What’s the difference between a SIMPLE IRA and 401k?

The 401(k) and SIMPLE IRA (Savings Incentive Match Plan for Employees Individual Retirement Account) are both employer-sponsored retirement savings plans, but they have some key differences. 

Here’s a breakdown of the distinctions between a 401(k) and a SIMPLE IRA:

1. Eligibility

401(k): Generally, any business entity, including corporations, partnerships, and sole proprietorships, can establish a 401(k) plan. Employers can choose to make the plan available to all employees or limit participation based on certain criteria, such as age and service requirements.

SIMPLE IRA: Geared toward small businesses with 100 or fewer employees who earned at least $5,000 in the preceding calendar year. Employers cannot maintain any other retirement plan, and employees must have earned at least $5,000 in any two prior years and be expected to earn at least $5,000 in the current year.

2. Employee Contributions

401(k): Employees can contribute up to $23,000 (as indexed for 2024)., with an additional catch-up contribution of $7,500 for those aged 50 and older.

SIMPLE IRA: Employees can contribute up to $15,500 (as indexed for 2023), with an additional catch-up contribution of $3,500 for those aged 50 and older.

Contribution limits are set each year

This page is a great resource from the IRS, but if they haven’t updated limits you can simply google “retirement plan limits for 20__” [year] and the latest published notice will pop up. Each October the IRS puts out the notice for the next year’s contribution limits.

3. Employer Contributions

401(k): Employers may choose to make contributions, such as matching contributions or profit-sharing contributions. Employer contributions are discretionary and subject to certain nondiscrimination testing.

SIMPLE IRA: Employers must make either a dollar-for-dollar matching contribution up to 3% of an employee’s compensation or a non-elective contribution of 2% of each eligible employee’s compensation (up to $330,000 in 2023).

4. Vesting

401(k): Employer contributions may be subject to vesting schedules, which determine when employees have full ownership of the employer-contributed funds.

SIMPLE IRA: All employer contributions are immediately 100% vested.

5. Plan Expenses

401(k): Establishing and maintaining a 401(k) plan can involve higher administrative costs, and employers may bear more of the administrative burden.

SIMPLE IRA: Generally simpler to administer, and the costs are often lower. The administrative responsibilities are typically shared between the employer and the financial institution holding the SIMPLE IRAs.

6. Nondiscrimination Testing

401(k): Subject to complex nondiscrimination testing to ensure that the plan does not favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).

SIMPLE IRA: Exempt from most nondiscrimination testing, making it an attractive option for small businesses.

7. Withdrawal Penalties

401(k): Early withdrawals before age 59½ may be subject to a 10% penalty, in addition to income tax.

SIMPLE IRA: Early withdrawals within the first two years of participation may be subject to a 25% penalty, in addition to income tax. After two years, the penalty reverts to 10%.

8. Loan Provisions

401(k): Some 401(k) plans allow participants to take loans against their vested account balance.

SIMPLE IRA: Generally, SIMPLE IRAs do not permit participant loans.

9. Employee Notifications

401(k): Requires employers to provide employees with certain information, including details about the plan, investment options, and fees.

SIMPLE IRA: Requires employers to provide employees with specific information about the plan, including the employee’s rights and obligations.

10. Contribution Deadlines

401(k): Employee salary deferral contributions can be made up to the tax filing deadline (including extensions) for the calendar year.

SIMPLE IRA: Contributions must be made by the employer’s tax filing deadline, including extensions.

Both 401(k) plans and SIMPLE IRAs offer valuable retirement savings opportunities, but the choice between them depends on the size of the business, the employer’s contribution preferences, and the desired level of administrative simplicity. 

Employers should carefully evaluate their specific circumstances and consult with financial professionals to determine which plan best aligns with their goals and the needs of their workforce.