SIMPLE IRA vs. 401(k): How Do They Differ?

A 401(k) plan is one of the most flexible workplace retirement plan options available, while a SIMPLE IRA plan is less flexible but also less complex to use and administer. Each of these has its own distinct pros and cons, but which is best suited for you is dependent on your personal needs. A financial advisor can help you pick the best retirement plan for your needs.

401(k) Definition

A 401(k) is a defined contribution retirement plan offered by an employer to its employees. Any business can offer one.

Under a 401(k), employees can set aside a portion of their income and invest it in a qualifying retirement account. This money is tax-deferred, which means that the employee does not pay federal income taxes on any of the money they choose to defer into the account. Instead, when you take out these funds, you’ll pay ordinary income taxes on your withdrawals.

For example, let’s say you set aside $5,000 into your 401(k) over one year. You would deduct this $5,000 from your income taxes for that year. Upon retirement, that $5,000 has grown into $40,000, and you withdraw it as needed. You would then pay taxes on those withdrawals based on the federal and state income tax brackets you fall under.

The 2024 contribution limit for a 401(k) is $23,000, up from $22,500 in 2023. If you’re over 50 and want to make catch-up contributions, you can add up to $7,500 to the limit for either year.

401(k)s can also come with a profit-sharing option. Although the details differ depending on the employer, a business receives a tax advantage for making profit-based contributions to its employees’ 401(k) accounts. The employer can structure this as a matching contribution or an explicit profit-sharing plan.

Finally, 401(k)s may have an employer matching component, in which employers choose to match some or all of their employees’ 401(k) contributions. Usually such arrangements have limits to how much the employer will match – for instance, an employer might match employee contributions up to 5% of their salary, and only have their contributions fully vest after 2 years.

SIMPLE IRA: Definition

A SIMPLE IRA plan is a retirement plan that allows employers and employees to jointly make contributions to an employee’s retirement account. It allows small businesses to mimic the retirement tax incentives of a 401(k). SIMPLE IRAs are part of the “Savings Incentive Match Plan for Employees” program.

Under this plan, you make what is known as a “salary reduction contribution.” This means that your contribution to the IRA is never paid to you. Instead, it goes directly to the retirement account. Your employer can then either make a matching contribution or pay a flat contribution for all employees equally.

You can contribute up to $16,000 to a SIMPLE IRA for 2024, up from $15,500 for 2023. Catch-up contributions are limited to $3,500 annually for 2023 and 2024. An employer can either match these contributions up to 3% or contribute a flat 2% of each employee’s pay (regardless of employee contributions), up to a total limit of $345,000 in 2024, up from $330,000 in 2023.

A SIMPLE IRA is a great choice for both the self-employed and small business owners with fewer than 100 employees. According to the IRS, “all employees who received at least $5,000 in compensation from you during any 2 preceding calendar years (whether or not consecutive) and who are reasonably expected to receive at least $5,000 in compensation during the calendar year, are eligible to participate in the SIMPLE IRA plan for the calendar year.”

When you’re self-employed, the IRS considers you to be both your own employer and employee. As a result, if you use a SIMPLE IRA, you’re allowed to make both the employer and the employee contribution. This means that you can both maximize your IRA contributions and not lose out on the the additional employer contribution.

SIMPLE IRA vs. 401(k): Key Differences

On the surface, SIMPLE IRAs and 401(k)s are similar retirement plans. Both encourage workers to save for retirement by letting them deduct their contributions from their federal income taxes. They also both allow employers to contribute to these retirement accounts. However, there are several important difference to understand.

Size

Any employer at all can get a 401(k) plan, making it one of the most accessible plans you’ll come across. So regardless of whether you have five employees or 500, you can start a 401(k) for them.

A SIMPLE IRA plan is only for certain types of employers. More specifically, businesses with more than 100 employees are ineligible. Only a small business can start a SIMPLE IRA for its employees.

Eligibility

Employee eligibility requirements are a bit less stringent for a 401(k) than a SIMPLE IRA.

If an employer offers a 401(k) plan, they must offer access to any employee who meets these requirements:

They are 21 or older
They have at least one year of service

Note that employers may offer it to younger employees, as well as to those who haven’t been with the company for a year. Indeed, it’s common for employees to get access to their company’s 401(k) plan on day one of their employment. These requirements just mean that employers who choose to offer a 401(k) are legally required to offer it to all employees who are over 21 and meet these criteria.

An employee is eligible for a SIMPLE IRA plan if:

They have received at least $5,000 in compensation in any of the previous two years
They expect to receive at least $5,000 in compensation during the coming year

Contribution Limits and Matching

Contribution limits are not equal with both accounts as they are lower for a SIMPLE IRA plan than with a 401(k).

An employee can contribute up to $23,000 to a 401(k) plan in 2024 (up to $30,500 if they are age 50 or older) and $22,500 in 2023 (up to $30,000 if they are 50 or older). Combined, employer and employee contributions to a single employee’s 401(k) cannot exceed the lesser of either 100% of the employee’s compensation or the total cap, which is $69,000 in 2024 and $66,000 in 2023 (not including the catch-up contribution).

An employee can contribute up to $16,000 to a SIMPLE IRA in 2024 (up to $19,500 if they are age 50 or older) and $15,500 in 2023 (up to $19,000 if they are 50 or older).

The employer must contribute either a dollar-for-dollar match up to 3% of the employee’s compensation or a flat 2% contribution. While employer contributions to a 401(k) plan are entirely optional, an employer must contribute to a SIMPLE IRA. So while 401(k) plan participants can potentially save more annually, SIMPLE IRA participants are guaranteed to get at least some employer matching.

Bottom Line

A SIMPLE IRA is only available to small businesses with 100 or fewer employees. There are also some minimum income limits that employees must meet to qualify for the plan. And the contribution limits are lower for SIMPLE IRAs than for 401(k)s. Still, SIMPLE IRAs have some advantages. While many employers offer generous matching with their 401(k) plans, such matching is totally optional. By contrast, participants in SIMPLE IRAs are guaranteed at least some matching from their employers. And SIMPLE IRAs are also available to self-employed people.

Next Steps for Planning Your Retirement

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If you want to set up and plan your retirement goals, SmartAsset’s retirement calculator can help you figure out how much you will need to save to retire comfortably.