SIMPLE 401(k)s, SIMPLE IRAs, and SEP IRAs – What Are They, and How Do They Compare to a 401(k) Plan?

As a small business owner, there are a lot of choices when it comes to a retirement plan for you and your employees. You may have come across SIMPLE (Savings Incentive Match Plan for Employees) 401(k)s, SIMPLE IRAs, SEP (Simplified Employee Pension) IRAs, and of course, the 401(k), as potential candidates. Unfortunately, just because it’s called SIMPLE, doesn’t mean it is. Let’s go through the ins and outs of these retirement plans and how they compare to 401(k)s, so you can get the facts straight about what is best for your business.

What is a 401(k)?

A 401(k) plan is a tax-advantaged retirement benefits plan and has become the most common type of retirement plan for businesses with employees. 401(k)s offer the greatest contribution limits for employees and employers and offer flexibility when it comes to plan features. You can choose a 401(k) that allows for 401(k) loans, hardship withdrawals, in-service distributions, vesting schedules, and more. 401(k) plans can be designed as a Traditional 401(k) or Safe Harbor 401(k) depending on the features you want and the ease of year-end administration you desire. 401(k)s do not have a limit on the number of employees employed by your business. As your business scales, your retirement plan can grow with it, and that means one less thing you need to worry about.

401(k)s allow eligible employees the ability to contribute money from their paycheck either pre-tax (Traditional) or post-tax (Roth deferrals). In addition, profit-sharing is a great way to reward employees and lower your taxes while you’re at it. You can think of it as employee bonuses with tax benefits.

With these plan offerings, you can attract and retain talented employees who appreciate the amount of options they will have when it comes to their retirement savings. But while 401(k)s are more flexible, some 401(k) plan designs have an extra level of plan administration and annual nondiscrimination testing to ensure that highly compensated employees are not being favored over non-highly compensated employees. Much, if not all, of these can be avoided with the Safe Harbor 401(k) design, which requires immediately vested employer contributions like the other retirement plans that are discussed here.

401(k) Contribution Limits

The maximum deferral amount for 401(k)s in 2024 is $23,000 with an additional $7,500 catch up contribution for those age 50 or older. These contribution amounts are adjusted annually for inflation, and are thousands of dollars greater than the contribution limits for SIMPLE 401(k)s.

What is a SIMPLE 401(k)?

A SIMPLE 401(k) is a simplified version of a 401(k) plan and is offered only to small businesses with fewer than 100 employees. If at any point the business exceeds 100 employees, there is a 2-year grace period before the plan must be switched over. SIMPLE 401(k)s offer the ability for eligible employees to contribute post-tax (Roth deferrals), and they include 401(k) loans, hardship withdrawals, and in-service distributions. They are not subject to nondiscrimination testing; however, they are required to annually file a Form 5500. If you’re in the market for a retirement plan with easy administration, a SIMPLE 401(k) checks that box, but do keep in mind that you can choose a Safe Harbor 401(k) plan design which automatically satisfies testing.

When starting the SIMPLE 401(k), there are some requirements when it comes to employer contributions. You the employer must make either:

• A matching contribution up to 3% of each employee’s pay, or
• A non-elective contribution of 2% of each eligible employee’s pay

The employees are immediately vested in any and all contributions and no other contributions can be made. Businesses with SIMPLE 401(k)s cannot sponsor another qualified plan such as a profit-sharing plan, so in general, they do not have the discretion to choose how they make contributions.

Keep in mind that SIMPLE 401(k)s must be established any time between January 1st and October 1st. The October 1st deadline allows employees to make salary-deferral contributions before year-end. To be eligible to participate in a SIMPLE 401(k) plan, employees may be required to work at the company for at least one year and be at least 21 years old.

SIMPLE 401(k) Contribution Limits

SIMPLE 401(k)s have lower contribution limits at $16,000 for 2024 with an additional $3,500 catch-up for those over 50, versus the traditional 401(k) contribution limits at $23,000 with an additional $7,500 catch-up contribution for those age 50 or older.

What is a SIMPLE IRA?

SIMPLE IRAs are similar in many ways to SIMPLE 401(k)s. Small businesses with less than 100 employees can choose a SIMPLE IRA for their retirement plan needs. An employer can sponsor a SIMPLE IRA, which allows them and their employees access to a retirement savings account that is tax-deferred, and as of 2023, SIMPLE IRAs are allowed to support Roth contributions too. Like with SIMPLE 401(k)s, SIMPLE IRAs have certain employee contribution requirements. You the employer must make either a:

• Matching contribution up to 3% of compensation (not limited by the annual compensation limit), or
• 2% nonelective contribution for each eligible employee

SIMPLE IRAs have most of the requirements of SIMPLE 401(k)s, with employees being 100% vested and contribution restrictions. However, SIMPLE IRAs allow employers who make 3% matching contributions to adjust the percentage to less than 3%, but no less than 1% for two out of every five years.

If you compare a SIMPLE IRA vs a SIMPLE 401(k), because SIMPLE IRAs are indeed IRA accounts, they don’t have access to 401(k) features such as loans. This makes end of year plan administration a bit easier, as there is no filing requirement for the SIMPLE IRA. Participants can still take distributions, but, unlike a 401(k), there’s a 25% penalty if a participant makes a withdrawal within the first two years of their IRA account. This is in addition to the 10% tax for early withdrawal before the age of 59½. Also, there is no age or service requirement for the SIMPLE IRA. Instead, any employee who earned at least $5,000 during any two preceding years and is expected to earn $5,000 in the current year must be allowed to participate in the plan.

A SIMPLE IRA can be established at any time between January 1st and October 1st if an employer has not previously sponsored a SIMPLE IRA. If the employer did previously sponsor a SIMPLE IRA, a new plan can only be started on January 1st. After establishment, SIMPLE IRAs must run on a calendar year basis. However, as of 2024, thanks to new Secure ACT 2.0 regulations, a company can now convert their SIMPLE IRA to SIMPLE 401(k) or a Safe Harbor 401(k) during the year versus waiting until January 1st.

If a business wants to terminate its SIMPLE IRA plan, it must do so at the end of the calendar year. Employers must notify the financial institution that it wishes to terminate the agreement and employees must be notified on or before November 2nd that the SIMPLE IRA will be discontinued.

SIMPLE IRA Contribution Limits

Simple IRAS have the same contribution limits as SIMPLE 401(k)s at $16,000 for 2024 (with an additional $3,500 catch-up for those over 50) versus the traditional 401(k) contribution limits at $23,000 with an additional $7,500 catch up contribution for those age 50 or older.

What is a SEP IRA?

This type of retirement plan enables employers to make optional contributions on a tax-deferred basis. Contributions must be disbursed to all eligible employees, and only the employer can contribute to the plan. Whether you’re self-employed or have employees, a SEP IRA is something you can consider. SEP IRAs don’t have some of the features that make 401(k)s so popular, such as loans, hardship withdrawals, or vesting schedules. SEPs are also not subject to non-discrimination testing due to their design.

In determining the company contributions, you can include up to 25% of the employee’s total compensation (limited to $345,000) not to exceed the annual limit (which is $69,000 for the 2024 tax year). There's no catch-up contribution at age 50 and older for SEP IRAs. Because SEP IRA contributions are optional each year, businesses with unpredictable incomes may find this plan to be a good fit, as they may not always be able to meet these contribution requirements. If this is a requirement for you, 401(k)s can also be designed to meet this potential need and still enable employee contributions in years it may not provide an employer contribution.

Employee eligibility for a SEP IRA plan includes those who are 21 or older, have worked for you for at least three of the past five years, and have earned a minimum of $750 in 2024. Businesses who have a SEP IRA can terminate the plan at any time, and although it is a good idea to notify employees of the termination, there is no strict requirement to do so.

Determining Which Retirement Option is Right for You and Your Business

Unlike a decade or two ago, there are few reasons to truly consider a SEP IRA, SIMPLE IRA, or SIMPLE 401(k) over a 401(k) plan. 401(k) regulatory changes have addressed most of the reasons SEPs and SIMPLEs were created such as:

1. 401(k)s plans using the Safe Harbor design automatically satisfy IRS testing requirements. It does require a 3% or 4% vesting match in most cases, which is similar to SIMPLE IRAs and SIMPLE 401(k)s.
2. 401(k) plans don’t require an employer match, so a business that may not match one year but does the next year can leverage 401(k) profit-sharing to meet this need. Plus, unlike a SEP IRA, employees can continue to contribute to the plan regardless of what the business decides.
3. The cost of 401(k)s used to be notably more than SEPs and SIMPLEs. Today, there are low-cost providers, and material IRS tax credits, when applied, can cover the costs of a 401(k) for the first three years of the plan. There are even tax credits for employer contributions, plus it’s tax deductible ongoing.

When you consider the flexibility and advantages of a 401(k) over SEPs and SIMPLEs, you can see why 401(k)s truly are preferred in most scenarios:

• Highest contribution limits for employees and equal overall limit with SEPs.
• Highest catch-up contributions for employees that are 50+ years of age.
• Greatest flexibility in determining whether you want to provide employer contributions and in the choices you have if doing so.
• Easiest access to monies in an emergency with 401(k) loans or hardship withdrawals if needed.
• Vesting options for those using as a retention tool.
• Scales as your company scales with no employee limits.
• Includes robust features such as automatic enrollment and auto-escalation can help more employees participate and contribute more to build a meaningful nest egg.

Key Takeaways:

1. SIMPLE (Savings Incentive Match Plan for Employees) 401(k)s, SIMPLE IRAs, and SEP (Simplified Employee Pension) IRAs are retirement plans built with the intension of simplifying the process of setting up and funding a retirement savings account for you and your business. Many of these advantages have been eliminated over time with changes in regulations for 401(k) plans
2. SIMPLE 401(k)s and SIMPLE IRAs have lower contribution limits compared to 401(k)s. While SEP IRAs have a higher contribution limit, all funding is provided by the employer and none by the employee. Employer contributions are optional each year which can prevent employees from building enough for retirement.
3. SIMPLE 401(k)s and SIMPLE IRAs are limited to less than 100 employees while there is no employee limit for 401(k)s and SEP IRAs.
4. SIMPLE 401(k)s, SIMPLE IRAs, and SEP IRAs are stripped down versions of 401(k) plans, and lack some features such as 401(k) loans, hardship withdrawals, vesting schedules, and profit-sharing options native to 401(k)s.
5. There is limited to no cost savings with SEP IRAs and SIMPLEs versus a 401(k) due to more low-cost providers in the space and small business IRS tax credits and deductions.

ShareBuilder 401k does not offer tax or legal advice. Consult with your tax or legal advisor before engaging in specific strategies.

Loan balances must be paid off in five years and if you leave your job, you may be required to pay back the full balance within a short-time frame or pay penalties and taxes. Most important, borrowing from your 401(k) can significantly reduce your retirement savings.