The best retirement plan for small businesses: SIMPLE IRA or 401(k)?

Luke Milholland CFP®,ChFC®,CLU®

So you are trying to decide which type of retirement plan to offer your employees, but aren’t sure where to begin? Then you are in the right place! 

While there are a handful of different retirement plans a business can offer, there are two main options to consider. One is called a SIMPLE IRA and the other is a 401(k). The one major exception is if you have no employees, or just have a few that you want to be very generous with. In that event, you could also consider a SEP IRA. Assuming that’s not the case, however, then you can narrow your decision-making to either a SIMPLE IRA or 401(k) plan. 

The SIMPLE in SIMPLE IRA stands for Savings Incentive Match Plan for Employees. IRA stands for Individual Retirement Plan. With these plans, the accounts are opened and owned directly in the employee's name and the company just sends off matching dollars to the employee's account for their portion. 

As far as 401(k)s go, many small businesses elect what is called a Safe Harbor provision which simplifies the plan features as well as the compliance obligations. Some of the allure of a 401k is the ability to get creative with company matching and vesting schedules, but to take advantage of some of these more unique and custom features a company has to subject itself to certain annual testing to ensure it isn’t unfairly favoring the highly compensated. For example, a company could offer an abnormally high match (i.e. 15%) and then put a vesting schedule in place where an employee has to stick around for a certain number of years (i.e. 3 years) to receive the company match. This is doable but the company will have to pass certain tests each year. With a Safe Harbor plan you give up some of the customization to have a simpler plan with less compliance testing.

Here's a side-by-side comparison of a Simple IRA and a Safe Harbor 401(k) plan for small businesses:

In summary, a Simple IRA may be more suitable for small businesses looking for a straightforward retirement plan with lower administrative costs and a simpler setup. On the other hand, a 401(k) plan offers higher contribution limits and greater flexibility (especially with a non-safe harbor plan design), making it preferable for businesses with larger budgets and more complex needs. Ultimately, the choice depends on the specific needs, resources, and preferences of the small business owner. 

If you need help deciding which plan is right for your company, feel free to schedule a free, no-obligation consultation and we’d be happy to help you explore your options.


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