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SIMPLE IRA Plan vs. 401(k) Plan

Employers often ask which plan is better.  While there is no true right or wrong answer, one could make a strong case for a 401(k) plan.  Most employers gravitate towards the SIMPLE IRA plan due to its simplicity with minimal administrative responsibilities and low expenses.  However, if the employer is willing to make the extra effort and cover certain plan expenses, a 401(k) plan is the better solution for both the employer and employees.

Contributions

There is a significant difference in allowed contributions, with 401(k) plans allowing almost three times as more in annual contributions than SIMPLE IRA plans.

For 2021, a SIMPLE IRA plan allows total employee and employer contributions of $19,300 ($22,300 if you are over 50) using a 2% non-elective employer contribution rate for an employee making $290,000. For 2021, a 401(k) plan allows total employee and employer contributions of $58,000 ($64,500 if you are over 50).

Additionally, 401(k) plans allow for Roth Deferrals unlike SIMPLE IRA plans.  Roth Deferrals are increasingly becoming a common feature in most 401(k) plans.

Fees

If fees alone were a factor, SIMPLE IRA plans would be the more suitable choice for the employer.  They do not require a Recordkeeper or a Third-Party Administrator (TPA).  Only requirement is a custodian, and they usually do not charge custodial fees to custody accounts.  Only cost would be transaction fees.  But in today’s investment world, there are plenty of No-Transaction-Fees funds available at brokerage firms like Schwab, Fidelity, or TD Ameritrade.

Alternatively, 401(k) plans require the services of a Recordkeeper, TPA, Custodian, and generally an ERISA Fiduciary, and there are fees associated with each service provider.  However, IRS does allow employers to take a tax deduction for certain plan expenses paid directly from a company checking account.

Administrative Responsibilities

SIMPLE IRA plans do not have any annual tax filing requirements.  However, annual plan details must be provided to employees.

Conversely, 401(k) plans are subject to annual filings and testing.  These are generally the responsibilities of a TPA, if one has been hired to administer the plan.

Available Investments

SIMPLE IRA plans have access to any investment available at the custodian selected for the plan. 401(k) plans are limited to a selected list of funds decided by the employer and an ERISA Fiduciary.  This is usually not an issue for most participants since most investment lineups include about 25 to 30 fund choices.

If a participant prefers to have an expanded list of investment options, he can always open a Self-Directed Brokerage Account (SDBA).

Prorata Rule

This is one key factor overlooked by most employers looking to create a retirement plan.  If you are actively doing Backdoor Roth conversions, then you certainly do not want to create a SIMPLE IRA plan. 

SIMPLE IRA plan balances are taken into consideration when doing a Backdoor Roth Conversion resulting in the application of the Prorata Rule.

401(k) plan balances, however, are not factored-in when doing Backdoor Roth Conversions rendering the Prorata Rule irrelevant.

Tax Credits

Whether you are looking to create a SIMPLE IRA plan or a 401(k) plan, you should act quickly as the IRS is offering tax credits for establishing and maintaining a retirement plan for a small business.

Companies with up to 100 employees can claim a tax credit to offset startup costs associated with establishing a new retirement plan.  Companies can get a tax credit of up to $5,000 per year for the first three years, with a maximum total credit of up to $15,000.

Defined Benefit/Cash Balance Plans

Another key factor that is generally overlooked is that SIMPLE IRA plans cannot be paired with a Defined Benefit or Cash Balance plan.  Conversely, 401(k) plans can be paired with either plan type.  For 2021, Highly-Compensated-Employees can contribute as much as $407,500 total to both a 401(k) PSP and a CB Plan combo.

Bottom Line

Both plans have pros and cons.  If you are looking for a low-maintenance cost-effective way to operate retirement plan, a SIMIPLE IRA plan may be for you.  But if the objective is to maximize retirement savings, a 401(k) plan is clearly the better choice. One will save you money now.  The other will help you save towards your retirement.