Offering your employees benefits that really make an important difference, such as saving for retirement really matters to them. Offering the right type of retirement plan can also benefit you as an owner or key stakeholder, in terms of the loyalty that it creates. When considering retirement plans, surprisingly, SIMPLE IRA plans get very little attention versus the traditional 401(k). In this article, I want to bring up some key pros and cons about how the plan works, and hopefully, encourage you to consider it as an option to help build wealth more simply and/or through a SIMPLE IRA!
First, the SIMPLE IRA is intended for businesses that have fewer than 100 employees and that have earned $5,000 or more during the preceding year. Businesses that have fewer than 100 employees make up 98.2% of most businesses across the United States, as published in the 2016 Census Bureau ASE report. It may not make sense for all small businesses, but I’d contend that it makes sense for many. Particularly, small businesses which may be younger and are concerned with the complexities of a traditional 401(k). That being said, SIMPLE IRA plans are easier to set up and run than other plans that require more details and oversight. In terms of affordability, SIMPLE IRA’s have lower administrative costs than a 401(k).
The second feature that I really like is the control that a business and employees can have. Your business has two options for matching, which provides great flexibility to a business. You can choose to match contributions or contribute a fixed percentage of each eligible employee’s pay. Matching a fixed percentage is pretty hard lined, but has some flexibility when administered properly. Matching can be attractive to employees when a business wishes to reward them by matching dollar for dollar up to 3% of compensation. Employers can also reduce the matching in certain circumstances to as low as 1% in any 2 out of 5 years. In terms of non-elective employer contribution, an employer can contribute 2% for each eligible employee’s compensation, which is subject to cost-of-living adjustments.
The third feature that stands out to me is the control or availability of investments. The SIMPLE IRA has employees share in the responsibility for their retirement savings, which can allow for control of the investments that can be used. This feature versus how a traditional 401(k) works is pretty unique, in that in a 401(k), participants are limited to the investments that have been determined by the plan sponsor, unless there is a Self Directed Brokerage Account feature, which is generally available to large businesses by design. The SIMPLE IRA allows employees to invest in the investments they choose and control as well as they are fully responsible for the investment selection.
Your business may be eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of implementing a SIMPLE IRA which is the fourth feature that is appealing. I, personally, love credits versus deductions as they can be more effective to your bottom line. As I mentioned, the start up costs are far lower than those of a 401(k). The set up fee for a 401(k) can be as high as $1,500 and doesn’t include the cost to maintain and administer the plan on a monthly basis. The cost for setting up a SIMPLE IRA may be as low as zero dollars up to possibly a few hundred dollars from an administrative perspective.
While there are plenty of great features that make the SIMPLE IRA very practical, there are a few cons that should be noted. The first potential disadvantage is the lower contribution limits than some of the other qualified plans available. For example, in 2020 the max contribution is $13,500 versus the $19,500 in a traditional 401(k). Keep this in mind, for a small business this amount might be practical and far greater than what someone can stash away into a Traditional IRA and no employer matching. A practical example is it is common for most to save a percentage of their income, and with larger employer groups, they might save 6%. If a person is earning $100,000 per year, their 401(k) contribution would be the same as if they were contributing into a SIMPLE IRA. Similarly, an employee who is over 50 would still be allowed to contribute “Catch-up” contributions of $5,000.
Another potential disadvantage to consider is that there is still oversight that must be adhered to, such as the time of the contributions, which generally must be funded by the close of the business calendar year. Also, a small business must present disclosure documents that inform participants about how the plan operates and notifications of changes in the plan’s structure. This is intended to provide employees with an opportunity to make decisions and timely actions to take with regards to their accounts. It is not too different from what a traditional 401(k) is required to do.
There is a lot of hype over 401(k)’s which can be intimidating to a small business. With the start up costs, the administration of the plan and all the service providers involved to manage the retirement plan, it’s understandable. It is not uncommon for a small business to become overwhelmed and delay opting in for a retirement plan. This is a huge burden that both the business owners and employees face, in terms of ability to start saving for retirement. Given the fact that most people cannot rely on Social Security, having a retirement plan as soon as possible helps acculiate a larger asset base.
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