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401(k) Advantages over SEP and SIMPLE IRAs

10/05/2009:

It may seem confusing trying to figure out what sort of retirement plan is the best fit for your business. Yet when you compare a 401(k) to SEP and SIMPLE IRA options, the main plan options for businesses with less than 25 employees, it becomes a much easier decision.

401(k)s not only offer higher contribution limits, but also offer more flexibility in design to manage business costs, taxes, and enable penalty-free access to funds via a loan if an emergency arises before reaching retirement age (59 ½). A summary of important differences include:

401(k) SIMPLE IRA SEP IRA
Who can contribute
Employee; Employer optional Employee & Employer Employer only; must contribute for all eligible employees
Max Employee Contribution
$16,500 w/$5,500 catch-up if over 50 years old $11,500 w/$2,500 catch-up if over 50 years old Not applicable
Employer Contributions
Optional, up to 25% of W-2 payroll with a $49K cap Required match of 100% first 3% of participating employee contributions or 2% of all eligible employee salaries Optional, but only way to fund; up to 25% of W-2 payroll with a $49K cap
Vesting Timing for Employer Contributions
Multi-year options or immediate Immediate Immediate
Access to Funds before age 59 ½ Penalty-free loans or 10% penalty for early withdrawal 25% penalty for withdrawing within first 2 years of participating; 10% thereafter 10% penalty for withdrawal before age 59 ½

Also the Roth option available with a 401(k) which has no income limitation is another advantage not available in the IRA options. As the cost for small business 401(k)s have dropped substantially, there aren't many reasons to consider anything else.

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