SIMPLE IRAs vs. 401(k) Plans – 4 Key Differences

While a SIMPLE IRA offers certain benefits to small business owners, a 401(k) may offer other advantages. These include higher contribution limits and flexibility over employer matching. Is this a good time to talk with clients about shifting to a 401(k)? Keep reading to learn more about both plan types.

Both 401(k) plans and SIMPLE IRAs let employees contribute part of each paycheck to a retirement investment account. The contributions are allowed to grow tax-free until an employee accesses the funds in retirement. In both plans, employer contributions can lead to even greater savings.

But the two plans do have their differences. For example, 401(k) plans can be combined with other retirement plans, while SIMPLE IRAs cannot. And as its name implies, the SIMPLE IRA can be easier and less expensive to set up than a 401(k) plan.

As clients look to you for guidance, share four key differences to help them decide whether to make the shift:

1. Employee Contribution Limits
Employees with 401(k) plans can contribute more to their retirement savings than those with SIMPLE IRAs. In 2022, the 401(k) deferral limit is $20,500. The SIMPLE IRA deferral limit is just $14,000.

The higher contribution limits of a 401(k) plan mean participants can experience greater savings and lower taxable incomes. A 401(k) also helps business owners maximize their retirement savings and attract new hires.

2. Employer Contributions
With 401(k) plans, employers can choose whether to match contributions and in what amount. Employers with SIMPLE IRA plans, however, are required to contribute to their employees’ retirement accounts. They must match up to 3% of an employee’s annual pay or make a contribution regardless of whether an employee contributes to the plan.

Employers who like the flexibility to decide might lean toward offering a 401(k) plan. This flexibility can help them better address the financial needs of their business.

3. Retirement Plan Eligibility
When it comes to who's allowed to join a plan, a 401(k) plan gives employers more control. They can limit eligibility, such as with a minimum age or time on the job, to control the costs associated with seasonal or part-time workers, for example. Eligibility rules can help employers meet their 401(k) goals and keep expenses lower.

Eligibility rules for SIMPLE IRAs, on the other hand, are more baked. Employers must offer enrollment to all employees who’ve earned $5,000 in the previous two years and who are reasonably expected to earn at least $5,000 in the current year. For small businesses, this could lead to higher expenses.

4. Vesting Schedules and Retention
Employers who offer a 401(k) plan can set up a schedule for when employees can be vested in non-safe harbor employer contributions. For example, a company may require three years of employment before an employee is vested. This fosters longevity and can help companies retain key talent.

Vesting schedules are not allowed with SIMPLE IRAs. Employees are immediately vested in their employer contributions, which means small companies may have a harder time keeping key employees.

Why is now a good time to talk with small business clients about shifting to a 401(k)? Because clients who make the transition later in the year may find it difficult to fulfill notification requirements and get started the following year.

Contact your retirement plan consultant for more insights. And be sure to ask about Accelerate, our 401(k) plan designed for small-plan clients.

For financial professional use only.