Key Takeaways
SIMPLE 401(k), SIMPLE IRA, and traditional 401(k) plans can help businesses offer retirement plans to their employees
SIMPLE 401(k) and SIMPLE IRA plans are limited to companies with fewer than 100 employees and require mandatory employer contributions
Traditional 401(k) plans allow for higher contribution rates compared to SIMPLE IRA and SIMPLE 401(k) plans, while also providing more flexibility
Whether your company offers an existing retirement benefit to its employees—or is brand new to retirement planning—it can feel daunting to navigate through the number of options available. Retirement plans are valuable for employees and employers alike, but personal and institutional needs can vary. SIMPLE 401(k), SIMPLE IRA, and traditional 401(k) plans provide employers of different sizes and growth trajectories with a plan that fits their goals.
However, each plan design comes with benefits and drawbacks. To help business owners make the right decisions for their employees, we’ll explore each retirement plan option in depth. In addition, below is a comparative table highlighting the key differences and features of SIMPLE 401(k), SIMPLE IRA, and traditional 401(k) retirement plans to help guide your decision-making:
| Features | SIMPLE 401(k) | SIMPLE IRA | Traditional 401(k) |
|---|---|---|---|
| Eligibility | Companies with ≤100 employees | Companies with ≤100 employees | No max employee limit |
| Employee Contribution Limit (2024) | $16,000 | $16,000 | $23,000 |
| Catch-up Contribution (Age 50+) | $3,500 | $3,500 | $7,500 |
| Mandatory Employer Contribution | Yes | Yes | No |
| Testing | Immediate 100% | No nondiscrimination/top-heavy testing | Yes, annually |
| Annual Filing (Form 5500) | Required | Not required | Required |
| Maximum Number of Employees | 100 | 100 | None |
| Establishment Period | Calendar year | Jan 1 to Oct 1 | Flexible |
What is a traditional 401(k) plan?
The traditional 401(k) plan is one of the most common retirement savings options on the market. Although 401(k) plans have increasingly become more attainable for small businesses, it’s still important to know what best fits your employees before you commit to sponsoring a 401(k) plan.
The traditional 401(k) plan can allow eligible employees to contribute money from their paycheck on a pre-tax basis or Roth basis:
Pre-tax deferrals go into an employee’s retirement account before federal and state taxes are taken out.
Roth contributions are made on an after-tax basis, meaning that the percentage or dollar amount deferred is determined after federal and state taxes have been taken out.
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Contribution limits for a traditional 401(k) plan
The maximum deferral amount for employee contributions is $23,000 for 2024 (inflation causes the IRS to evaluate limits annually, which often leads to increases). If an employee is age 50 or above, they can contribute an additional $7,500 to an account as a “catch-up contribution.”
What are the benefits of a traditional 401(k) plan?
Higher contribution limits. Employees with strong financial discipline and those with higher salaries will appreciate the opportunity to contribute several thousand dollars more per year to their retirement accounts compared to SIMPLE plans.
No max number of employees. Your company can scale without needing to change plans, which is one less thing to think about as you focus on growth. If you’re a high-growth startup, this is one way to avoid administrative headaches down the road.
A flexible retirement vehicle. The traditional 401(k) can be offered alongside other types of retirement plans, giving companies more diversity and flexibility in their offerings. This can help attract and retain talented employees.
Vesting Schedule. Depending on plan design, employer contributions can become vested over a period of up to six years, which helps plan sponsors retain talented employees.
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What are the drawbacks of traditional 401(k) plans?
Nondiscrimination testing. Traditional 401(k) plans are subject to several nondiscrimination tests on an annual basis that could require additional unexpected contributions for a plan sponsor or require that certain highly compensated employees receive refunds of contributions annually.
Large number of options. Choosing your options from all of the offerings of a traditional 401(k) plan can be confusing.
What is a SIMPLE IRA?
The Small Business Job Protection Act of 1996 led to the creation of the Savings Incentive Match Plan for Employees (SIMPLE IRA). SIMPLE IRAs are generally tailored to small businesses and self-employed individuals. In fact, an employer may only sponsor a SIMPLE IRA plan if they have 100 employees or fewer earning $5,000 in the prior calendar year. Employers that are part of a controlled group should take care when considering a SIMPLE IRA and be sure to include all employees in the controlled group when determining their employee count. As an employer grows, it may exceed the 100-employee threshold. There’s a grace period of two years though, to accommodate growing businesses.
An employer that sponsors a SIMPLE IRA cannot sponsor any other qualified retirement plan for the same employees during the calendar year. This is referred to as the “exclusive plan rule.” An employer that is part of a controlled group must also take this into consideration before starting a SIMPLE IRA.
A SIMPLE IRA can be established any time between January 1 and October 1 if an employer has not previously maintained a SIMPLE IRA. If the employer previously maintained a SIMPLE IRA, it can only start a new one on January 1. After establishment, a SIMPLE IRA must run on a calendar year basis.
A SIMPLE IRA is established using an IRS-approved model document. Each employee will have a SIMPLE IRA established in their own name. Depending on the model form that’s used, all individual SIMPLE IRAs may be held at a single institution or at an institution of the employee’s choice. Employees who have at least $5,000 of compensation from the employer in any two prior years (whether consecutive or not) and are expected to receive at least $5,000 of compensation in the current year must be eligible to participate in a SIMPLE IRA. Employees covered by a collective bargaining agreement, or who are nonresident aliens with no U.S.-sourced income, can be excluded.
Contribution limits for a SIMPLE IRA
Eligible participants may make pre-tax salary deferrals to a SIMPLE IRA. Roth deferrals are not permitted. In 2024, the max annual contribution limit for a SIMPLE IRA is $16,000 (compared to the traditional 401(k) limit of $23,000), and catch-up contributions for employees age 50 and over max out at $3,500.
Employers are required to make a matching contribution of 100% on the first 3% of compensation deferred. Alternatively, they may make a nonelective contribution of 2% of calendar year compensation (capped at $345,000) for all employees who earn more than $5,000 in compensation for the year. Employer contributions are immediately 100% vested. The compensation limit ($345,000 for 2024) does not apply to the 2% matching contribution. If a plan participant has a salary of $350,000 for 2022, the SIMPLE IRA matching contribution could be as high as $10,500. No other contributions can be made to a SIMPLE IRA.
What are the benefits of a SIMPLE IRA?
Compensation limits do not apply to employer matches. Employees may receive a match based on total compensation and are not limited by the annual compensation limit ($345,000 for 2024).
No testing. SIMPLE IRAs are not subject to the top-heavy or nondiscrimination testing rules that apply to a 401(k) plan. All employees will be able to contribute up to the full deferral limit and the employer does not have to worry about a potential additional top-heavy contribution popping up unexpectedly.
Reduced administrative burden. SIMPLE IRAs don’t allow loans or other distributions that the employer must monitor. In addition, a SIMPLE IRA is not required to file an annual Form 5500, which can reduce the administrative burdens (and costs) of operating the plan.
What are the drawbacks of a SIMPLE IRA?
Mandatory employer contributions. Unlike a traditional 401(k) plan that allows the employer flexibility with respect to employer contributions, SIMPLE IRAs require employers to make a mandatory employer contribution every year.
Lower contribution limits. Employees may only defer $16,000 (with an additional $3,500 catch-up for those over 50) to a SIMPLE IRA in 2024, compared to the $23,000 (with an additional $7,500 catch-up for those over 50) an employee can defer to a traditional 401(k) plan. For an employee who is 50 or older, this $11,000 difference may make a significant difference in retirement readiness.
Roth contributions unavailable. Roth contributions are a popular item to add to a traditional 401(k) plan and are important to many employees as a part of their estate planning process. However, only pre-tax deferrals are permitted to a SIMPLE IRA.
No vesting schedule. All employer contributions are immediately 100% vested. There’s no incentive for an employee to remain employed over time to accrue vesting in the employer contribution.
Strict size restrictions. SIMPLE IRAs have limited ability to grow with employers over time due to the 100-employee eligibility rule. Growing companies may quickly outgrow the SIMPLE IRA model. An employer may have to spend time and resources on making new retirement plan decisions sooner than anticipated.
No other qualified plans permitted. The “exclusive plan rule” prevents employers from sponsoring another qualified plan such as a profit-sharing plan, reducing employer’s flexibility with respect to retirement benefits.
Strict timing on termination. Employers should be aware that a SIMPLE IRA can only be terminated—thereby ending an employer’s obligation to make contributions—at the end of a calendar year. Employers must notify the financial institution that it will not make a contribution for the next calendar year and that it wishes to terminate the agreement. Employers must also notify employees on or before November 2 that the SIMPLE IRA will be discontinued.
Limits on withdrawal opportunities: Participants cannot take loans from a SIMPLE IRA, eliminating a potential opportunity to borrow money from the account. Participants can take distributions at any time but, in addition to the 10% excise tax for early withdrawal before the age of 59 ½, there’s an additional 25% penalty if the participant makes a withdrawal within the first two years of their IRA account being established.
What is a SIMPLE 401(k) plan?
Unlike a SIMPLE IRA, a SIMPLE 401(k) plan is a qualified plan and has a trust. In this way, it resembles a traditional 401(k) plan. However, to avoid the complicated nondiscrimination testing rules that apply to traditional 401(k) plans, a SIMPLE 401(k) must follow some SIMPLE IRA rules. This includes the SIMPLE IRA deferral contribution limits, the 100-employee limit, the exclusive plan rule, mandatory employer contributions, 100% immediate vesting, and the calendar year requirement.
SIMPLE 401(k) plans are also subject to many of the same rules as a traditional 401(k). They have more flexibility in determining who’s eligible to participate in the plan, but they must pass coverage testing. They also may allow for loans or other in-service distributions. A SIMPLE 401(k) plan is also required to file a Form 5500.
Contribution limits for a SIMPLE 401(k)
Eligible participants may make pre-tax salary deferrals to a SEP IRA. Roth deferrals are permitted. In 2024, the annual max contribution limit for a SIMPLE 401(k) plan is $16,000 (compared to the traditional 401(k) limit of $23,000), and catch-up contributions for employees age 50 and over max out at $3,500. Employers are required to make a matching contribution of 100% on the first 3% of compensation deferred. Alternatively, employers may make a nonelective contribution of 2% of calendar year compensation (capped at $345,000) for all employees who earn over $5,000 in compensation for the year. Employer contributions are immediately 100% vested. No other contributions can be made to a SIMPLE 401(k).
SIMPLE 401(k) plans are subject to the Section 415 annual limit on contributions. which is the lesser of 100 percent of the employee's compensation or $69,000 for 2024 ($76,500 with catch-up contribution).
What are the benefits of a SIMPLE 401(k)?
No testing. SIMPLE 40(k) plans are not subject to the top-heavy or nondiscrimination testing rules that apply to a 401(k) plan. Employees may contribute up to the full deferral limit and employers do not have to worry about a potential additional, required top-heavy contribution popping up unexpectedly.
Flexible eligibility. Unlike SIMPLE IRAs, SIMPLE 401(k)s have the same opportunity to design eligibility for participants as traditional 401(k) plans do. This may reduce the cost of employer contributions when compared to the SIMPLE IRA.
Flexible distribution opportunities. SIMPLE 401(k) plans may allow loans and in-service distributions similar to a traditional 401(k).
What are the drawbacks of a SIMPLE 401(k)?
Mandatory employer contributions. Unlike a traditional 401(k) plan that allows the employer more flexibility when it comes to employer contributions, SIMPLE 401(k) plans require employers to make a mandatory employer contribution every year.
Lower contribution limits. As with SIMPLE IRAs, employees may only defer $16,000 (with an additional $3,500 catch-up for those over 50) to a SIMPLE 401(k) in 2024, compared to the $23,000 (with an additional $7,500 catch-up for those over 50) an employee can defer to a traditional 401(k) plan.
No vesting schedule. All employer contributions are immediately 100% vested. There is no incentive for an employee to remain employed over time in order to accrue vesting in the employer contribution.
Strict size restrictions. Growing companies may find that the SIMPLE 401(k) model is outgrown too fast. Unlike a SIMPLE IRA plan, the employer could amend the SIMPLE 401(k) to become a traditional 401(k), which may save some time and resources on making new retirement plan decisions.
No other qualified plans are permitted. The “exclusive plan rule” prevents employers from sponsoring another qualified plan such as a profit-sharing plan, reducing the employer’s flexibility with respect to retirement benefits.
Understanding which retirement plan is best for your business
When it comes to retirement planning, the solutions are as diverse as the needs are great. And on the surface, SIMPLE 401(k)s and SIMPLE IRAs plans can simplify the process of adding a retirement plan for small businesses. However, lower contribution limits, inflexible plan design, and required employer matches may overshadow the perceived benefits. That’s why it helps to thoroughly research your options before choosing the right plan for you.
Human Interest offers flexible, customized retirement plans that can meet the needs of small and medium-sized businesses. Whether you’re a small business planning to stay small or a growing business looking to scale, Human Interest has a 401(k) plan that can meet your business needs. Get started today.
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Article By
Wendy Baker, J.D.Wendy Baker is Senior Legal Counsel at Human Interest, bringing over 25 years of experience exclusively in the ERISA space, spanning defined contribution plan recordkeeping and administration. She has a J.D. from Case Western Reserve University, is a member of the North Carolina and Ohio Bars, the American Bar Association, and industry groups.
