We recommend a 401(k) plan for most smaller businesses looking to set up a retirement plan for the first time. Clients often hear about SEP or SIMPLE IRAs – both are marketed as cheaper and easier to maintain because they are exempt from certain IRS and Department of Labor filing requirements. However, both offer little flexibility and smaller contribution limits, which can damage the financial health of both the employer and employee.
What is a SEP IRA?
A SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP.
- Employees can’t make contributions but will still receive employer contributions.
- Contribution amounts are limited.
- There is a limited ability to put in place eligibility criteria for company contributions.
- Employer contributions must be equal for all employees, including owners.
- Employer must transmit employee and employer contributions to each account, which can be burdensome and confusing (more on this later).
- Vesting schedule on company contributions is not allowed.
- Participant loans are not permitted.
What is a SIMPLE IRA?
A SIMPLE IRA plan is a plan that relies on required matching employer contributions. While many 401(k)s operate with matching employer contributions, for SIMPLE IRAs contributions are mandatory and the contribution limits are lower.
- Employees may choose to make salary reduction contributions and the employer is required to make either matching or non-elective contributions.
- 2022 employee contributions are limited to $14,000, compared to $20,500 in a 401(k) plan.
- 2022 employee catch-up contributions are limited to $3,000, compared to $6,500 in a 401(k) plan.
- The employer must contribute each year 2-3% of each eligible employee’s compensation.
- The employer must transmit employee and employer contributions to each account, which can be burdensome and confusing (more on this later).
- No additional contributions can be made, while 401(k)s can take advantage of profit share contributions.
- Participant loans are not allowed.
What is Better: a SEP/SIMPLE or a 401(k) Plan? A 401(k) Plan!
SEP & SIMPLEs are marketed as cheaper and easier because they are exempt from many of the reporting requirements required of 401(k)s. However, they lack the flexibility offered by a 401(k) plan, which is particularly important to smaller or emerging/growing businesses.
We find that businesses tend to quickly outgrow a SEP/SIMPLE IRA plan. If your workforce has grown, you will want the ability to put more restricting eligibility and participation criteria in place. In addition, 401(k) plans also offer more flexibility and increased contribution limits.
For more tips and information regarding retirement plans, contact us.
