SIMPLE IRA vs 401k – Which Plan is Better for You?

SIMPLE IRA vs 401k - which is a better option? Well, both plans are different in a lot of ways. But they’re designed with the same purpose: helping employees save for retirement. Knowing about what both these plans offer is very important. After all, this is how you’ll be able to make a choice. And remember, making the right choice matters a lot here; the golden years of your life depend on it. Here is your detailed guide on simple IRA vs 401k. Read till the end and you are covered for all you need to know about these two plans.

• Both SIMPLE IRA and 401k are employer-sponsored plans that allow employees to grow their retirement income without worrying about taxes.
• SIMPLE IRA is specifically designed to benefit small businesses with employees no more than 100.
• 401k retirement plans are suitable for companies of all sizes and have a higher contribution limit than SIMPLE IRA.
• Both 401k plan and SIMPLE IRA offer immediate vesting, meaning that employees have full right to their employer’s contributions immediately after deposited into the account.

SIMPLE IRA vs 401k – Let’s Talk Retirement Planning!

Both of these plans – SIMPLE IRA vs 401k – come with their own pros and cons. For instance, SIMPLE IRA lives up to its name it’s simpler or you can say more straightforward. On the other hand, a 401k retirement plan may be more complex but it offers flexibility. To thoroughly understand both of these, it's a good idea to hire retirement plan specialists. Anyhow, let’s talk about these two employer-sponsored plans in detail:

What is SIMPLE IRA & How it Works?

SIMPLE IRA aka Savings Incentive Match Plan for Employees IRA is a tax-deferred employer-sponsored plan. Moreover, it's a joint project of the Employee Benefits Security Administration (EBSA) and the Internal Revenue Service. Besides, a SIMPLE IRA is usually created by employers as well as self-employed individuals (sole proprietors). This plan is specifically beneficial for employees of small businesses. You should know that the plan criterion is quite similar to that of a traditional IRA in terms of contribution, distribution, and investments as we as roll over.

“SIMPLE IRA is beneficial for small businesses in a lot of ways. It lets you and your employees save for retirement. It’s tax-deferred and also helps retain the workforce.” – U.S. Department of Labor

For this plan, both employers and employees jointly contribute to the employees’ accounts. Furthermore, an employer can either make a matching or a flat contribution. Before you decide to go with this type of retirement plan, make sure you know everything about it, including eligibility criteria. 

Are You Eligible for a SIMPLE IRA?

Just like other retirement plans, you have to qualify for the SIMPLE IRA plan to sign up for it. Employers and employees have to comply with the following conditions to be eligible for a SIMPLE IRA:

• Employers should have no more than 100 employees
• Employees must receive at least $5,000 of salary for the previous year

If you tick off the above two points, you are all set to benefit from this plan. It is usually best for small businesses, self-employed people, tax-exempt organizations, and government entities. Being easily understandable, this plan can be your way forward to achieve a secure financial life. Moreover, consult a professional advisor before you make any decision about your SIMPLE IRA or SEP IRA or any other retirement plan.

How to Contribute to a SIMPLE IRA?

As aforementioned, both employees and employers contribute to a SIMPLE retirement account. In fact, employers can match contributions too. It’s not compulsory but they have the option to do so. Besides, you should know that they may not match 100% of what an employee contributes but it’s still a considerable amount. Here are the rules for both employees and employers.

➢ For Employees

Just like other retirement programs, the Internal Revenue Service has set certain rules for contribution in this plan, such as:

• The annual contribution limit for 2024 is $16000
• Catch-up contributions have a limit of $3500 per year

➢ For Employers

Not just the employees, the employers also have to follow a certain set of rules when providing employees with SIMPLE IRA contributions. This includes:

• Match employee’s annual contribution up to 3%
• Contribute a flat 2% of the employee’s salary

Having a thorough understanding of how contribution limits work is really important. This way, you’ll be able to strategize on these limits to max out your retirement savings. However, doing all of these alone can be overwhelming. You need professional assistance to guide you through the complexities of retirement planning. Therefore, it is always better to consult a retirement advisor before you make any decision. They are experienced professionals and know how to maximize client benefits.

What are the Pros of a SIMPLE IRA?

Whether or not you should sign up for this retirement plan depends on what perks and downsides it has. Therefore, to decide which one is better, we should assess the 401k vs SIMPLE IRA pros and cons first. Let’s begin with the positives. After all, the first thing that attracts participants is the amazing benefits a plan offers:

• Easy Administrative Management

The best thing about a SIMPLE IRA is that it’s really easy to set up and maintain. Yes, that’s right! With this plan, it doesn't bind you to follow an extensive list of instructions like a 401k or a 403b or other typical retirement plans. Although it’s as simple as its name, you should not handle its nuances on your own. Always get professional advice. It helps you make the right decision at the right time. 

• Lower Setup & Maintenance Costs

Another plus point of this plan is that it won’t drain your finances on administrative charges. This is because the setup and maintenance costs of a SIMPLE IRA are lower than many plans. That is why it’s a really affordable option for small businesses. Moreover, the initial setup involves minimal paperwork and fees. Ongoing maintenance costs are also relatively low and are usually covered by the financial institution managing the plan. 

• Choose Your Account Provider

Apart from its highly manageable setup and administration, this plan also allows participants to choose their account provider. Interesting, right? Well, you should know that this lets them to select a financial institution that best suits their investment preferences and needs. As a result, employees can adjust their retirement savings strategy and avail of varied investment options along with better customer service provided by different institutions.

What are the Cons of a SIMPLE IRA?

It’s true that a SIMPLE IRA is beneficial in a lot of ways. But with pros come cons too. As we now know about the amazing benefits of this IRA, we should also know about its downsides. Here we go:

• Lower Contribution Limits

This is the major downside of SIMPLE IRA. After all, that else we sign up to a retirement plan for: to save for our future as much as we can. But, unlike other plans, this plan has a lower contribution limit. For 2024, employees can add up to $16000 to their account with an additional $3,500 catch-up contribution for those aged 50 and older. This lower limit majorly impacts higher-income earners as it restricts them from maximizing their retirement savings. 

• Early Withdrawal Penalty

If you haven’t reached the retirement age of 59 ½ and withdraw money from your SIMPLE IRA account, you’ll have to pay an early withdrawal penalty of 10% on the amount you take out. This puts an emphasis on the plan’s usage for long-term retirement savings. Besides, if you withdraw funds within the first two years of participation, a hefty 25% penalty applies, in addition to regular income taxes.

• No Other Plan Allowed

Employers offering a SIMPLE IRA cannot provide any other retirement plan for their employees. Resultingly, this restriction ensures the simplicity and cost-effectiveness of the plan. Besides, this plan usually caters to small businesses. So, having a single IRA is not big of a deal for them. Moreover, having only one retirement plan for employees simplifies administration and compliance.

• No Loans Allowed

Unlike other retirement plans, SIMPLE IRA doesn’t allow any loans from the funds you have been accumulating in your account. What does this mean? Well, this means that you have fewer options to access your money before you reach the age of retirement. This is good in some ways as it lets your savings pool without any disruption. However, in case of any emergency, you won’t be able to access your funds in the SIMPLE IRA.

What is a 401k Plan & How it Works?

In the next phase of our SIMPLE IRA vs 401k, we’ll discuss the nuances of the other plan – 401k. Well, a 401k is also a tax-deferred plan devised to help employees collect some retirement income. With consistent annual contributions, they can save up a considerable amount to build a secure and sound life. You should know that its a defined contribution plan, and gives employers a chance to match their contributions.

“A portion of the employee’s annual salary is automatically deduction as a 401k contribution.” – Internal Revenue Service

Clearly, a 401k allows you to pay less as taxes and save more for your retirement. After all, the whole point of these savings is to achieve the ideal retirement life you want to like. Anyhow, always consult a 401k financial advisor before you make any kind of decision regarding your retirement planning.

Are You Eligible for a 401k plan?

As we’re talking about how both SIMPLE IRA vs 401k work, it’s important that you know about the eligibility criteria for a 401k. As you know a SIMPLE IRA is just for small companies but this is not the case for 401k. This plan is for businesses of all sizes. In fact, employees of private, for-profit, and non-profit organizations can qualify to sign up for a 401k if they tick off the following criteria:

• The employee must be 21 years or older
• Must have worked at the company for at least a year
• Members of specific unions are not eligible
• Non-resident employees are not eligible
• Part-timers qualify under specific conditions

The company or employer usually decides the time when you can start contributing to a 401k. Besides, those who comply with the qualification terms are all ready to avail of the benefits of this plan. So, if you’re eligible talk it out with your employer and start contributing to your retirement account now. After all, the earlier the better.

What are the Contribution Limits of a 401k Plan?

You should know that the contribution limits for a 401k are higher than those of a SIMPLE IRA. This gives you room to contribute more and save more for retirement. Besides, this is specifically beneficial for high-income earners. How so? Well, the higher limit allows them to contribute as much as they can. Anyhow, here are the new contribution limitations set by the Internal Revenue Service for 2024:

• Employees can contribute up to $23000 on an annual basis
• Those who are above 50 can make catch-up contributions
• These catch-up contributions can be up to $7500

With catch-up contributions, the amount you can save up every year becomes really high. Besides, a 401k also allows for employer matching. And hey, you can use this feature of the plan to max out your savings. For this, contribute as much as you can. As a result, your employer will have to match your contribution amount, leading to more savings.

What are the Pros of a 401k Plan?

While talking about SIMPLE IRA vs 401k how can we miss the advantages a 401k offers. Believe me, when I say this, its pros are what make this plan one of the most preferred retirement plan among American employees. Here’s what it offers:

• Higher Contribution Limits

A 401(k) offers higher contribution limits compared to a SIMPLE IRA. Therefore, it's suitable for all businesses of all sizes. As aforementioned, it lets you contribute more to your retirement account on an annual basis. Furthermore, these higher limits result in more savings and enable employees to build a more substantial retirement nest egg.

• Loans are Allowed

Unlike SIMPLE IRA, a 401k retirement plan allows participants to borrow from their retirement savings. This is a plus in case of financial emergencies or significant expenses, such as buying a home or funding education. Moreover, loan amounts usually vary for every plan but usually, participants can borrow up to 50% of their vested balance, capped at $50,000.

• More Investment Choices

With a 401k retirement plan, participants have more investment options as compared to a SIMPLE IRA. After all, it lets you choose from various mutual funds, stocks, bonds, and other securities. This leads to a more personalized and diversified portfolio. Simply put, your 401k provides better ways for long-term financial growth.

What are the Cons of a 401k?

Although this retirement plan is pretty flexible, it also has some downsides. Let’s talk about them so you can make a better, well-informed decision regarding retirement planning:

• Complicated Administration

Many employers and employees prefer this plan over the others. However, a major downside to it is its complicated setup and maintenance process. This plan comes with a list of instructions to follow. Besides, complying with these instructions is necessary if you want to avoid penalties. Also, get professional consultation to thoroughly understand the rules and regulations of the plan.

• Higher Setup & Maintenance Costs

Unlike the SIMPLE retirement plan, this plan has high setup and maintenance charges. The former has a standard setup and maintenance fee while for 401k they vary based on the plan the employer chooses. Because of more setup costs, you have to spend more. This may impact your annual contributions.

SIMPLE IRA vs 401k comparison chart

Both of these employer-sponsored plans help employees build their ideal post-retirement life. While SIMPLE IRA is beneficial for employees of small businesses, 401k caters to businesses of all sizes. Besides, these two plans differ from each other in several ways. The difference between SIMPLE IRA and 401k majorly involves:

• Size
• Eligibility
• Contributions 

To make the above info more digestible for you, here is a SIMPLE IRA vs 401k comparison chart. It covers all the details in a comprehensive manner so you can understand it better.

SIMPLE IRA vs 401k - What is Better?

Well, deciding which is better – SIMPLE IRA vs 401k – totally depends on your employee needs and financial goals. We’ve provided you with all the pros, cons, and limitations so you can make a better decision for yourself and your workforce. The most important thing is that you must have a plan. Without it, you won’t be able to provide a secure future to your employees. And hey, they deserve it!  After all, they work so hard for you. They also deserve a peaceful time in their life. So, don’t waste time, assess what these plans have to offer you from above and make a choice now – SIMPLE or 401k. Let your employees build the life they want to lead.