401(k) vs SIMPLE IRA: Which is Right for Your Business?

401(k) or SIMPLE IRA? 

Whether you’re just looking to confirm a choice or haven’t even begun to make one, you know this is an important decision. The kind of plan you pick could have an enormous impact on the finances of everyone involved in your business. 

But retirement plans are complex. With all the nuances and complicated jargon, it can be really tough to know which plan is best for your small business. 

So with this guide, we’re going to take a different approach. 

Rather than hitting you with vague pros & cons or a massive, jargon-filled table, we’ll instead drill into the 4 key ways 401(k)s and SIMPLE IRAs differ. 

We’ll use real world numbers, as well as the expertise we’ve gathered servicing over 5,000 small business retirement plans, to provide you with an easy-to-understand comparison between the two plans. 

By the end of this guide, our aim is for you to be crystal-clear on which plan is right for you.

Ready to get started? Let’s drill right in.

How 401(k)s and SIMPLE IRAs Work

To start, it helps to understand how these plans are the same.

Both plans allow employees to automatically contribute a percentage of each paycheck to a retirement investment account. This contribution (known as an “elective deferral”) is not subject to IRS income taxes when it’s deposited, nor is it subject to capital gains taxes as it grows. The money gets to grow tax-free until the employee withdraws during retirement.

Both plans also allow (or even require in the case of a SIMPLE IRA) employers to make a tax-advantaged contribution to their employees’ accounts.

So at their core, 401(k)s and SIMPLE (Savings Incentive Match for Employees) IRAs are very similar. Where they differ is in the details. We’ll take a look at those next.

401(k)s are Better for Building Wealth

If building wealth over the long haul is a top priority for you or your employees, a 401(k) is almost always the better plan. 

The reason for this comes down to two things: how much employees can defer, and how much control you have over employer contributions. 

We’ll talk about each below.

401(k)s Offer Higher Elective Deferral Limits 

With 401(k)s, employees can defer up to $23,000 for 2024.

With SIMPLE IRAs, elective deferrals max out at $16,000 for 2024. 

Catch-up contributions also follow this trend. SIMPLE IRAs allow an additional $3,500 for employees over the age of 50, while 401(k)s allow for over twice that amount at $7,500. 

The 401(k)’s larger employee contribution limit translates to greater savings and a lower taxable income for plan participants. Not only does this make 401(k) plans more powerful for business owners who want to maximize their retirement savings, but it also makes the benefit more attractive to employees and job candidates who want to do the same. 

The higher savings potential of a 401(k) doesn’t end there.

401(k)s Let Employers Contribute More to Key Employees

When accounting for both the employee deferrals and the employer contribution, the maximum the IRS allows to be put into a defined contribution retirement plan is $69,000 for 2024 ($7,500 if catch-up eligible). Reaching that limit, however, is only possible with a 401(k).

401(k) plans allow employers to make profit sharing contributions. Depending on the formula used, these contributions can allow business owners to funnel large sums of money to themselves, or to make generous contributions to key employees.

If you’re a real high roller, 401(k)s can also be combined with cash balance retirement plans, which can allow you to contribute more than $200,000 in pre-tax retirement savings depending on your age.

By contrast, SIMPLE IRAs do not allow profit sharing contributions, nor can they be combined with cash balance plans (or any other retirement plan for that matter). They also limit the employer contribution to no more than 3% of an employee’s compensation.

This makes 401(k) plans vastly superior for any business whose owners or employees are high-earners who want to maximize their retirement savings.

Here’s a table to sum it all up:

401(k)s are powerful tools for building wealth, but that’s not the only reason they’re so popular…

401(k)s Can be Customized to Meet Your Needs

401(k)s are far more customizable than their SIMPLE IRA cousins.

This flexibility can make them far more effective at accomplishing their goals, whether that’s to help small business owners maximize their contributions, help the business attract & retain key talent, or simply help employees save for retirement. 

We’ll drill into a few of the major differences, and then summarize those and more in the table below:

401(k)s Don’t Require Employer Contributions 

With 401(k)s, employers can choose whether or not they want to contribute to their employees’ accounts, and how much they contribute.

SIMPLE IRAs, however, require employers to contribute. Employers must choose one of two contributions:

1. Matching Contribution: the employer matches the employee’s contributions dollar-for-dollar up to 3% of the employee’s annual compensation.
2. Nonelective Contribution: the employer makes a contribution equal to 2% of the employee’s annual compensation (up to $345,000), regardless of whether or not the employee makes any elective deferrals. 

If your profits fluctuate from year-to-year and you’re worried you might not be able to make the required contribution, a SIMPLE IRA may not be for you.

401(k) Vesting Schedules Help You Retain Talent

401(k) plans allow employers to add a device called a vesting schedule to non-safe harbor contributions.

Basically, these schedules control the rate at which employees gain ownership over the employer contribution. For example, an employer might mandate that employees be employed for 3 years before the contribution belongs to them. This incentivizes your employees to stick around until their contributions are vested, which helps you retain talent.

With SIMPLE IRAs, vesting schedules are not allowed. All contributions made by employers are immediately owned by the employee. So if retaining key talent is a big focus of yours, a SIMPLE IRA may not be the best bet.

401(k) Eligibility Rules Help You Control Costs

401(k)s give you much more control over who is allowed to join the plan, and who is to be excluded. For instance, with a 401(k), you might offer the plan only to employees who are 21 years or older who have worked for your company for at least 1 year. This makes it much easier to control costs or limit complexity if your business employs young, seasonal, or part-time workers. For more detail, read our guide on 401(k) eligibility.

By contrast, SIMPLE IRAs require employers to be much more lenient with who can join. With a few exceptions, all employees who earned $5,000 in any prior 2 years, and who can be reasonably expected to earn at least $5,000 in the current year, are eligible for the plan. Given that SIMPLE IRAs also require employer contributions, this could make them a costly liability for some businesses.

We’ve summarized these points, as well as a few other ways 401(k)s are more flexible than SIMPLE IRAs in the chart below:

SIMPLE IRAs are Easier to Run Than 401(k)s

While 401(k) plans are powerful, highly-flexible savings tools, they also require more complex and time-consuming administration. 

SIMPLE IRAs sacrifice savings power and flexibility in exchange for being easier to run.

Let’s take a closer look at the workload requirements for each.

The 3 Easy Tasks to Start a SIMPLE IRA

Most of the work in running a SIMPLE IRA comes when you start the plan, and can probably be done in a few hours. It comes down to 3 simple things:

1. Executing a Written Agreement: basically, all you have to do here is fill out and sign IRS Form 5304-SIMPLE or Form 5305-SIMPLE to lay out the rules of the plan. Then you simply keep the document on file - you don’t even need to file it with the IRS.
2. Setting Up SIMPLE IRA Accounts for Each Employee: basically, you log into the provider’s platform and create an account for each employee. How long this takes you depends on how many employees you have, but should be fairly simple and not too time-consuming.
3. Providing Notice to Each Eligible Employee: you have to provide required information to eligible employees when they join the plan, and then each year thereafter. Luckily, this is as simple as just sending them your signed copy of Form 5304 or 5305.

So basically, you fill out a form, set up a few IRA accounts, then send that same form to your employees when they join and once a year thereafter. Simple as that.

401(k) Administration – More Rules Means More Responsibilities

Because 401(k)s are so much more flexible than SIMPLE IRAs, it should come as no surprise they’re also subject to more complicated rules. Employers have a fiduciary responsibility to ensure these rules are met. 

As you might imagine, being a plan fiduciary includes a lot of administrative responsibilities. These include…

• Sending notices and enrolling new employees as they become eligible
• Depositing contributions into participant accounts in a timely manner
• Running annual nondiscrimination testing to ensure the plan doesn’t favor high-earners
• Filing Form 5500 with the IRS at the end of every year
• ...and much more.

The good news?  A competent 401(k) provider will complete the more difficult and time-consuming tasks for you and provide simple direction for you to complete the rest.

Depending on the size of your business, how often you hire new employees, how often you run payroll, as well as which 401(k) provider you work with, this might take you no more than 16-20 hours a year.

If keeping your plan administration responsibilities to a minimum is a high priority for you, a SIMPLE IRA might be a better option.

Administrative simplicity isn’t the only advantage of a SIMPLE IRA - they can oftentimes be cheaper than 401(k) plans as well.

SIMPLE IRAs are Cheaper Than 401(k)s… Usually...

It’s a commonly-held belief that SIMPLE IRAs cost less than 401(k)s. While some quick internet research would suggest that this is true, the reality is it’s not quite that simple. Let’s take a closer look...

SIMPLE IRA Setup & Administration Costs are Much Lower

Running a 401(k) is a lot more complex than a SIMPLE IRA - both for your business and for your provider. As such, 401(k)s require fees to pay for administration services such as recordkeeping, asset-custody, and third-party administration. 

In addition, starting a 401(k) can require a lot of paperwork, so there’s usually always a fee for plan establishment. Generally, this shouldn’t cost you more than $500.

SIMPLE IRAs are usually free of these types of fees. It’s not uncommon to see SIMPLE IRAs advertised with no establishment fees, and oftentimes with very minimal or no administration fees.

So by that measure, SIMPLE IRAs are clearly cheaper. If your business is just starting out, or you’re just looking to check a box on retirement benefits and keep your business expenses to a minimum, SIMPLE IRAs are usually the way to go.

However, we do want to offer a word of caution. 

Whether you open a SIMPLE IRA or a 401(k), there are some major pitfalls that can cost you and your employees thousands if you’re not careful.

The Hidden Dangers of Investment Fees

Investment fees are paid by plan participants to pay for the mutual funds or investment products used to grow their money. Often charged as a small percentage of the assets invested, these fees are automatically deducted from participants’ accounts.

While there’s nothing inherently bad or unfair about these fees, there are a few exceptionally shady practices to watch out for.

Sales Loads Severely Reduce Contributions

These are basically sales commissions, usually paid to a broker. They work by taking a percentage of the money invested - either when it is first put into the fund (called a “front-end load”) or when it’s taken out (called a “back-end load”).

For example, some providers (John Hancock or American Funds are notable examples) might take a front-end load of up to 5.75% from SIMPLE IRA participants every time they put money into their accounts. 

Not only can fees like these completely eradicate the SIMPLE IRA match, but they can also put a huge dent in participants’ accounts over time thanks to the power of compound interest. 

Because 401(k)s are more strictly regulated, their investments are less likely to include sales loads. 

However, that’s not to say that 401(k)s are without their own hidden dangers...

Revenue Sharing Eats Away at Participant Returns

Revenue sharing is the practice of adding 401(k) administration fees to the operating expenses of a mutual fund. These additional fees are then used to compensate a 401(k) provider for plan administration services like recordkeeping or investment advice. Because revenue sharing payments increase the cost of 401(k) investing, they reduce participant returns.

A big problem with revenue sharing – among others – is the fact these payments are based on a percentage of plan assets. As a 401(k) plan participant contributes more money to their account, they can end up paying way more for the same level of service over time. Meanwhile, their 401(k) provider’s profits keep going up and up and up. 

Doesn’t seem fair, does it?

Revenue sharing is a really common practice for small business 401(k) plans. In fact, we analyzed the fees of over 200 plans, and found that roughly 85% of plans paid revenue sharing or some other form of indirect fee paid from fund expenses. 

We don’t have any statistics for how common revenue sharing is with SIMPLE IRAs. Many SIMPLE IRA providers might limit fund selection to their own proprietary funds, but if they don’t, there’s a strong possibility that they include revenue sharing or some form of sales commission as well.

The truth is, with both SIMPLE IRAs and 401(k)s, you have to be really careful. The financial services and investment industry is littered with traps that can cost you and your employees big. 

The last thing you’d want is to open a SIMPLE IRA trying to save on costs, and in doing so, force your employees to pay big commissions.

On the flip side, it does you no good to open a 401(k) to help max out your savings, only to have them severely and unfairly reduced by revenue sharing. 

So regardless of which plan you go with, pay close attention to the investment fees. 

On top of that, be sure to work with a 401(k) provider who’s transparent and charges fees based on headcount rather than plan assets to the extent possible. That’s the only surefire way of knowing the 401(k) fees you’re paying are truly in line with the services you and your participants are receiving.

401(k) vs SIMPLE IRA Chart - Pros & Cons

We’ve just covered a lot of nitty-gritty details and differences, so here’s a snapshot of each plan, broken out by pros and cons:

401(k) vs SIMPLE IRA: Which is Right for My Small Business?

By now, we hope that the differences between these retirement plans is clear, and that you have a pretty good idea which is best for you. 

To recap:

401(k) plans are extremely powerful tools for building wealth. Their high contribution limits and plan design flexibility make them perfect for business owners who are trying to maximize their savings, or attract high-end talent looking to do the same. 

On the other hand, SIMPLE IRAs are extremely simple. Their lax administrative requirements and low costs make them excellent choices for businesses who want to help their employees with a no-hassle retirement benefit.

Whichever plan you choose, pay close attention to your investment costs, and be sure to work with a provider who doesn’t charge sales loads or hidden revenue sharing fees. If you do that, you and your employees will be well on your way to a successful retirement. And that’s what’s most important, isn’t it?