If you work for a small business (one with 100 or fewer employees) you may not think much of your retirement savings options. In fact, a recent study from LIMRA found that only 42% of small businesses offered retirement benefits. There are, however, a few retirement savings vehicles intended just for small businesses: SIMPLE IRAs and SIMPLE 401(k)s. These were born out of the Savings Incentive Match Plan for Employees (SIMPLE) program, and they are both tax-advantaged. While the two plan choices are similar, there are a few subtle differences worth noting.What Is a SIMPLE IRA?
SIMPLE IRAs are a cost-effective way for small businesses to offer a retirement plan. This is mainly because they don’t require the startup costs or ongoing expenses of a traditional retirement plan, like a 401(k).
SIMPLE IRAs are available to any small business with 100 employees or less. Your employer may receive a grace period if their company surpasses 100 employees, though. To qualify for this retirement savings account, the employer cannot offer any other retirement plan.
To gain eligibility for a SIMPLE IRA, an employee must meet one of two requirements:
Employees make SIMPLE IRA contributions via salary withholding. The annual contribution limit for this plan in 2019 is $13,000. This is up from the $12,500 limit that was in place from 2015 to 2018. However, those older than 50 years of age are eligible to make catch-up contributions of up to $3,000 a year.
The employer must contribute to a SIMPLE IRA annually. There are two options. An employer can either make a non-elective 2% contribution for every employee; or match up to 3% of an employee’s contributions on a dollar-for-dollar basis. In the former case, even employees who don’t contribute to their SIMPLE IRA will still get their employer’s 2% annual contribution. The IRS caps this at $280,000.
Another thing to keep in mind when it comes to SIMPLE IRAs is that employees are always 100% vested. This means that they own all the funds in their SIMPLE IRA account. This differs from 401(k)s, which often have vesting schedules which restrict access to matching funds until a period of time has elapsed.
While employees can technically withdraw from their SIMPLE IRA, it isn’t advisable. Outside of certain exceptions, withdrawals before age 59.5 are subject to a 10% IRS tax penalty. This increases to a massive 25% penalty if the withdrawal is done within the first two years the account is active.What Is a SIMPLE 401(k)?
A SIMPLE 401(k) is another tax-advantaged savings vehicle that allows employees of a small business to save for retirement. These also provide access to employer matching, which can be beneficial over the long-term. As with SIMPLE IRA plans, an employer must match an employee’s contributions up to 3%, or make a non-elective, flat 2% contribution of each eligible employee’s pay.
Like SIMPLE IRAs, SIMPLE 401(k) plans are only available for employers with 100 or fewer employees. Employers offering SIMPLE 401(k)s are also granted a two-year grace period in the event their company surpasses 100 employees.
Similar to their IRA counterpart, the 2019 contribution limit for SIMPLE 401(k) plans is $13,000. Again, a $3,000 catch-up limit is available for anyone 50 and over. Withdrawals before age 59.5 are subject to a 10% early distribution penalty.
Employees are fully vested in all SIMPLE 401(k) contributions. Remember, this means they own all funds in their SIMPLE 401(k), rather than waiting a designated amount of time to become vested. A company cannot offer other retirement plans in addition to a SIMPLE 401(k).SIMPLE IRA vs. SIMPLE 401(k): Key Differences
A SIMPLE 401(k) offers optional loans, as well as hardship withdrawals. This level of flexibility is impressive, as this type of plan doesn’t place employees’ funds too far out of reach.
Despite not having a formal loan option like SIMPLE 401(k)s do, you can still withdraw from your SIMPLE IRA as you please. Just know that doing so before age 59.5 will likely incur a 10% or 25% early withdrawal tax penalty.
Filing requirements for a SIMPLE IRA are nominal for plan administrators. A SIMPLE 401(k) requires the annual filing of Form 5500. This extra work could prove to be a lot to handle, especially for very small businesses.
Although an employer cannot offer other plans to employees who qualify for the SIMPLE 401(k), they can provide an additional plan to those employees who fall outside of the qualification guidelines. Employers using a SIMPLE IRA plan cannot do this, which could leave some employees on the outside.
There is no minimum age for a SIMPLE IRA. Conversely, SIMPLE 401(k)s can require participants to be 21 years or older, plus have at least one year of service time.How to Start a SIMPLE IRA and a SIMPLE 401(k)
If a SIMPLE IRA is the direction you want to go, you’ll need to follow a few steps. They go as follows:
The process for starting a SIMPLE 401(k) is essentially the same, only there is no official IRS documentation. Instead, you’ll need to create a written prospectus that details the plan. It might be worth consulting with a financial advisor to ensure you do this correctly.
Once your SIMPLE 401(k) is active and its funds are at a trustee of your choosing, you must maintain the plan. This principally involves filing Form 5500 with the IRS annually. You also must distribute documentation of the state of the plan to your employees, including:
Both SIMPLE IRAs and SIMPLE 401(k)s are solid retirement savings options for employees at small businesses. Though these plans have many similarities required employer contributions, tax-advantaged savings, vesting rules and some requirements for participants there are several important differences to keep in mind. Think about participant age limits, grace period availability and length (if a company surpasses 100 employees) and the ability to take a loan out against your funds.
Do ample research on each plan’s rules, requirements and limits. Then compare them with your anticipated needs as a plan provider or participant. This should leave you feeling confident that you’re making the best financial decision for you, your company and your employees.Next Steps for Your Retirement Planning
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