year by the IRS. For 2023, that amount is $22,500. Employees who are 50 or older can contribute an additional $7,500 in catch-up contributions.1 

There are numerous benefits to offering a 401(k) plan as your retirement benefit: 

• No max number of employees: Companies can offer a 401(k) and continue to grow without the burden of having to change their offering in the future to scale for growth. 
• Vesting schedule: Plans can be designed so that employer contributions can become vested over a period of up to six years, helping to retain talented employees over time. 
• Loans and withdrawals may be allowed: Plans can be designed to allow participants to take withdrawals from their 401(k) balance if they meet the criteria set forth in the plan document. 
  

What is a SIMPLE IRA?

SIMPLE IRA plans are a retirement benefit tailored to small businesses and self-employed individuals. A business can only offer a SIMPLE IRA if they have 100 employees or less who earn $5,000 in the calendar year.   

Because the SIMPLE IRA has an employee limit, businesses need to be mindful of their employee counts as they may need to change plan types in the future if they eclipse the 100-employee maximum. However, there is a two-year grace period for making that adjustment to accommodate the rapid growth of many businesses. 

Like the 401(k) plan, there are contribution limits for the SIMPLE IRA. Eligible participants may make deferrals to the account. The contribution limit for a SIMPLE IRA in 2023 is $15,500. Catch-up contributions totaling up to $3,500 can be made by employees 50 or over in 2023. 

What are the benefits of a SIMPLE IRA? 

• Compensation limit does not apply on the employer match. 
• There is no nondiscrimination testing. 
• Mandatory, instant vesting. 

There are a few other important factors to consider with a SIMPLE IRA. For example, employers that sponsor a SIMPLE IRA cannot offer any other qualified retirement plans for their employees during that calendar year. 

While employer matching is optional in a 401(k), employers are required to match 100% on the first 3% of compensation deferred by their participants. Alternatively, employers may make nonelective contributions of 2% (capped at $330,000) for employees who earn more than $5,000 per year.  

Additionally, employer contributions are immediately vested at 100% with these plans, meaning these funds are available to them immediately if they choose to liquidate their account. 

There are deadlines for establishing a SIMPLE IRA, as well. These plans can be established any time between January 1 and October 1 if the employer has not previously maintained a plan. If they have previously had a SIMPLE IRA, a new one can only be started on January 1. Once established, a SIMPLE IRA must run on calendar year timing. 

SIMPLE IRA vs. 401(k) 

When businesses are choosing which retirement plan to offer, the options may be overwhelming. Depending on the individual business, one or both plan types may be a good fit. Choosing the right plan will depend on company size, goals, employee and employer preferences, desired flexibility and more.  Both plan types offer specific benefits that may make them the right fit for a business.  

One thing to keep in mind when assessing plan types is the nondiscrimination testing associated with 401(k) plans. Annual nondiscrimination tests for 401(k) plans require work from the plan sponsor.