SIMPLE 401(k) Plans: All You Need to Know

SIMPLE 401(k)s, or Savings Incentive Match Plan for Employees, are a type of employer-sponsored 401(k) plan designed for small brands with less than 100 workers. It provides a low-cost alternative for companies with less than 100 workers to provide a qualified retirement plan to workers earning at least $5,000 in the prior calendar year.

Workers’ payments to a SIMPLE 401(k) plan grow tax-deferred and are completely vested, making it a great way to save money for retirement. When it comes to retirement savings, a SIMPLE 401(k) plan provides workers with an option that is on par with that provided by larger companies.

A SIMPLE 401(k) plan, while different from a traditional 401(k) in a few ways, nonetheless provides retirement savings tax benefits. Thus, a  Simplified Employee Pension Plan or SIMPLE 401(k) may be an excellent retirement savings vehicle for workers of small brands.

Read this article to gain an understanding of the concept of a SIMPLE 401(k), how it operates, and the numerous pros and cons) of this form of retirement plan.

What is a SIMPLE 401(k)?

To help small brands save money, the Internal Revenue Service created the Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plan option for small brands with 100 or fewer workers. 

Employer payments to the plans are capped at 3% of pay for matching payments or 2% for non-elective payments for all qualified workers. A SIMPLE 401(k) plan is a type of retirement account that only allows worker payments.

To increase one’s retirement savings, it is highly recommended that one make use of workplace payments. In addition, employers who participate in SIMPLE 401(k) plans are obligated to provide safe harbor payments, which are 100% vested regardless of whether or not the worker participates in the plan.

With a SIMPLE 401(k), workers can deduct their payments from their paychecks and not pay taxes on them until they take the money in retirement. Withdrawals can commence at age 59 ½, similar to a traditional 401(k) plan, and may be liable to a 10% penalty in addition to income taxes.

The main difference from a traditional 401(k) is that the employer is obligated to match worker payments. Successful brands that have expanded to hire over 100 individuals have two years to file their taxes. You have 2 years from the time your brand enrolls in a SIMPLE 401(k) to convert to a traditional 401(k) if your workforce raises from 85 to 115 people.

How Does a SIMPLE 401(k) Plan Work?

SIMPLE 401(k)s are similar in function to traditional 401(k)s. Direct payroll deductions from workers’ paychecks allow them to invest their pre-tax dollars in any of a small number of options provided by the plan’s administrator.

Maximum payments to a SIMPLE 401(k) plan in 2022 are as follows: Workers can contribute up to $14,000 ($13,500 in 2021) in voluntary deferrals; those who are 50 or older can contribute an extra “catch-up” contribution of $3,000.

Employer payments are not required under a SIMPLE 401(k) plan, but they are under a traditional 401(k) plan, which is a major distinction between the two. Either 2% of each qualifying worker’s pay (as a nonelective payment in addition to any worker payments) or a matching contribution of up to 3% of pay is required of employers. 

For the contribution to be tax-deductible, it must be uniform for all plan members. A company cannot offer a 3% match to its owners and managers while providing a 2% nonelective contribution to its workers.

The maximum amount an employer can put in is capped, among other things. For purposes of calculating employer payments and benefits, the maximum salary that can be used is $305,000 in 2022 ($290,000 in 2021). In this case, the highest contribution an employer may give would be 2% of $305,000, or $6,100, based on a worker’s annual salary of $355,000.

SIMPLE 401(k) vs. SIMPLE IRA: What’s the Difference?

Contributions to a SIMPLE 401(k) or SIMPLE IRA are made on a pre-tax basis, like those made to traditional 401(k)s and IRAs, respectively. Furthermore, both options are restricted to workers at small brands.

With a SIMPLE IRA, employers can restrict their matching payments to between 1 and 3 percent. In addition, unlike SIMPLE 401(k)s, participants in SIMPLE IRAs are not eligible to take out loans.

Furthermore, for 2 out of every 5 years, an employer who provides SIMPLE IRAs and chooses to make matching payments might choose to reduce the sum to under 3%, but not below 1%. The SIMPLE 401(k) plan lacks this flexibility. Lastly, a SIMPLE IRA does not necessitate the filing of IRS Form 5500 each year.

SIMPLE 401(k) Plan: Pros and Cons

A SIMPLE 401(k) plan may be an option for small brands with fewer than 100 workers who want to provide retirement savings opportunities to their workers. You might get some clarity by weighing the primary benefits and drawbacks.

 Pros

• The SIMPLE 401(k) plan gives workers instant, 100% vesting on their payments. That means that the annual payments made by workers are entirely theirs to keep. So even if they frequently switch jobs, they won’t have to worry about losing any of their investments.

• Loans against SIMPLE 401(k) accounts are accessible to workers. If a worker needs a quick infusion of cash, they can borrow from their SIMPLE 401(k) plan provided that they have the commitment to repay the loan in accordance with the plan’s repayment rules. Their failure to timely repay the loan could result in taxation and penalty fees.

• The tax benefits of a SIMPLE 401(k) plan are substantial. The employer’s payments are deductible, and the worker’s payments and earnings are tax-deferred until distribution, providing a double tax break.

•  Employers can increase their chances of retaining valuable workers. Workers can still put money away for retirement even if they work for a small brand thanks to payroll deductions. In addition to making it simpler to hire and retain staff, this strategy can increase the likelihood that those hired will remain with the company.

 Cons

• Mandatory employer payments have been implemented. Each eligible worker in a SIMPLE 401(k) plan must receive either a 2% non-elective contribution from their employer or a dollar-for-dollar match of worker payments up to 3% of compensation, whichever is greater. For a brand owner, this may be devastating financially.

• Worker payments have modest limits. In 2022, the limit for worker payments to a SIMPLE 401(k) will be $14,000, with a $3,000 catch-up limit for those over age 50.

• The company is not allowed to provide any other retirement options. A SIMPLE 401(k) plan and another retirement plan cannot be offered to the same group of workers by the same company without violating IRS rules.

Who Can Qualify for a SIMPLE 401(k) Plan?

SIMPLE 401(k) plans are accessible to brands with 100 or fewer workers. All workers over the age of 21 must be offered participation in the plan, and the company cannot provide these workers with another retirement option. If an employer sets up a plan, they must submit Form 5500 annually.

Workers qualify if they made at least $5,000 in the prior calendar year from all sources combined (including bonuses). In order to participate in a SIMPLE plan, workers must have worked for the company for at least a year.

Is SIMPLE 401(k) Worth It?

In order to reduce worker turnover and increase retention, it is important to provide them with adequate support. Your workers can benefit from retirement plans, such as SIMPLE 401(k) plans, while they are still employed by your company.

Even while there are many positive aspects to SIMPLE 401(k) plans, such as flexible rules and the flexibility to borrow money, not all brands should adopt them. Your options could be constrained by their scarcity and the low donation caps.

Final Thoughts

Self-employed people and brand owners may find the Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plan especially appealing because it offers a number of the same perks as a traditional 401(k) plan, such as tax-deferred payments as well as loan alternatives, but with the absence of administrative compliance charges.

Some firms may be put off by the limitations and regulations that come with a SIMPLE 401(k) plan, such as the fact that the IRS forbids them from providing their workers with access to any other retirement plans.

Depending on your necessities and those of your brand, you can choose a suitable retirement savings plan from among the many accessible. You and your workers are not limited to the 401(k) and SIMPLE 401(k) plans for saving for retirement.