What is a SIMPLE 401k Plan?

Having a solid retirement plan is an important step in retirement preparedness. A retirement plan can help you save for your future needs. Moreover, retirement saving accounts are considered a lot safer than other forms of investments like trading in the stock market or investing in real estate and can offer you a steady rate of growth over the years. There are a number of retirement plans that you can choose from depending on your income, future goals, liabilities, family needs, and personal preferences. The nature of your job can also impact your choice. Some common retirement saving accounts include a traditional 401k, a Roth 401k, a traditional IRA (Individual Retirement Account), Roth IRA, etc.

401ks are fundamentally employer-sponsored plans, while an IRA is something you can open and start investing in on your own. There are no employer contributions in an IRA. IRAs and 401ks are further divided into retirement saving accounts such as Solo 401(k), Safe Harbor 401(k), 403(b), etc. One such type is the SIMPLE 401k retirement account.

Understanding retirement accounts is not only crucial for employees who save in these instruments for their later years, but also for employers. As an employer, the retirement account you offer your employees can greatly impact your finances, your business’s credibility, and your employees’ motivation to work.

SIMPLE 401ks can be a great fit for small business owners. Read on to know everything there is about a 401k SIMPLE account:

What is a SIMPLE 401k account?

The life of small business owners can be full of challenges. The hassles of running a business with little manpower and limited funds and means can be a challenging task. To top this, the earnings are not always stable. While you may make a fortune one month, the next few could bring in a lull. However, no matter the scale of your business, it is important to offer your employees incentives and other benefits that can help them excel in their life and save for their future.

401k SIMPLE accounts are the perfect retirement savings options that small business owners can offer their employees. Short for Savings Incentive Match Plan for Employees, a SIMPLE 401k can be most easily described as a blend of a SIMPLE IRA and a traditional 401(k) plan. The SIMPLE 401k plan works in a similar manner as the traditional 401k but specifically caters to the needs of small enterprises that may not have as many funds and employees as bigger corporations. If you have further questions or clarifications on the most suitable retirement account for your employees, consider consulting a financial advisor for guidance.

How does the SIMPLE 401k plan work?

A SIMPLE 401k plan works exactly like a traditional 401k plan. Employees can defer a part of their salaries towards the retirement account and save for the future. The plan administrator provides fund options that the employees can choose from and invest their pre-tax dollars from their paychecks into. The distributions are taxed on withdrawal. Similar to other retirement accounts, the SIMPLE 401k also has contribution limits that are set by the Internal Revenue Services every year. For 2021, the contribution limit is $13,500 per year. There is also an additional contribution limit of $3,000 per year for people aged 50 or above. The employer contribution limit has been capped at $290,000 for 2021. This has been increased in 2021 from the previous limit of $285,000 for 2020.

As an employer, you can make a matching contribution to the account up to 3% of the employee’s salary. You can also make a non-elective contribution of up to 2% of the employee’s salary if the employee does not contribute to the plan themselves. So, the total contribution cannot be more than 3% of $290,000, which is $8,700, or 2% of $290,000 in the case of non-elective contributions, which is $5,800.

Who can use a SIMPLE 401k account?

A SIMPLE 401k account can only be used by small business owners, provided they meet the conditions mentioned below:

You must have a maximum of 100 employees or less.
Your company’s employees should have no other retirement plans like an IRA, etc.
All employees must be at least 21 years old.
All employees should have completed at least a year with the company and clocked in at least 1,000 hours.
All employees should have received at least $5,000 in compensation for the previous year.
The company must file Form 5500 every year.
In the case of any former employees who have remaining balances in the plan, the company also has to file Form 8955-SSA.

In addition to this, you can only set up a SIMPLE 401(k) account between January 1 and October 1.

What are the withdrawal rules for a SIMPLE 401k account?

The withdrawal rules of a SIMPLE 401k plan are similar to a traditional 401k account. Employees can only withdraw their funds after the age of 59.5. Any withdrawals before this age will result in a 10% penalty.

What are the pros and cons of setting up a SIMPLE 401k account?

A SIMPLE 401k can offer many benefits along with some drawbacks, as mentioned below:

Pros of having a SIMPLE 401k retirement account

Ideal for small businesses: A SIMPLE 401k retirement account is a suitable option for small businesses as they result in fewer costs. Large retirement plans can be hard to afford for small companies. Not providing a retirement plan at all can also result in dissatisfaction among employees and impact their productivity. SIMPLE 401ks offer a way out with lower costs and no compliance rules.
100% vested contributions: The contributions made towards a SIMPLE 401k are 100% vested immediately. This implies that the employee has complete ownership of the account and the funds in it from the moment the contribution is made. This offers more financial security to employees when they quit their job or shift between companies. The employer cannot withdraw or take out their contribution at any time.
Catch up contributions: Similar to a traditional 401k and IRA, SIMPLE 401ks also have a catch up contribution limit for people over 50. This allows people nearing retirement to invest more and save a bigger corpus for their golden years in a short span of time.
Loans facility: An employee can apply for a loan against the SIMPLE 401k. This can be extremely helpful in the case of a financial emergency. It helps employees stay afloat during unprecedented times and eliminates the need for high-interest loans.

Cons of having a SIMPLE 401k retirement account

Cannot be clubbed with another retirement account: You cannot offer any other retirement account to your employees along with a SIMPLE 401k retirement account. This also includes IRAs.
Low contribution limits: When compared to a traditional 401k retirement account, the contribution limits for a SIMPLE 401k are quite low. For the year 2021, the contribution limit for a traditional 401k has been set as $19,500. This is $6,000 more than $13,500 for SIMPLE 401ks. In five years alone, this could add up to a difference of $30,000 and over a long term of 15 years, this would be $90,000. This can severely impact the savings rate of employees working at smaller companies.
Strict rules: The rules and regulations to set up a SIMPLE 401k plan are stringent and rigid. If you have even one more employee than 100, you will not be able to set up this account. If the employees have not completed a year or earned less than $5,000 in the previous year, they will not qualify to invest in the account. This can create hassles and dissatisfaction among different employees.
Less control for the company: The 100% vested contributions are a boon to the employee but can create some issues for the employer. The employer loses control over their money instantly. Most other retirement accounts have a fixed vesting period of a few years. For example, a traditional 401k retirement account can have a vesting period of up to 6 years.
Cannot be used for short service employees: The SIMPLE 401k plan can only be used by long service employees who have been working with the company for at least a year and worked a minimum of 1,000 hours in a year. This does not include short service employees, interns, etc.

What other options can you choose apart from a SIMPLE 401K?

There are some other options that offer similar or better benefits than a SIMPLE 401k account, such as:

SIMPLE IRA: A SIMPLE IRA is a good alternative to a SIMPLE 401k plan. It is a tax-deferred account with no age limit to join the plan. Moreover, the account can be used by employers as well as self-employed individuals. It does have some similarities to the SIMPLE 401k plan. So, you cannot have more than 100 employees in your company or offer it to an employee who has not received at least $5,000 in compensation in the previous year. The contribution limit for the SIMPLE IRA is also the same as a SIMPLE 401k for 2021. However, employer contributions are not 100% vested.
SEP IRA: The Simplified Employee Pension IRA account can be used by sole proprietors, business partners, as well as self-employed individuals. The SEP IRA can be used with other retirement accounts too. So if an individual has a 401k retirement account from another employer and is working part-time at another venture, they can use the SEP IRA along with the 401k to save for their future needs. There are no strict rules about the number of employees in a company or the minimum age of employees to set up the account. Moreover, the employer may or may not make matching contributions to the account. Self-employed individuals can contribute up to 25% of their net earnings from self-employment or up to $58,000 in 2021.
Regardless of which option you choose, it is important for small businesses to offer their employees a solid retirement plan that can help them prepare for their golden years. Setting up a retirement account also helps lower your attrition rate and increase the retention rate. It can help keep your employees motivated and develop a sense of loyalty towards your company.

To summarize

Retirement planning is an important part of any working individual’s life and retirement accounts like a SIMPLE 401k plan can help employees build their savings. They are a good option for small business owners and offer similar benefits as traditional 401ks. But, they can present certain limitations for both the employer as well as the employee. So, if you are concerned about their drawbacks, you can consider other options like the SEP or SIMPLE IRA. If you are not sure about the best option, you can also consult a professional financial advisor and get their expert opinion on the matter.