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SIMPLE 401(k) vs. Traditional 401(k)

What is a SIMPLE 401(k) plan? In 1997, the SIMPLE 401(k) was established so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. This type of ‘mini’ plan is targeted at businesses of 100 employees or less that offer no other retirement savings plan.

Employees who are 21 years or older and have been employed for at least a year can be eligible to participate in this plan.

Employer Contributions - Employers have two options for contribution. The first contribution method encourages employee participation by requiring the employer to match all employee contributions up to 4% of their salaries, with a $6,000 limit.

The second option is a fixed contribution plan. In this case, employers pay a flat 3% of a worker's salary. This contribution is required for all participating employees, regardless of whether the employees contribute on their own.

SIMPLE Plans vs. Traditional Plans

Less expensive?
The SIMPLE 401(k) is not subject to the stringent discrimination tests that apply to traditional 401(k) plans since the employer is required to make a contribution, either in the form of a match to employees who elect to participate or a non-elective ‘flat’ percentage of eligible compensation. The annual costs of administering the plan could be reduced.

Lower maximum employee contributions allowed
SIMPLE 401(k) plans have lower maximum employee contribution limits than traditional 401(k) plans. For instance, the maximum that an employee can contribute to a SIMPLE 401(k) for 1999 is $6,000, $7,000 for 2002; the maximum employee contribution on a 401(k) is $10,000, $11,000 in 2002. This may severely restrict employees who want to maximize their retirement savings.

Mandatory employer contributions
SIMPLE 401(k) plans require employers to make contributions to their employees' accounts. Employer contributions are optional for traditional 401(k) plans. Traditional 401(k)s provide that employees may make contributions to their account regardless of whether the employer makes contributions. This provides greater funding options to the employer.

Automatic vesting of employer contributions
Employer contributions made to SIMPLE 401(k) plans are automatically fully vested. Traditional 401(k) plans, in comparison, provide employers the option of creating vesting schedules, whereby employer contributions become fully vested over a period of years. Vesting offers a distinct advantage to the employer. Employer contributions must ‘vest’ before the employee can enjoy complete control of the money. Vesting creates incentives for employees to continue with a specific employer rather than ‘taking’ the contribution and bouncing to the next job.

Less flexibility?
SIMPLE 401(k) plans offer the advantage of a ‘cookie cutter’ plan design with lesser administration fees. The tradeoffs are less flexibility as the business grows. A traditional design can offer a variety of employer funding options and the ability to not fund the plan in slow economic downturns. Traditional 401(k)s are defined contribution profit sharing plans by design, and therefore can offer the employer the ability to deposit a ‘year-end’ contribution in addition to the employer match contributed throughout the year.

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last updated on Wednesday, January 02, 2008 11:23 AM