Comparison: Simple IRA Vs 401k – Which Is Better For Me And My Small Business?

If you’ve landed on this article, chances are you’re a small business owner looking for the best retirement plan for your business. But with so many options out there, it can be pretty overwhelming trying to decide which one is right for you. And let’s be honest, the last thing you want to do is waste time and money. But don’t worry, we’re here to help. This article will compare the two most popular options: Simple IRA vs 401k. 

And we’ll go over the pros and cons of each so you can make an informed decision about which is right for your business. 

The first consideration is the size of your business.

For instance, If you have less than 100 employees (making $5,000 or more per year) and want something without a lot of administrative burden, a Simple IRA might be perfect for you.

But if you have more than 100 employees and want more flexible options, a 401k plan might be just what you need.

The Four Most Common Reasons for Considering Retirement Plans

At Baron Payroll, we work with hundreds of businesses each year that have tax and retirement questions. And we’ve found that there are typically four reasons business owners have questions on Simple IRA’s, 401k’s and other programs:

1. Employee recruitment and retention 
2. Decreasing your tax burden
3. You want to retire one day
4. You’re required by law in your state

Employee Recruitment and Retention

Are you tired of turnover?

Having the right benefits package can be a big factor in determining if your team is content with their job or looking to jump ship. 

So why not make sure that you offer them options and flexibility when it comes to choosing their benefits? 

401k plans give employees choices in how to use the money - they can simply withdraw it, keep it where it is, or roll it into an IRA account. 

And similarly, Simple IRAs provide two years of stay before they have the freedom to move their savings into another retirement plan - giving employees enough time to really decide what’s best for them. 

Decreasing Your Tax Burden

Basically, any time a corporation makes a contribution to a retirement plan, regardless of what it is, it’s deductible from the corporate profit at the end of the year. 

This means both plans allow employees to contribute directly from their salary (pre-taxed). And they are only taxed once the money is withdrawn. 

And what’s great is regardless of the plan you choose, employer contributions are tax deductible! 

You Want To Retire One Day

So, you want to be able to enjoy life after work without worrying about how much money you have left over for fun activities or travel. But you have a looming question over your head. 

Will my business be worth enough for me to sell and live comfortably after I retire? 

The good news is both retirement plans are an excellent way to put your mind at ease and provide security for your future self. 

Plus, if you choose a Roth IRA or other tax-advantaged savings account, you may even be able to reduce the amount of taxes paid on those funds over time! 

All in all, investing in a retirement plan helps reduce the amount of money going to Uncle Sam, but it also gives you a chance to start seeing returns on your investments sooner!

You’re Required By Law In Your State

And last but not least, you might be looking for a retirement plan for your company because your state requires it by law. 

As of October 2021, employers across New York are now mandated to provide their employees with retirement savings plans, providing some financial security for years to come. 

With this new mandate in place, you must give your employees access to a retirement savings plan if:

• You've been in business for at least two years 
• You employ 10 people or more within the state of New York

How Much Will A 401k Or Simple IRA Plan Cost Me?

401k retirement plans are more expensive than Simple IRAs.  Why?

• Start up costs of $500 - $2,000 
• TPA (Third Party Administrator) fees
• Higher annual participation fees

Start up costs

Beginning a 401k plan for retirement comes with an added cost—a start up fee. This one-time expense is necessary to get the ball rolling and ensure your longterm savings goals are on track. 

• 401k - $500 - $2,000
• Simple - None

TPA fees

TPAs, or Third Party Administrators, make sure employee benefits are qualified and that financial paperwork is filed correctly. They provide a variety of services but the associated fees depend on how complex those services are - generally speaking, more complicated work means higher rates.

• 401k -  $750 to $3,000 per year plus
• Simple -  None

Annual Participation Fees

Depending on your retirement plan, annual participation fees can range from a small cost to a large amount. 

Participation fees for Simple IRAs are typically lower because you manage the account yourself and don't need to hire experts. But 401ks are more complicated and involve turning over your money to experts, which drives up the cost.

• 401k -  per-participant annual fee anywhere from $15 to $60 a year
• Simple - per-employee fee of around $25 to $35 a year that’s typically waived at a certain account balance

What Are the Maximums Employees Can Contribute?

The contribution limitations of a 401k plan is higher than a Simple IRA. But what does that mean? 

More in the bank each year leads to bigger savings and more money to invest down the road - allowing your workforce to save up for something as ambitious as retirement that much faster.

Here are the maximum contribution rates for 2022:

• 401k - 
• $20,500 for employee contributions
• $6,500 for catch-up contributions for employees aged 50 and over
• $61,000 for the total contributions from both the employee and employer (or $67,500 for those over 50) if you decide to offer an optional match and profit-sharing contribution.
• Simple - 
• $14,000 for employee contributions
• $3,000 for catch-up contributions for employees aged 50 and over

Other contribution factors to consider:

• 401k -
• These employee contributions have the option to be pre-tax or post-tax, depending on if you offer an option for Roth contribution
• And if you choose a Roth contribution option, your employees will receive tax-free distributions once they retire
• Simple - 
• When it comes to contributions for Simple IRAs, the biggest difference is that instead of having the option to match, as you do with 401ks, you are required to make a contribution every year
• And when you contribute, you can either contribute 2% of an employee’s compensation or a dollar-for-dollar match of up to 3% of the employee’s contribution
• And if you choose the dollar-for-dollar match, you are allowed to contribute less than 3% for up to two years within a five year span

What Are The Vesting Rules For A 401k And Simple IRA?

With a 401k plan, you can create a plan where employees gradually take ownership of your contributions over a period of time to encourage employee retention. This is called a vesting schedule. 

On the other hand, with a Simple IRA, employees always take immediate ownership of your contributions.

• 401k - 
• You have the option to choose a vesting schedule to encourage employee retention
• For example, with most vesting schedules, employees get 0% ownership of your contributions after the first year, 20% after the second year, 40% after the third year, 60% after the fourth year, 80% after the fifth year, and 100% ownership after the sixth year. 
• Alternatively, you can choose a "safe harbor match" which means that employees will immediately take ownership of your contributions. 
• Simple - 
• A vesting schedule is not an option and your employees will always take immediate ownership of contributions

What Are My Options Within A 401k And Simple IRA?

Do your employees need more options in their plan? 

Then you might want to consider a 401k over a Simple IRA.

• 401k - 
• A 401k offers more options to borrow money from their accounts (this came in handy during the pandemic) 
• And it offers flexibility to make profit-sharing contributions
• Simple - 
• A Simple IRA plan doesn’t allow for either option

How Much Of An Administrative Burden Will Each Plan Be?

With so much on your plate, the last thing you want is more paperwork. 

So when it comes to the administrative burden, 401k’s are a little more strenuous when making sure that you meet everything that’s required. 

• 401k - 
• Sending eligibility notices
• Depositing contributions
• Annual compliance testing
• Filing the Form 5500 annual report every year
• Simple - 
• Completing a Simple IRA adoption agreement
• Setting up an account for each employee

And that’s it!

Now that you have learned about the pros and cons of both plans, hopefully, you’ll be able to make the right decision for your small business.