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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. Another big difference is that you can opt for a Roth version of the plan, whereas the SIMPLE IRA allows no Roth provision.
SIMPLE IRA vs. 401(k)
Here are the need-to-know differences between SIMPLE IRAs and 401(k)s:
Employers with 100 or fewer employees
Any employer with one or more employees
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
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
Minimal account fees
Varies by plan.
Any investments available through the financial institution that holds accounts
Investment selection curated by employer and plan administrator.
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.
How important is it to offer the Roth option?
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.) There is no Roth version of the SIMPLE IRA. The account is subject to many of the same rules as a traditional IRA: Contributions reduce your taxable income for the year, but distributions in retirement are taxed as ordinary income. That said, 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.
» Ready to open a SIMPLE, traditional or Roth IRA? See the top-rated IRA account providers
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 $61,000 ($67,500 if 50 or older) in 2022. For 2023, the limit is $66,000 ($73,500 if age 50 or older).
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 no Roth version is allowed.
We’ve laid out the pros and cons for these and other retirement plan options for the self-employed.