The Savings Incentive Match Plan for Employees 401(k), otherwise called a SIMPLE 401(k), is a simplified version of a traditional 401(k). SIMPLE plans were created so that small businesses could have a cost-efficient way to offer a retirement account to their employees.
SIMPLE 401(k) plans do not require annual nondiscrimination tests, which ensure that a plan is in line with IRS rules. This type of testing usually has to be done by professionals, which can be prohibitively expensive for small employers, preventing them from using other types of 401(k)s.
A SIMPLE 401(k)s retirement plan is available to businesses with 100 or fewer employees including sole proprietorships, partnerships, and corporations. It’s also one of a number of retirement options for the self-employed. For small business owners or self-employed individuals, understanding how SIMPLE plans work can help decide whether it makes sense to set one up.
For employees whose employer already offers a SIMPLE 401(k), getting to know the ins and outs of the plan can help to understand the role they play in saving for retirement.
How Does a SIMPLE 401(k) Work?
A SIMPLE 401(k) functions much like a regular 401(k). Employees contribute pre-tax money directly from their paycheck and invest that money in a handful of options offered by the plan administrator.
In 2022, the SIMPLE 401(k) limits are as follows: The maximum for employee elective deferrals is $14,000 ($13,500 in 2021); employees 50 and older could make an additional “catch-up” contribution of $3,000 to boost their savings as they neared retirement.
One significant difference between traditional 401(k) plans and SIMPLE 401(k) plans is that while employer contributions are optional with a 401(k) plan, under a SIMPLE 401(k) plan they are mandatory and clearly defined. Employers must make either a matching contribution of up to 3% of each employee’s pay or make a nonelective contribution (independent of any employee contributions) of 2% of each eligible employee’s pay. The contribution must be the same for all plan participants: For example, an employer couldn’t offer himself a 3% match while offering his employees a 2% nonelective contribution.
There are other limits on how much an employer can contribute. The maximum compensation that could be used to figure out employer contributions and benefits is $305,000 for 2022 ($290,000 for 2021). So if an employer offered a 2% nonelective contribution and an employee made $355,000 a year, the maximum contribution the employer could make would be 2% of $305,000, or $6,100.
As with a regular 401(k), contributions to a SIMPLE plan grow tax-deferred—meaning an employee contributes pre-tax dollars to their plan, and doesn’t pay income tax on that money until they withdraw funds upon retirement. Typically, the tax-deferred growth means that there is more money subject to compounding interest, the returns investments earn on their returns.
Withdrawals made before or during retirement are subject to income tax.
Who Is Eligible for a SIMPLE 401(k)?
To be eligible for a SIMPLE 401(k), employers must have 100 or fewer employees. They cannot already offer these employees another retirement plan, and must offer the plan to all employees 21 years and older.
Employers must also file Form 5500 every year if they establish a plan.
For employees to be eligible, they must have received at least $5,000 in compensation from their employer in the previous calendar year. Employers cannot require that employees complete more than one year of service to qualify for the SIMPLE plan.
What Are the Pros of a SIMPLE 401(k) Plan?
SIMPLE 401(k)s offer a number of benefits that make them attractive to employers and employees.
• Simplified rules: While large companies may have the money and staff to devote to nondiscrimination testing, smaller companies may not have the same resources. SIMPLE 401(k) do not have these compliance rules, making them more accessible for small employers. What’s more, the straightforward benefit formula is easy for employers to administer.
• “Free money”: Employees are guaranteed employer contributions to their retirement account, whether via 3% matching contributions or 2% nonelective contributions.
• Fully-vested contributions: All contributions—those made by employees and their employers—are fully vested immediately. Employees who qualify for distributions can take money out whenever they need it. While this can be good news for employees, for employers it removes the option to incentivize workers to stay in their job longer by having their contributions vest several years into their tenure with the company.
• Loans and hardship withdrawals: While withdrawals made before age 59 1/2 are subject to tax and a possible 10% early withdrawal penalty, employees can take out loans against their SIMPLE 401(k) just as they can with a traditional 401(k). These options add flexibility for individuals who need money in an emergency. It’s important to note that 401(k) loans come with strict rules for paying them back. Failing to follow these rules may result in stiff penalties.
What Are the Cons of a SIMPLE 401(k) Plan?
While there are plenty of positives that come from offering or contributing to a SIMPLE 401(k), there are also some important downsides.
• Plan limitations: Employers cannot offer employees covered by a SIMPLE 401(k) another retirement plan. So employees and self-employed individuals who want to have both a 401(k) and a personal IRA may be limited by this type of plan.
• Lower contribution limits: For 2022, a traditional 401(k) plan allows for $20,500 annual maximum 401(k) contributions from employees, with an additional $6,500 catch-up contribution for those 50 and older. These contribution limits are considerably higher than SIMPLE plan limits, which are $14,000 with an additional “catch-up” contribution of $3,000 for employees over age 50. This means an employee could contribute an additional $6,500 in elective deferrals and $3,500 in catch-up contributions with a traditional 401(k).
• Limited size: SIMPLE Plans are only available to employers with fewer than 100 employees. That means if a business grows beyond that point, they have a two-year grace period to switch from their SIMPLE plan to another option.
SIMPLE 401(k) vs. SIMPLE IRA
Generally speaking, when comparing SIMPLE IRAs and 401(k)s, the rules are similar:
• They’re only available to businesses with 100 or fewer employees.
• Employers must either offer a 3% matching contribution or a 2% nonelective contribution.
• Employers can only make nonelective contributions on up to $305,000 in employee compensation.
• Employee contribution limits to SIMPLE IRAs are the same as their 401(k) counterparts.
• Employer and employee contributions are fully vested immediately.
There are a few differences worth mentioning:
• Whereas all employer contributions are subject to the cap for SIMPLE 401(k)s, only nonelective contributions are subject to the $305,000 compensation cap for SIMPLE IRAs. (This makes it possible that employees making more than $305,000 annually may receive higher matching contributions from a SIMPLE IRA than they would from a SIMPLE 401(k).)
• If employers make matching contributions of 3%, they may elect to limit their contribution to no less than 1% for two out of every five years.
• SIMPLE IRAs do not allow employees to take out loans from their account for any reason.
• There are no minimum age requirements for SIMPLE IRA contributions.
SIMPLE 401(k) plans can be especially attractive for self-employed individuals or small business owners, as they have many of the same benefits of a traditional 401(k) plan—including tax-deferred contributions and loan options—but without the administrative compliance costs that come with a regular 401(k) plan.
Some of the requirements and rules associated with a SIMPLE 401(k) plan might be unattractive to some employers, however, including the fact that the IRS prohibits employers from offering other types of retirement plans to employees who are covered by a SIMPLE 401(k).
There are many answers to the question of which retirement savings plan is right for you or your business. Beyond traditional 401(k) and SIMPLE (401)k plans, there are traditional, Roth, SIMPLE and SEP IRAs, among other options.
When it comes to setting retirement goals and learning about the best ways to meet them, SoFi Invest® can help. SoFi offers Roth or traditional IRAs, as well as a broad range of investment options, member services, and a robust suite of planning and investment tools
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