Retirement savings plans come in many shapes and sizes. Some retirement accounts are personal accounts such as IRAs, while others are setup by companies to benefit their employees. SIMPLE IRAs and 401k plans fall into the latter category. Both offer significant tax advantages for retirement investing, but the two types of retirement plans are very different.
Employer Sponsored Retirement Plans
Unlike traditional IRA accounts or Roth IRAs, employer sponsored plans cannot be set up by individuals. Rather, these retirement plans must be started by businesses according to IRS rules and regulations. Employees contribute to both SIMPLE-IRA plans and 401k plans via salary deferrals. Employers may contribute to both plans as well. Contributions by employees are made with pre-tax dollars. Employer contributions provide a business tax deduction for the company.
SIMPLE-IRA plans are designed for small businesses only. The tax code restricts SIMPLE-IRAs to businesses with 100 or fewer employees. 401k plans may be used by companies of any size. SIMPLE-IRA plans must cover all employees with at least $5,000 in compensation. Companies with SIMPLE plans must contribute either 2 percent of an employee's salary regardless of the amount the employee contributes, or they must match employee contributions dollar-for-dollar up to 3 percent. 401k plans allow for a wide variety of matching and profit-sharing contributions.
For small businesses there are several advantages to using a SIMPLE plan versus a 401k plan. One of the major advantages is that a SIMPLE-IRA retirement plan can be setup using a one-page IRS Form, whereas a 401k plan requires a multi-page plan document that must spell out numerous terms and conditions for the plan. Another big advantage is that unlike 401k plans, SIMPLE plans do not have to comply with the rules regarding top-heavy plans.
401k and SIMPLE-IRA Accounts
For employees 401k accounts and SIMPLE-IRA accounts share many of the same rules and regulations. Both accounts impose a 10 percent penalty if money is withdrawn before the account owner turns 59 1/2 years old. Both accounts offer tax deferral on all gains and interest while the money is inside of the accounts. One major difference between 401k plans and SIMPLE-IRAs is that the employee may contribute more money to a 401k. The annual contribution limit for 401k plans is $16,500 while the annual contribution limit for SIMPLE-IRAs is $11,500.
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