The two most common employer-sponsored retirement plan types are 401(k) plans (403(b) for non-profits) and SIMPLE IRA plans. Each type of plan has definite pros and cons, and professional advice is needed to evaluate each plan type before adopting the best fit for your business. Employers should seek this advice from accountants and/or financial planners, NOT payroll companies who sell 401(k) plans “out of a box.” The national payroll companies have sales reps who sell 401(k) plans as a “product” but generally are not advisors/consultants in helping business owners make the best decisions to meet their needs. We have seen way too many small employers coming to AccuPay from the national payroll companies with 401(k) plans who would have been better served with a SIMPLE IRA plan. The purpose of this PayDay article is to discuss the pros/cons of 401(k)/403(b) plans vs SIMPLE IRA plans.
WHY DO SO MANY EMPLOYERS END UP WITH 401(K) PLANS WHEN SIMPLE IRA PLANS MAY BE A BETTER FIT FOR THEM?
Follow the money!! National payroll companies aggressively sell 401(k) plans, and generate income by doing so—setup fees, ongoing recordkeeping/administration fees, investment fees, etc. These 401(k) plans also make payroll services “stickier” when they are integrated with ADP/Paychex payroll. On the other hand, a SIMPLE IRA generates little if any fees/profits (many SIMPLE IRA custodians charge zero in administration fees to manage the plan)—-and since SIMPLE IRA plans are much easier to administer, it is easy for an employer with a SIMPLE IRA plan to change payroll providers—–so much less “sticky” than the vastly more complex 401(k) plans!
The choice of the “right” employer retirement plan requires analysis and “trade-offs” between the pros/cons of 401(k) vs SIMPLE IRA plan. As previously mentioned, accountants and financial planners are unbiased advisors to their clients about which type of plan best fits the business owner. However, they are often left out of the plan decision when a sales rep for a national payroll company asks their payroll client, “Would you like to offer your employees and yourself a retirement plan?”—-If the answer is yes, it is almost always a 401(k) plan since that is “where the money’s at.”
WHO CAN OFFER 401K AND SIMPLE IRA PLANS?
Employers with 100 or less employees can offer SIMPLE IRA plans to their employees. 401(k) plans can be offered to any number of employees, and actually can be setup by self-employed consultants with no employees (solo 401k plans). SIMPLE IRA plans were enacted into law as a means for smaller employers to offer retirement benefits to their employees in a simple, straightforward manner—–minimal oversight, minimal regulations and minimal costs as compared to the much greater bureaucracy of 401(k)/403(b) plans. Employers with fewer than 100 employees can choose to offer either a 401(k) or SIMPLE IRA plan—-larger employers cannot offer a SIMPLE IRA plan.
EMPLOYEES CAN CONTRIBUTE MORE TO 401(k) PLANS THAN SIMPLE IRA PLANS
An employee, to include the owner-employee, of a SIMPLE IRA plan can contribute up to $16,500 in 2025, from their salary, as compared to $23,500 to a 401(k)/403(b) plan. Catch-up/additional contributions for employees age 50 or more are $3,500 to a SIMPLE IRA plan and $7,500 to a 401(k) plan. Recent legislation provides that employees ages 60 to 63 can increase their regular age 50 catch-up contributions by an additonal 50%, or $1,750 to SIMPLE and $3,750 to a 401(k) plan. Finally, the Secure Act 2.0 enables employees of employers with 25 or fewer employees to be able to increase both their regular and catch-up employee contributions by an additional 10%. (You can learn more about the Secure Act 2.0 on our blog.)
SO—-business owners who want to contribute more than $20K per year in tax-deductible retirement funds may choose to adopt a 401(k) plan so they can contribute more to their retirement accounts. It is also common for a 401(k) plan to be “paired” with a discretionary “so-called profit-sharing plan” (which is seldom based on profits!) in order for the employer to contribute yet more in total to the combined 401(k)/PS plan—-A SIMPLE IRA plan cannot be “paired” with a Profit-Sharing Plan in order to produce very significant overall retirement funding.
An employer with several high income employees (say a medical practice) often will select a 401(k) plan so the higher income employees can contribute far more to their 401(k) plan than a SIMPLE IRA plan with its lower funding limits.
WHAT ABOUT SMALLER EMPLOYERS WHO DO NOT HAVE HIGH INCOME EMPLOYEES?
Employees who are earning $50K to $100K per year are often fine with an annual SIMPLE IRA annual “cap” of $16,500 on their retirement plan contributions, and are not wanting to contribute more than the SIMPLE IRA contribution limits to a 401(k) plan. In many cases, they only wish to contribute 3% or so of their wages to the SIMPLE IRA plan, so they can get the employer match of “dollar for dollar up to 3%,” which is often associated with a SIMPLE IRA plan. As such, they are totally fine with a SIMPLE IRA plan. The owner-employees of the smaller employer may choose to limit their own SIMPLE IRA funding to the lower permitted funding of the SIMPLE IRA plan as opposed to the 401(k) plan, and perhaps will “sock away” investments outside of a qualified retirement fund to make up the difference.
ADMINISTRATION OF A SIMPLE IRA PLAN COMPARED TO A 401(k)/403(b) PLAN
A SIMPLE IRA plan is generally adopted by a 2 or 3 page document offered by financial planners, brokerage firms (think Schwab, Fidelity, etc) and even banks. The setup cost is minimal and often zero, and the plan sponsors charge very little and, in many cases, nothing to manage the SIMPLE IRA plan. If an employee with a SIMPLE plan terminates employment, they do not apply for a distribution but instead already have their SIMPLE IRA account, personally. The SIMPLE IRA plan is not required to file an annual Form 5500 with the IRS or DOL—A SIMPLE IRA plan does not permit loans from the plan or “hardship distributions,” which 401(k) plans often have. A SIMPLE IRA plan is not discriminatory if only the owners wish to participate, whereas 401(k) plans have intricate annual “testing” by TPA firms to determine if the plan discriminates in favor of owners and highly compensated employees. Operating a SIMPLE IRA plan is essentially “simple.”
401(k) plans have lengthy plan agreements which employers adopt based on a large number of decisions about employer and employee funding, vesting schedules, eligibility and entry dates, so forth and so on. (Employers adopting a 401(k) plan need to work with consultants to help them design a plan which best meets their objectives—–401(k) plans should never be purchased “out of a box!”) These plans also require annual testing to ensure they do not discriminate in favor of owner-employees or “highly compensated employees” as to employee or employer contributions for the current year, and often are also tested to ensure that employee balances of owners/highly compensated employees are not “top heavy” as to amounts.
BOTTOM LINE—-401(k) plans are very complex and are tested to ensure they do not discriminate in favor of owners or other highly compensated employees. SIMPLE IRA plans are “simple” to administer and actually are OK even if only the owner-employees participate—-no testing required.
A FEW CONCLUSIONS WHEN COMPARING 401K PLANS WITH SIMPLE IRA PLANS FOR EMPLOYERS WITH 100 OR FEWER EMPLOYEES
A 401(k) plan is generally preferable for high income participants who want to contribute greater permitted amounts each year to their retirement accounts—-and can afford to do so—-and are willing to pay for the added bureaucracy, testing, etc which is required of 401(k)/403(b) plans.
A SIMPLE IRA plan is often preferable for a small business owner who:
- wants to offer a retirement plan to employees for retention and recruitment
- has employees who are not high earners who want to contribute more than $16,500 each year to their retirement accounts
- wants to “keep it simple.”
What about a business owner who wants to contribute the higher 401(k) plan limits each year to retirement but whose employees are not extremely high income earners?—-An expert consultant/tax advisor needs to evaluate the pros/cons of each plan and “weigh” the pros vs the cons of the two plan choices!!
WHAT IS VIRTUALLY NEVER PREFERRED?—-A payroll company which markets and sells retirement plans “out of a box” to generate the fees and profits associated with 401(k) plans—–This is why they never promote SIMPLE IRA plans—–Follow the money!!
IN CONCLUSION
Selection of the retirement plan “type” which best fits your company’s objectives should only be done by consultants/experts in tax/HR law—-accountants/financial planners, with the help of TPA/plan consultants who have no economic bias as to 401(k) or SIMPLE IRA plans. It is much easier to adopt the “right plan” to begin with than to terminate a 401(k) plan which is not a good fit—A 401(k) plan is often the best choice, BUT an employer with 100 or fewer employees should weigh the pros/cons of selecting a SIMPLE IRA plan for retirement planning purposes.
This PayDay is for educational purposes only and does not constitute tax and/or legal advice. Any links to external resources are for educational purposes only. AccuPay is not affiliated with nor receives any renumeration from any outside sources. Please consult with your tax and/or legal advisor before applying any suggestions made here or through external links.