A Reader Asks #10: SIMPLE IRA vs. 401(k)

Here is the other reader question I have been a bit slow to answer.

What are the advantages and disadvantages of offering a 401(k) vs. a SIMPLE IRA plan to employees of a company with 15 employees?

I am going to answer your question from the employee perspective since I believe that is what you are asking. Perhaps the biggest difference to an employee between a 401(k) and a SIMPLE IRA is the maximum contribution and catch up provisions. In 2007, a 401(k) has a maximum employee contribution of $15,500 with a $5000 catch up provision for employees age 50 and older. A SIMPLE maxes out at $10,500 with a $2500 catch up provision.

The other big difference for an employee has to do with premature distributions. In a 401(k), withdrawals taken prior to age 59 ½ will generally be subject to a 10% tax penalty. If the same premature withdrawal were taken from a SIMPLE and the account is less than two years old, then the tax penalty is a whopping 25%. This higher penalty restricts rollovers and transfers within the first two years so the employee may find a SIMPLE more restrictive than other types of retirement plans.

I find it interesting that you specifically asked about the employee differences. Most of the time, the employee does not get a choice. They are limited to the plan their employer selects so most of the time we look at the differences from an employer perspective. Since the SIMPLE plan is only available to employers with fewer than 100 employees, most of the time the employer who is considering a SIMPLE plan is also an employee. Often the selection is made solely on the employers desire to defer more than the maximum allowable in the SIMPLE.

But an employer also has two other big differences to consider. The 401(k) is a form of a profit sharing plan. There may be a backlash from the employees if this was to happen, but the employer is not required to contribute on behalf of the employee. A SIMPLE plan requires employer contributions. The only choice the employer gets is a selection between making a 2% non-elective contribution for every employee and matching the employee's contributions up to 3%.

However, most employers tend to focus on the administrative costs. A 401(k) has both testing and reporting requirements which must be met and maintained. Unless this is the employer's area of expertise they will probably need to pay someone to administer the plan. For a 15 employee company, this cost will generally run a couple of thousand dollars a year.

Related reading:

• SIMPLE IRA Plan (official IRS website)
• SIMPLE IRA Plan
• For Entrepreneurs A SIMPLE IRA May Be Best
• The Different Types of IRA's
• What is a SIMPLE IRA?

mail by chona kasinger

Comments

[Carl Lingen]

Art,

Thank you for this great post. I appreciate you answering from an employer and employee perspective. Every business who is looking to put in a retirement plan should read this post.

Things have been quite busy with brining on 8 clients for the first of the year. Hope to see you at the Central Iowa Bloggers meeting.

Carl

[Art Dinkin]

Carl,

Thanks for the comment as well as the link from your blog! Have not seen you in a while and that is my fault. We are in our new building and I would love to show you around!