Are you thinking of starting a retirement plan for your employees or do you currently have a Simple IRA and are now wondering if it is time to move to a 401(k)? Understanding key differences will help you determine an optimal path.
It is always important to be clear on your objectives, in this case as the employer sponsoring the plan and for you personally if you are the owner. What do you want to accomplish and why? With that criteria in mind you can better evaluate options.
As the name implies, a Simple IRA is a simple approach to offering tax deferred savings opportunities for owners and employees. A 401(k) Safe Harbor Profit Sharing Plan also offers preferential tax savings opportunities, but with more options and higher limits.
The table below outlines key plan attributes, including the notable differences in contribution limits. Figures are based on IRA limits prescribed in 2022.
401(K) SAFE HARBOR PROFIT SHARING PLAN
Employee Annual Contribution Limit
$14,000, $17,000 for those age 50+
$20,500, $27,000 for those age 50+
100% match up to 3% OR 2% non-elective (contributed even if the employee contributes $0)
100% match up to 3% plus 50% of the next 2% for a maximum of 4% OR 3% non-elective
IRS Total Annual Contribution Limit (e.g. employee, match, profit sharing)
$61,000, $67,500 for those age 50+
100% vested in all contributions
Subject to plan design
Profit Sharing Option
No, limited administrative requirements
Yes, and other administrative requirements
Record Keeping and Administration
Individual Simple IRA accounts held at a financial institution
Service provider(s) required for the plan
The 401(K) safe harbor provision allows owners and highly compensated employees, which include non-owners that are immediate family members of owners, the ability to contribute up to the maximum deferral limits without concern for passing non-discrimination tests that are influenced by the contributions of other employees. Employer profit-sharing contributions are optional at the sole discretion of the plan sponsor. The profit-sharing feature provides owners, for example, an opportunity to materially increase tax deferred contributions while rewarding employees with at least the minimum required.
Both plan types allow for employees to be fully and immediately eligible for enrollment. However, offering generous eligibility rules may be unwise if you expect high employee turnover. This is because you likely do not want to invest plan administration time and employer contributions on behalf of short-term employees.
Both plan types permit eligibility restrictions and to do so is quite common. The most restrictive criteria for a Simple IRA limits eligibility to an employee who received at least $5,000 in compensation from the employer during any two preceding calendar years and is reasonably expected to receive at least $5,000 during the current calendar year. The most restrictive condition for a 401(k) plan is to require 1,000 hours in a service year.
Generally, Simple IRA costs are paid by the participant through their account and resemble, or may be identical to, the cost structure of other “retail” accounts. Whereas, 401(k) plans offer “institutional” cost structures. Record keeping and financial advisor fees are often paid by plan participants, proportional to account balances. The administration fee, if separate, is typically paid quarterly by the plan sponsor. Fees are often structured so that cost is not prohibitive to starting a 401(k) plan. Furthermore, a 401(k) plan becomes increasingly efficient as plan assets increase.
Evaluating your options does not need to be done alone. The knowledge and experience of an advisor adds value and provides guidance while navigating details and decision-making, all with a focus on your objectives.