There tends to be a lot said about SIMPLE IRAs, profit-sharing plans and the SBO-401(k). But not much attention is given to the SIMPLE 401(k) plan. When it is mentioned, the question usually is why would one choose a SIMPLE 401(k) instead of a SIMPLE IRA or regular 401(k) plan? The fact is, the SIMPLE 401(k) plan is a cross between a SIMPLE IRA and traditional 401(k) plan and offers some features of both plans.
Here we review some of the features and benefits of the SIMPLE 401(k) plan and compare it to the traditional 401(k) plan.
SIMPLE 401(k) Advantages
- No Testing – An employer that adopts a traditional 401(k) plan may be required to perform certain non-discrimination and top-heavy testing to ensure that the plan operates in compliance with IRS rules. Generally, such testing must be done by professionals who specialize in that area and can be quite costly. SIMPLE 401(k) plans, on the other hand, do not require these tests. This can be very appealing to a small business owner who likes the features of the 401(k), but can't afford the administration costs of testing.
- Loans Allowed – Loans can be an attractive feature of a qualified plan because employees and business owners usually like the idea of being able to borrow their own funds and make loan and interest payments to their own accounts. The loan feature can be made available in both SIMPLE and traditional 401(k) plans.
- Immediate Vesting of Contributions (For the Employee) – With a traditional 401(k), employer contributions can be subject to a vesting schedule that makes employees wait a specified number of years before they receive them. By contrast, contributions to a SIMPLE 401(k) are immediately 100% vested according to IRS rules; an employee who meets the requirements to receive distributions from the plan may withdraw their entire account balance whenever they like and won't lose it if they switch jobs after the money is in their account.
SIMPLE 401(k) Eligibility Requirements
- Employer – The SIMPLE 401(k) is available to those same employers who are eligible to adopt a traditional 401(k) plan: this includes sole proprietors, partnerships and corporations. However, while there is no restriction on the number of employees for the traditional 401(k) plan, only employers who adhere to the 100-employee limit can adopt a SIMPLE 401(k) plan. Under the 100-employee limitation rule, a SIMPLE may be established by an employer that had no more than 100 employees who received at least $5,000 in compensation for the preceding year.
- Employee – Employees who are at least 21 years old and have completed at least one year of service must be allowed to participate in the SIMPLE 401(k) plan.
SIMPLE 401(k) Disadvantages
- Immediate Vesting of Contributions (For the Employer) – The fact that that an employee who meets the requirements to receive distributions from the plan can withdraw their entire account balance at any time is not beneficial to employers. The vesting schedule of a traditional 401(k) plan may help to reduce high employee turnover by making employees wait a specified period of years to partially or completely vest in employer contributions.
- Availability – SIMPLE 401(k) plans are only available to small companies (eligible employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the previous year. Note that IRS rules prohibit a company from offering other types of retirement plans to employees already covered by a SIMPLE 401(k). That said, such companies may choose to maintain a separate retirement plan for other groups of employees not covered by the SIMPLE 401(k).
- Contribution Limits are Lower – Employee contribution limits for a SIMPLE 401(k) plan are lower than the limits for the traditional 401(k) plan. The salary deferral limits of both plans for 2019 are $13,000 and $19,000, respectively (both up $500 from 2018). The SIMPLE catch-up contribution limit is $3,000, or half of the 401(k) catch-up amount permitted for savers age 50 or older (both unchanged from 2018). According to the IRS, employers must make either a matching contribution of up to 3% of each employee's pay or a non-elective contribution of 2% of each eligible employee's pay.
SIMPLE 401(k) Annual Notice Requirements
The employer must provide a deferral notice to each eligible employee for the year the plan is established and for each year the employer continues to maintain the plan. Generally, the notification must be provided at least 60 days before the employee would be eligible to participate in the plan. This notification must include a statement of the employee's right to make salary-deferral contributions to the plan and to terminate their participation in the plan.
An employer is required to provide employees with an explanation of the plan's features and benefits prior to the effective date of the traditional 401(k) plan.
Deadline to Establish SIMPLE 401(k)
A SIMPLE 401(k) must be established between January 1 and October 1. An exception applies to businesses that come into existence after Oct. 1. For these businesses, the plan can be established as soon as administratively feasible.
The Bottom Line
We've reviewed just some of the highlights of the SIMPLE 401(k) plan. As you can see, SIMPLE 401(k) vehicles offer some attractive features, in that they don't require testing but do allow loans. However, they do have some disadvantages when compared with other plans.
If you think the SIMPLE 401(k) might be suitable for your business, be sure to consider the pros and cons. More detailed information can be obtained from your 401(k) plan provider and your tax professional.