Pre-COVID, a small business investigated a move from their SIMPLE IRA to a more traditional 401(k) plan. The growing organization was quickly approaching and looking to surpass 100 employees. Growth slowed significantly, layoffs ensued, and the need to move from the existing SIMPLE disappeared. While their current employee count hovers around 60, competitive labor markets and a desire to advance their retirement benefits structure has caused the organization to re-engage in exploration of a more traditional 401(k) plan.

The Savings Incentive Match Plan for Employees (SIMPLE) was created in 1996 by the Small Business Jobs Protection Act. The SIMPLE was intended to encourage small businesses (100 or less employees) to adopt a retirement program that was easy to understand and operate. The SIMPLE permits eligible employees to defer funds from the paycheck and the employer is required to make a contribution of either 2% of compensation or a 100% match up to 3% of compensation. SIMPLEs are generally funded through an IRA for each eligible and participating employee. Once deposited, the employer ordinarily retains no responsibility for the funds; they are in control of the SIMPLE participant and the IRA custodian.

Small businesses that exceed 100 employees are required to freeze their SIMPLE within a certain time period and they may adopt a traditional 401(k) [or 403(b)] plan in its place. For some small businesses, like the one in our example, there may be more pressing reasons to adopt a 401(k) plan than employee headcount.

While it is true that SIMPLEs require less employer contribution and have low to no administrative costs, they also have virtually no plan design flexibility. Employers sponsoring 401(k) plans, on the other hand, can customize features to meet their needs and the needs of their employees. It’s that flexibility of plan design and the ability to set aside significantly more for retirement on an annual basis with a 401(k) plan that often outweighs the simplicity and low cost of the SIMPLE. Deferral limits are greater, catch-up contribution limits higher, and overall total contribution limits per person can be significantly more. Traditional 401(k) plans can exclude certain employee classifications (subject to compliance testing) and can carry vesting schedules which encourage employees to stay longer with the employer or risk loss of retirement savings through forfeiture.

As an added incentive to small businesses with 100 or less employees, the original SECURE Act (2019) offered start-up tax credits of 50% of administrative costs, capped at $5,000 annually for three years. SECURE 2.0, enacted in December 2022, enhanced the start-up tax credits for small businesses with less than 51 employees by increasing the tax credit to 100% of qualified start-up costs up to $5,000 annually. Over a three year period, these small businesses could enjoy $15,000 or even $16,500 if they added auto enrollment, which offers its own credit of $500 per year for three years. SECURE 2.0 also introduced tax credits for employer matching or profit-sharing contributions for the first five years of the plan. These apply to small businesses with 100 or less employees.

Is it time for your small business to adopt a 401(k) plan?

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