SIMPLE 401(k): Retirement Savings for Business Owners and the Self-Employed
If you’re a small business owner, chances are you’ve looked into offering some sort of retirement account. Similarly, self-employed business owners may wonder how they can save for retirement in a tax-advantaged way.
Unfortunately, retirement accounts can be costly.
Businesses with no employees may prefer a Solo 401(k) or SEP IRA.
This is due to the way these plans benefit self-employed business owners. However, companies with employees must or may want to look at other options.
One option you may not be aware of is a SIMPLE 401(k) plan.
These plans may be a good fit if you’re a business owner or self-employed person with 100 or fewer employees.
Here’s what you need to know to see if this retirement plan could be a good fit for your business.
What is a SIMPLE 401(k) Plan?
A SIMPLE 401(k) is a version of a 401(k) plan to help employees save for retirement.
SIMPLE stands for Savings Incentive Match Plan for Employees.
SIMPLE 401(k) plans are ideal for...
An employer who has 100 or fewer employees and wants to offer retirement plans.
In fact:
To qualify for this plan type, this is a requirement. And, these employers are not allowed to offer any other retirement plans.
They must also be willing to file an annual tax form called Form 5500.
If your small business can meet these requirements, a SIMPLE 401(k) plan may work.
How employees and employers contribute to a SIMPLE 401(k)
Employees contribute to a SIMPLE 401(k) plan by having money withheld from their paycheck.
This money is then deposited into their SIMPLE 401(k) account at an individual participant level by the employer.
As part of running a SIMPLE 401(k) plan, employers must also participate in the SIMPLE 401(k).
Employers must make mandatory annual contributions to eligible employees’ accounts.
This mandatory contribution can be made in one of two ways.
Either way, it must be applied universally across all eligible employees.
These mandatory contributions are called safe harbor contributions. This is due to the fact plan participants are automatically fully vested in them.
The first employer contribution option is a matching contribution of up to 3% of an employee’s pay. In order for the employee to earn the matching contribution, they must contribute to the account, as well.
The other option is a non-elective contribution of 2% to each eligible employee’s pay.
SIMPLE 401(k) contribution limits and deadlines
Employees can contribute up to $16,000 to their SIMPLE 401(k) plan accounts in 2024.
If an employee is age 50 or older, they get access to a catch-up contribution. In 2024, the catch-up contribution amount is $3,500. This brings their total potential contribution amount for 2024 to $19,500.
These limits are lower than a traditional 401(k) plan’s contribution limits.
Employers must contribute either a 3% of an employee’s pay matching contribution or a 2% non-elective contribution to each eligible employee.
As a small business owner, you must remit the contributions to the plan.
The employees’ deferral amounts come out of their paychecks but you must be remitted to the plan.
Employee contributions that come out of their paycheck should be deposited as soon as possible.
You also have to make employer contributions based on your plan’s requirements.
Check with your tax advisor and plan documents to determine when this contribution must be made by.
Other rules for these plans
Once you make contributions to an employee’s account for the employer portion, they are fully vested in that amount.
Matching or non-elective contributions must be made to all eligible employees.
Not all employees may be eligible, though.
Check your plan’s documents to see when an employee becomes eligible for your plan.
This is different from traditional 401(k) plans. Traditional 401(k)s may allow vesting of ownership of an employer match over several years.
As an employer, you’ll have to fill out Form 5500 each year. This is a reporting tax return to document information about the retirement plan.
These plans do offer the possibility of loans and in-service withdrawals for participants.
Your plan documents must establish this as an option to offer these features.
Adding them to your plan could cause more administrative headaches.
However, they can offer valuable benefits to your employees that need them.
When Does a SIMPLE 401(k) Make Sense?
A SIMPLE 401(k) plan may make sense for your company, depending on the circumstances.
These plans only work for employers with 100 or fewer employees.
That said, self-employed people with no employees have better options to consider.
This assumes they don’t plan to hire employees.
A solo 401(k) plan would likely offer self-employed individuals more flexibility and higher contribution limits.
It also offers a Roth option if opened at a brokerage that supports this.
Small business owners looking to grow could be a perfect fit for a SIMPLE 401(k) plan, though. One hundred employees is a relatively large number for a company starting out with zero or just a couple of employees. The SIMPLE 401(k) plan doesn’t offer as high of contribution limits as a regular 401(k).
Even so, the lower start-up and operating costs make this an attractive way to offer a retirement plan rather than not offering one at all.
If you want to offer the option of in-service withdrawals and participant loans as a benefit, a SIMPLE 401(k) allows this possibility when other plans may not.
SIMPLE 401(k) Plan vs. SIMPLE IRA Plan
Another option your small business may want to consider is a SIMPLE IRA plan.
SIMPLE IRAs and SIMPLE 401(k)s are very similar in many aspects.
Notably, SIMPLE IRAs do not require an employer to file a Form 5500 each year.
This makes a SIMPLE IRA a bit easier to manage.
Unfortunately, SIMPLE IRA plans don’t offer participant loans. This provides less flexibility for your employees.
Like a SIMPLE 401(k), SIMPLE IRAs have a 100-employee limit. Both plan types also require the same employer contribution options. Employers cannot offer other retirement plans with either type of plan, as well.
SIMPLE 401(k) vs. SEP IRA
A SEP IRA plan is another option some business owners may want to look into.
This plan type varies in many ways from a SIMPLE 401(k) plan.
First, employees don’t make contributions to a SEP IRA.
Instead, only the employer makes contributions.
An employer’s contributions are limited to 25% of each employee’s pay.
The actual dollar limitation for this account is much higher than a SIMPLE 401(k). The maximum dollar contribution, subject to the percentage limit, is $58,000.
This allows self-employed business owners to put more money away for themselves.
The downside of these plans is a big one for business owners with employees.
The employer must contribute to each employee’s SEP IRA using the same percentage. If a business owner wants to max out their account using 25%, they must also max out their employee’s accounts.
Self-employed individuals have a different calculation to reach the 25% of pay limit.
Rather than just salary, a self-employed person must calculate their pay as follows.
First, start with your net earnings from self-employment.
Then, deduct one-half of the self-employment tax.
Finally, deduct contributions to your own SEP IRA.
This lowers the contribution limit for yourself versus a regular employee.
A SEP IRA doesn’t require you to fill out an annual reporting form, either.
This reduces the maintenance and overhead of managing a SEP IRA.
Maximizing a SIMPLE 401(k) Plan
Maximizing a SIMPLE 401(k) plan comes down to your employees’ choices.
Once you offer a plan, it’s up to your employees to participate.
If you offer matching employer contributions, your employees should at least contribute up to the match.
This allows them a guaranteed return on their money, thanks to the employer matching contributions.
If an employer opts for the mandatory non-matching contributions option, employees don’t have as much incentive to participate.
Educating employees about the impact of putting money aside for retirement may help.
This is especially true if you can help them understand the impact of time and compounding returns.
Consult an Expert
Finding the perfect retirement plan for your small business is a serious decision.
For this reason, you should consult an expert.
A brokerage firm may be able to help you find the perfect plan for your business’s needs.
They have a vested interest in helping you choose a plan that makes them the most money, though.
Instead, consider consulting a fee-only fiduciary financial planner that works with business owners of your size.
These planners charge you for their services directly and don’t earn commissions.
A suitable planner should be able to help you figure out your personal and business’s financial needs.
Then, they can find the perfect retirement plan for your business.
