Skip to content

What’s the Difference Between a 401(k) and a SIMPLE 401(k) Retirement Plan?

What’s the Difference Between a 401(k) and a SIMPLE 401(k) Retirement Plan?

Last Updated: December 19, 2023

As a business owner, offering your employees a solid retirement plan isn't just a perk—it's a priority. According to Vestwell's 2023 Retirement Trends Report, 98% of workers said it’s important for their employer to provide a retirement benefit, with 3 out of 4 employees naming the 401(k) plan as a preferred choice.

But did you know that there are different types of 401(k) plans? One notable alternative to the traditional 401(k) plan is the SIMPLE 401(k) plan. So, how does it measure up against the traditional 401(k)?

In this article, we’ll discuss the differences between these two types of retirement plans, diving into their unique advantages, potential drawbacks, and how to choose the right fit for your business.

401(k) Plans vs. SIMPLE 401(k) Plans

401(k) Plan Basics

The 401(k), perhaps the most well-known type of retirement plan, can provide tax advantages for employees and employers. It’s a savings plan sponsored by employers that allows employees to set aside a portion of their income for retirement.

SIMPLE 401(k) Plan Basics

The SIMPLE acronym stands for "The Savings Incentive Match Plan for Employees" and is an employer-sponsored retirement savings plan designed specifically for small businesses with 100 or fewer employees. This plan type offers a, well, simpler option for small businesses wanting to provide retirement benefits to their employees, as it is not subject to the non-discrimination rules that apply to traditional 401(k) plans.

Contributions

401(k) Plan Contributions

Employees can contribute up to $23,000 to their 401(k) plan in 2024 unless you happen to be over 50, in which case you may make additional "catch-up" contributions up to $7,500.

As an employer, you may also make tax-deductible contributions to your employees' 401(k) accounts, but you’re not required to do so.

There are two types of employer contributions:

  • Matching contributions are funds that employers add to their employees' 401(k) accounts based on the amount the employee contributes. The formula for this match can vary widely among companies. A common match might be something like "50% of the employee's contributions up to 6% of their salary."
  • Non-elective contributions differ from matching contributions because the employer makes non-elective contributions regardless of how much the employee contributes. Essentially, the employer contributes a fixed percentage of the employee's salary to the 401(k) regardless of whether the employee chooses to contribute anything at all. For instance, an employer might decide to contribute 3% of each eligible employee's salary into their 401(k) annually. Whether the employee contributes 10%, 1%, or nothing at all, the employer still contributes 3%.

The 2024 limit for both employee and employer contributions is $69,000.

SIMPLE 401(k) Plan Contributions

SIMPLE 401(k) plans work in much the same way as a regular 401(k), allowing employees to make pre-tax contributions from each paycheck. The maximum contribution by an employee for 2024 is $16,000. If the employee is age 50 and over, an additional “catch-up” contribution of $3,500 is allowed.

Unlike a traditional 401(k) plan, with a SIMPLE 401(k) plan, the employer must make either:

  • A matching contribution up to 3% of each employee’s pay, or
  • A non-elective contribution of 2% of each eligible employee’s pay.

Employees are fully vested in all contributions, meaning they immediately have complete ownership of both their own contributions as well as their employer’s contributions. Additionally, employers cannot make any other contributions to a SIMPLE 401(k) plan.

Taxation and Withdrawal

401(k) Plan Taxation and Withdrawal

Employees can contribute to traditional 401(k) plans with pre-tax dollars, reducing their taxable income for the year. These contributions and their subsequent earnings grow tax-deferred, meaning they're not taxed until withdrawal. Upon retirement, withdrawals are taxed as ordinary income.

Some employers offer a Roth feature where they make contributions after taking out taxes. The benefit of Roth contributions is that distributions, including earnings, are tax-free during retirement if certain conditions are met.

There are also tax benefits for employers. They can deduct their contributions to their employees’ plans, as well as administrative costs, from their taxes.

Withdrawals from a 401(k) are typically allowed without penalty after age 59½. Before this age, a 10% penalty usually applies, with some exceptions like financial hardship or disability. Once they reach age 72 (73 if they reach age 72 after Dec. 31, 2022), account holders must take Required Minimum Distributions (RMDs) annually, calculated based on IRS guidelines.

SIMPLE 401(k) Plan Taxation and Withdrawal

Both employee and employer contributions into a SIMPLE 401(k) plan are made on a pre-tax basis. The funds can grow tax-deferred until you begin withdrawing them from the account in retirement, at which point they will be taxed as regular income. Roth deferrals are not permitted for SIMPLE 401(k) plans.

Employees can begin withdrawals at age 59½ without any penalties; however, if the employee withdraws funds before this age, the IRS will assess a 10% penalty in addition to their regular income taxes.

Vesting Criteria

401(k) Plan Vesting

Employees are immediately vested in their contributions and any earnings on them.

Employer contributions, on the other hand, may vest immediately or according to a graded or cliff schedule:

  • Graded Vesting: Employees gradually earn ownership of the employer contributions over time. For example, they might gain 20% ownership after one year, 40% after two years, and so on until they're fully vested.
  • Cliff Vesting: In this all-or-nothing approach, employees gain 100% ownership of the employer's contributions after a set number of years. If they leave the company before this, they forfeit these contributions. After reaching the specified period, they're fully vested.

SIMPLE 401(k) Plan Vesting

Employer and employee contributions to a SIMPLE 401(k) are 100% vested as soon as they are deposited. This means that the employee owns 100% of their account balance and the employer cannot forfeit, or take it back, for any reason.

Eligibility

401(k) Plan Eligibility

Any size business is eligible to offer a 401(k) plan.

For employees to participate in a company's 401(k) plan, they often need to be at least 21 years old and have worked for the employer for a minimum of one year. If the 401(k) plan includes employer contributions, like matching or nonelective contributions, employees might need up to two years of service to qualify for these contributions. But when they do qualify, they have full ownership (or are 100% vested) in these employer contributions.

While these are the standard IRS guidelines, employers have the flexibility to establish less restrictive eligibility requirements.

SIMPLE 401(k) Plan Eligibility

Businesses with 100 or fewer employees that do not maintain any other employer-sponsored retirement plan can adopt a SIMPLE 401(k).

Like with a 401(k) plan, employees generally must be at least 21 and have one year of service before they can participate. Employers have the flexibility to establish less restrictive eligibility requirements.

Advantages and Disadvantages

When deciding which retirement plan is right for your business, consider these differences between 401(k)s plans and SIMPLE 401(k) plans.

401(k) Plans:

Advantages:

  • Higher contribution limits
  • Employer contributions can be subject to a vesting schedule, which can incentivize employees to stay with the company for a longer period of time

Disadvantages:

  • Subject to nondiscrimination rules

SIMPLE 401(k) Plans:

Advantages:

  • Not subject to nondiscrimination rules
  • Straightforward benefit formula

Disadvantages:

  • Lower contribution limits
  • No vesting schedule
  • Maximum number of employees is 100

Conclusion

Whether you opt for the traditional 401(k) or the SIMPLE 401(k), offering a retirement benefit can help your business recruit and retain top talent. While the conventional 401(k) offers higher contribution limits and potential for a vesting schedule, the SIMPLE 401(k) provides a straightforward option tailored for smaller businesses, free from the complexities of nondiscrimination rules.

Remember, the best choice depends on your business's unique needs, size, and situation. Fortunately, Vestwell can help design a plan that’s right for you. Vestwell is a digital retirement plan platform that takes the hassle out of setting up and administering an employer-sponsored retirement plan.