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Simple IRA vs. 401k | The Pitfalls of a Simple IRA

Choosing between a Simple IRA vs. a 401k can be overwhelming. After all, the plan that you choose will determine the trajectory of your small business going forward.

Among other things, your decision for a retirement plan will determine your:

  • Own retirement prospects

  • Employees retirement prospects

  • Employee retention and turnover rates

  • The desirability of your business to talent

When faced with this dilemma, many small business owners have a natural inclination to choose a Simple IRA. Well, why not? It requires fewer documents, is easy to implement, and even has “simple” in its name.

However, there’s more to retirement plans than meets the eye, and this post will help demystify the Simple IRA plan by comparing and contrasting it to its peer, the 401(k).

Simple IRA vs. 401k

Both the Simple IRA and 401(k) are retirement plans. With a retirement plan, your employees contribute a percentage of their salaries called an elective deferral, which is then invested into a long-term retirement fund.

Both the 401(k) and the Simple IRA allow the employer to participate by making contributions to the employee’s retirement funds.

The similarities don’t end here. The Simple IRA and the 401(k) share the same tax benefits, which are:

  • Contributions are exempt from income taxes

  • The growth/ capital gains in your retirement funds are exempt from taxes

  • The government only taxes your funds at withdrawal

Simple IRA

A Simple IRA is an acronym for Savings Investment Match Plan for Employees. Its name gives it away as one of the easiest paths to a retirement plan for your employees.

The government designed Simple IRAs with small businesses in mind. That said, to benefit from this plan, your business should have 100 or fewer employees. As an employer in a Simple IRA, your contributions are either:

  • A non-elective contribution of at least 2% of the remuneration for all employees earning above $5,000

  • A matching contribution of 100% of the first 3% of an employees contribution

Some of the benefits of using a Simple IRA for your business include:

  • Easy to set up and deploy

  • Relatively inexpensive

  • Has a low maintenance burden


A traditional 401(k) is another popular retirement plan that your small business can offer your employees in place of a Simple IRA.

By choosing this retirement plan, your business sacrifices simplicity for flexibility, more options, and customization.

Any business, regardless of its size, can join the 401(k) retirement plan and start building the future of its employees.

What Makes A 401(k) Better Than A Simple IRA

Your decision will eventually come down to the unique circumstances of your business and your preferences as an employer.

However, there are several pitfalls that should make a Simple IRA a less desirable option, even for a small business.

These pitfalls include:

Lower Contribution Limits

By choosing a Simple IRA over a 401(k), you automatically forgo the higher contribution limits that comes with the latter.

A Simple IRA limits your contribution in three ways:

  • You get a yearly maximum of $13,500 which is $6,000 less than you would get in a 401(k) plan

  • Both you and your employees above 50 get a maximum of $16, 500 which is $9, 500 short of what you would get in a 401(k)

  • Your catch-up contributions at $3,000, are half what a 401(k) offers.

With an average rate of 8% a year, a small difference of $ 6,000 each year will result in a massive $180,000 difference in 3 decades.

Lack Of A Profit-sharing Option

By opting for a Simple IRA, you miss out on the profit-sharing option a 401(k) offers. This option allows your business to write off taxes on the matching contributions you make to your employee’s retirement accounts.

Moreover, it allows you to make more generous contributions to yourself or, better yet, performing employees as a motivation.

Lack Of Flexibility In Contribution

A Simple IRA gives you little room when it comes to matching your employee’s contribution. First, unlike a 401(k), it is mandatory that you match your employee’s contribution.

In a 401(k), however, you get to choose whether you want to match your employee’s contribution. Moreover, you have the freedom of matching from 0-25% of your employee’s contribution.

If that’s not enough, you don’t have to match your contributions dollar-for-dollar as you have to in a Simple IRA.

Vesting Not only does a Simple IRA mandate that you make contributions, but it also makes 100% of all contributions you make vested.

Vesting means that your employee can withdraw your contributions at any time without needing prior permission.

A non-vested retirement fund like a 401(k), on the other hand, comes with its fair share of benefits. For example, by mandating that your employees can’t withdraw your matching contributions until the 2nd year, you can retain employees and reduce turnover.

Less Control Over Who Joins In a Simple IRA, you have extremely limited control over the employees who can enroll in your firm’s retirement plan.

The law strictly mandates that all employees who have earned $5,000 in any two prior years and are expected to earn the same in the current year should be in your Simple IRA. In a 401(k), however, you have more control over who joins. The employees who join your

401(k) must be:

  • 21 years old and above

  • Have more than a year’s experience

The Loan Option A Simple IRA plan significantly inconveniences you or your employees early or premature access to your retirement savings. It has no loan option and fines all early withdrawals at 25%.

However, with a 401(k), your employees can tap into their retirement savings during emergencies through a loan.

No Roth Option The most significant deal-breaker for Simple IRA accounts is the lack of a Roth Option. Like you saw above, retirement plans are exempt from taxes right until the point of withdrawal.

Well, the Roth Option offers a way around this eventual tax. With this in your 401(k) plan, your employees make after-tax contributions to a Roth account, and then have their eventual withdrawal tax free.

Every business, just as every retirement plan, is unique. When determining a Simple IRA vs. a 401k, you’ll need to take all aspects into consideration. Taking your time to do your research.

If you need help finding which plan makes sense for your company, schedule a plan discussion with us or download our retirement plan decision tree that helps guide your decision making process and helps you choose which plan might be right for you (see below)

Download PDF • 412KB

Feel free to use me as a sounding board.

Best regards,

- Kurt

Kurt S. Altrichter, CRPS®

Fiduciary Advisor | President

Direct: 952.828.5336

Email: |

8400 Normandale Lake Blvd, Bloomington, MN 55437


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