The naming schemes thrown around in the world of retirement plans can mislead even the savviest of business owners. How can you tell which one is actually the best? The first and correct answer to that question is always “it depends.” There is no one-size-fits-all retirement plan, and a blend of plans may be the best approach. But when you have to pick one or the other, don’t always opt for the simplest method. Get guidance and find a solution that goes deeper than the name.
Let’s take the SIMPLE IRA and the 401(k). The 401(k) has become one of the most popular retirement investment plans available and is synonymous with employee contribution plans across a multitude of American companies. But it has developed a reputation for being expensive and hard to manage, especially for small- to medium-sized companies. This is largely in comparison to plans like the SIMPLE IRA, which I find can keep costs down for small business owners by lowering contribution limits and administrative fees for employers with less than 100 employees. This can give the employer a vehicle for providing retirement savings in a cost-efficient manner that doesn’t cut heavily into their bottom line.
But lowering costs is just one part of business, and opting into the SIMPLE IRA plan could restrict many of the options a 401(k) provides. For example, even though the SIMPLE IRA can be used for a smaller number of employees, an employer has much less control over which of those employees can opt into the plan. According to the IRS, employees who have received (and are expected to receive this year) $5,000 or more in compensation from an employer for any previous two years can participate. A 401(k) can be much more selective in the age of an employee (over 21) and the length of service (one year). So even if the 401(k) may come with extra costs for the business owner, the flexibility it provides to focus on vested, higher-earning employees may provide significant value to the company. Additionally, the high employee contribution limits of $18,500 for 2018 or $19,000 for 2019 in a 401(k) may also be a plus, with extra profit-sharing options available to a 401(k) plan in addition to the employer match option that could allow the total contribution to rise much higher than what is possible under a SIMPLE IRA. In a SIMPLE IRA, workers younger than 50 have a $12,500 maximum contribution. Those 50 or older can get a $3,000 catch-up contribution, making the overall maximum $15,500. In 2019, the maximum is $16,000. Managing the benefits of 401(k) contribution options is what could allow a business owner to make the higher limits work on their behalf.
This may take pressure off of a business owner and could allow that money to be funneled back into the business and other retirement plans. An additional benefit in a 401(k) is a loan provision, so the money deferred in the retirement accounts of owners could be leveraged for additional lines of capital to grow a company or provide financial relief. This would be impossible under the SIMPLE IRA plan, which provides no such provisions.
So, what really makes a SIMPLE IRA simple? In essence, my experience is that it’s easy to set up and inexpensive to operate. Yet many business owners that opt into this type of retirement plan could find themselves with much less flexibility in employer contributions, fewer features and lower contribution limits than some other retirement plans, like the 401(k). Employers that spend the time to set up a 401(k) plan along with complementary retirement plans, such as a cash balance plan or a 401(h), can often increase their ability to fund their retirement.
You’re probably still asking, “But is the 401(k) really the best plan?” The answer hasn’t changed: It depends. It makes sense to review your current plan and really look to see what will give you the best tax advantage.
Some key preliminary questions to ask when trying to decide which plan is better for your company are:
• What are the company’s primary goals for establishing the plan?
• How much do the owners plan to contribute to the plan?
• What administration costs are you able and willing to pay?
• Do you require a loan provision in the plan?
Every company’s employee demographics are different, so once you have these basic questions answered, you can begin to determine the right plan for your employees.