401(k) vs. SIMPLE: Is it Really That Simple?
by Ken Morris
The Savings and Incentive Match Plan for Employers, or "SIMPLE"
plan, is similar to a standard 401(k) plan in that it allows for
the deposit of employee elective salary deferrals and employer
contributions into an account that grows on a tax deferred basis
until withdrawn; but, the SIMPLE has fewer administrative
requirements than the 401(k) plan.
This article will focus on two important topics relative to
SIMPLE plans; the mechanics of how the plans are established and
a few of the many considerations involved in comparing the
SIMPLE to a standard 401(k) plan.
With regard to the mechanics of the plan, an employer has two
options for implementing a SIMPLE plan. SIMPLE contributions may
be deposited into either a SIMPLE (k) trust, one pooled account,
or into SIMPLE IRA accounts, where one account is established
for each participating employee. While the two types of plan
arrangements are similar with regard to contributions, deferrals
and the absence of non-discrimination tests and top-heavy
requirements, there are substantial differences that make the
SIMPLE IRA format a more favorable alternative. The SIMPLE (k)
places considerably more burden for record-keeping and
disclosure on both the employer and the custodian of the plan
assets. The SIMPLE IRA is more consistent with the original
Congressional intent of a low cost retirement savings plan for
small businesses and will likely be used for most SIMPLE plans.
References in the examples below are to the SIMPLE IRA.
Comparison of the SIMPLE and the standard 401(k) retirement plan
generally focuses on the employer's position on several plan
related issues: 1. deferral limits, 2. flexibility of employer
contributions, and 3. plan administration expenses. The
following examples illustrate how these issues impact a small
business considering whether to adopt either a SIMPLE plan or a
standard 401(k) plan.
Example 1 - Euro-Car, Inc. is a small auto repair shop with 14
employees. Hans and Franz are in their 40's, each own 50% of the
business, and their annual earned income is between $125,000 and
$150,000. Hans and Franz want to establish a retirement plan
that is beneficial to them personally, allows both employee and
employer contributions, and is inexpensive to maintain. Some of
the employees indicated an interest in a retirement savings
plan; but when surveyed, only 4 of the employees confirmed that
they would actually make salary deferral contributions to the
plan.
A SIMPLE plan is likely the better alternative in this
situation. The SIMPLE salary deferral limit of $10,000 being
less than the 401(k) salary deferral limit of $15,000 is not an
issue because of restrictions imposed by 401(k)
non-discrimination requirements. Due to the small number of
eligible employees electing to make a salary deferral
contribution, the 401(k) plan non-discrimination testing would
limit Hans and Franz to less than $10,000 in salary deferral
anyway. In addition, despite a mandatory SIMPLE matching
contribution, the limited number of employees participating
would require a minimal employer matching contribution for the
non-owner employees. Finally, the low employee participation
would cause the 401(k) to be top-heavy, which requires a
mandatory employer contribution to all eligible employees of 3%
of compensation.
Example 2 - Computer Consultants, Inc. specializes in helping
small business utilize technology. The average compensation for
their 15 employees is over $30,000. The owners, Tom and Jerry,
are in their 30's and have indicated that all employees would
elect to participate in some type of savings plan. Tom and Jerry
want the flexibility of making a discretionary profit sharing
contribution when the company does well, but they also want to
maximize what they can do for themselves.
Here, the 401(k) plan is likely more attractive than the SIMPLE
plan because of the higher deferral limits and the flexibility
of making both a match and an additional profit sharing
contribution with the 401(k) plan. With a high level of employee
participation, non-discrimination tests pose no problem. So both
Tom and Jerry could be able to defer up to the $15,000 salary
deferral limit in a 401(k). The high level of participation and
recognition of the plan by employees would mitigate the
significance of plan administration costs.
Summary - In comparing the SIMPLE to the standard 401(k)
alternative, the level of employee participation is an important
factor - the higher the participation level, both as a
percentage of eligible employees and as a percentage of their
compensation, the more attractive the 401(k) alternative
becomes. The SIMPLE plan is an attractive alternative for small
businesses where: 1) plan administration costs are a major
obstacle to doing a 401(k); 2) where the difference in the
deferral limits between the two plans is not an issue; or 3) the
flexibility to make a much larger or no employer contribution is
not important.
Of course, there are other issues to consider when evaluating
the SIMPLE and the standard 401(k) plans. Please, consult with
your tax advisor or Financial Advisor prior to adopting either
plan.
About the author:
Fearing the American worker is being left in the dark, Mr.
Morris, a fee based Investment Advisor Representative, based in
Central Ohio, with Raymond James Financial Services, Inc., helps
401k participants get
the most out of their retirement.
|