A SIMPLE 401(k) plan gives employees who work at small businesses a way to save for retirement that is similar to traditional plans offered by larger employers. Though there are some differences with traditional 401(k) plans, a SIMPLE 401(k) offers similar tax incentives that can help you save for retirement.
Saving for retirement is no simple task. Not only is it increasingly difficult for Americans to put enough money away for a comfortable future, but it can be confusing to navigate the many savings vehicles available.
For individuals working at small businesses, a SIMPLE 401(k) could be a great tool to help save for retirement.
What is a SIMPLE 401(k)?
“Savings incentive match plan for employees,” or SIMPLE 401(k) plans are intended to be cost-effective retirement plans offered to small businesses with 100 employees or less. With the plans, employer contributions are limited to either a dollar-for-dollar matching contribution, up to 3 percent of pay; or a non-elective contribution of 2 percent of pay for each eligible employee. No other employer contributions can be made to a SIMPLE 401(k) plan.
Taking advantage of employer contributions can be a great way to help individuals boost retirement savings. Additionally, SIMPLE 401(k)s offer safe harbor contributions, meaning employers are required to make fully vested contributions, regardless of the employee contributing or not.
How a SIMPLE 401(k) plan works
A SIMPLE 401(k) plan is very similar to how a traditional 401(k) plan works in that it allows employees to defer compensation on a pre-tax basis now to help fund retirement later. Assets contributed to the plan are able to be invested and grow tax free until you begin making withdrawals during retirement.
Who does a SIMPLE 401(k) apply to?
A SIMPLE 401(k) is for small business owners with 100 or less employees, according to the Internal Revenue Service (IRS). Employers must make contributions to employee’s plans and employees can’t be offered any other types of retirement plans, including IRAs.
In terms of employees, those who are 21 years or older and have served at least one year at the company for a total of 1,000 hours or more are eligible to enroll, depending on the plan.
Difference between a SIMPLE 401(k) and traditional 401(k)
A SIMPLE 401(k) is similar to a regular 401(k) in terms of tax benefits — money is invested pre-tax, meaning the full value of each dollar goes into an investing portfolio.
However, a SIMPLE 401(k)’s contributions are fully vested, whereas regular 401(k)s might not have full vesting until a future date. This can be great for individuals who might not be at a job long-term (say, two years or more) but still want to take advantage of an employer-sponsored retirement plan.
Additionally, SIMPLE 401(k)s are held under less regulatory scrutiny than regular 401(k)s and are only permitted for businesses with 100 employees or less. This reduced regulation makes them less expensive for employers.
Difference between a SIMPLE 401(k) and SIMPLE IRA
Both SIMPLE 401(k)s and SIMPLE IRAs are tax-deferred retirement savings accounts, meaning they allow participants to make contributions with pre-tax dollars.
SIMPLE IRAs have different match options for employers; an employer can reduce contributions to 1 to 3 percent if they choose. Additionally, SIMPLE IRAs do not allow participants to take loans, unlike SIMPLE 401(k)s.
Both plans are for employees of small businesses only.
How to set up a SIMPLE 401(k)
A SIMPLE 401(k) can only be set up if an individual’s employer offers the plan. While it’s a great idea to enroll, individuals should be careful to read the fine print for any fees they may incur.
Chad Parks, founder and CEO of Ubiquity Retirement + Savings, and a finance veteran with more than 25 years of experience in the industry, says any type of retirement plan can come with a wide range of fees, including management, participant and administrative fees.
“You need to ask the questions and say, what investments are you using? And how much do those costs as a percentage of my assets? Is there or is there not a flat participant fee?” says Parks. “And the range is very broad. I mean there’s very inexpensive and affordable plans and then there is very expensive and not so affordable plans.”
While experts agree that enrolling in any employer-sponsored retirement plan with matching contributions is a great idea, individuals should always be aware of how much those plans are costing them.
Maximum allowed contributions
The maximum amount employees can contribute to a SIMPLE 401(k) is $16,000 in 2024, according to the IRS. The bureau adds “this amount may be increased in future years for cost-of-living adjustments.” Participants age 50 or older can contribute an additional $3,500 in 2024.
Individuals should be aware that SIMPLE 401(k) contribution maximums are significantly lower than the maximum amount allowed in regular 401(k)s.
Pros and cons of SIMPLE 401(k)s
SIMPLE 401(k)s are a great tool for small business owners who can’t afford large retirement plans for their employees.
As with any financial tool, there are pros and cons to factor while deciding whether to offer or enroll in SIMPLE 401(k)s:
Pros
In SIMPLE 401(k) plans, all required employer contributions are always 100 percent vested. This means that regardless of how long an employee works at a company, they will be able to keep 100 percent of the company’s match in their SIMPLE 401(k) fund. Some regular 401(k) plans require employees to work for a certain period of time in order to be able to keep the company’s contributions, meaning they could lose out on money if they leave a job earlier than expected.
Participants who are at least age 50 by the end of the year can make catch-up contributions. Like regular 401(k)s, a SIMPLE 401(k) allows catch-up contributions for individuals age 50 and older. In 2024, the IRS allows for an additional $3,500 to be contributed to SIMPLE 401(k) plans, giving these participants the opportunity to invest a total of $19,500 per year.
Loans are permitted. For those who need cash, a SIMPLE 401(k) allows participants to take a loan from their plans. This is different from a withdrawal, which would be subject to a possible 10 percent penalty for those who take one under the age 59½ depending on the circumstances.
401(k) loans are usually last-resort options for individuals who need cash. These loans come with risks, including having to pay back the full amount sooner than the standard five-year period if you leave an employer or get fired. Additionally, pulling money out of an investment fund means it misses out on the power of compounding — and an individual earning less in the future than if they left the money untouched.
Cons
Employers can’t offer other retirement plans. SIMPLE 401(k)s may be cost-effective for employers, but they come with strict rules. The most restrictive rule tied to these plans is that employers can’t offer other types of retirement-savings vehicles for employees.
The maximum contribution limits are lower than other retirement-savings vehicles. A traditional 401(k) has an annual contribution limit of $23,000 in 2024; however, a SIMPLE 401(k) only allows participants to contribute up to $16,000 in the same year. Experts say that over time, these lower contribution thresholds could hurt individuals.
“It’s important for people to understand the contribution limits being lower [than a traditional 401(k)] is very significant,” says Vanguard Financial Planner Lauren Anastasio, CFP. “So the ability to save, if you stay with that employer over a long period of time, is minimized by those limits.”
That being said, it’s imperative for individuals to be strategic with how they’re saving.
“Any employer sponsored plan is just one of a variety of vehicles that someone should be thinking about when it comes to saving for the long term,” Anastasio says.
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