401k vs. SIMPLE

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employee elective salary deferrals and employer contributions into an account that grows on a tax deferred basis until withdrawn; but, the SIMPLE has fewer administrative requirements than the 401(k) plan.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.

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