SIMPLE IRA vs. 401(k): The Pros and Cons of Each Plan
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The SIMPLE IRA vs. 401(k) decision is, at its core, a choice between simplicity and flexibility for employers.
The aptly named SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees, is the more straightforward of the two options. It’s quick to set up, and ongoing maintenance is easy and inexpensive. But if you have employees, you are required to provide contributions to their accounts. (Here's more on what a SIMPLE IRA is and how to open one.)
Although a 401(k) plan can be more complex to establish and maintain, it provides higher contribution limits and gives you more flexibility to decide if and how you want to contribute to employee accounts.
SIMPLE IRA vs. 401(k)
Here are the need-to-know differences between SIMPLE IRAs and 401(k)s:
SIMPLE IRA | 401(k) | |
|---|---|---|
Employer eligibility | Employers with 100 or fewer employees | Any employer with one or more employees |
Employee eligibility | All employees who have compensation of at least $5,000 in any prior 2 years, and are reasonably expected to earn at least $5,000 in the current year | All employees at least 21 years old who worked at least 1,000 hours in a previous year |
Employer contribution rules |
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Contribution limits |
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Administrative responsibilities | No annual tax filing requirements; annual plan details must be sent to employees | Subject to annual compliance testing to ensure plan does not favor highly compensated employees |
Fees | Minimal account fees. | Varies by plan. |
Investment options | Any investments available through the financial institution that holds accounts. | Investment selection curated by employer and plan administrator. |
Pros |
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Cons |
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More details |
Source: IRS.gov
SIMPLE IRA vs. 401(k): How to decide
Startup costs and ease of setup often dictate the choice between retirement savings plans. But there are other factors to consider as well. To help decide which plan is best, answer the following questions:
Why are you setting up a retirement plan?
For many small-business owners, the answer is that they’re trying to maximize their own retirement savings dollars. If that’s the case, contribution limits should weigh heavily in your decision. For high earners especially, the higher contribution limit of the 401(k) makes it a more attractive choice than a SIMPLE IRA.
» Thinking about the future? Learn about succession planning for your business.
Did you know the Roth options have changed?
As mentioned earlier, the IRS allows employers to offer a Roth 401(k). (Quick reminder: A Roth 401(k) is funded with after-tax contributions in exchange for tax-free distributions in retirement.) Previously, there was no Roth provision for SIMPLE IRAs, but a section of Secure Act 2.0 allows SIMPLE IRAs to accept Roth contributions as of January 2023. And the IRS allows participants to save in both a SIMPLE IRA and a Roth IRA at the same time.
Will you need to adjust employer contributions?
Although a nice perk to attract potential employees, employer contributions are not required of companies that offer 401(k) plans. You also have the freedom to set vesting terms, which allows you to require employees remain employed by you for a set time before taking ownership of your contributions to their accounts. Employer contributions to employee SIMPLE IRA accounts are mandatory, though you can choose between two matching arrangements dictated by the IRS. Contributions to a SIMPLE IRA are immediately 100% vested.
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You have other choices
If you are self-employed or a small-business owner, your options may not be limited to SIMPLE IRA vs. 401(k). There are a variety of retirement plans at your disposal.
» MORE: Learn the basics of IRAs
For example, if you run a business with no employees, a solo 401(k) is worth considering. As the employer and (your own) employee, you’re allowed to contribute a total of up to $66,000 ($73,500 if age 50 or older) in 2023.
A SEP IRA also has a high contribution limit for business owners and self-employed individuals, though there is no catch-up contribution for savers 50 or older. The drawbacks: Like the SIMPLE IRA, a SEP requires employers to contribute to eligible employee accounts, and Roth contributions are now allowed.
We’ve laid out the pros and cons for these and other retirement plan options for the self-employed.
