401k or IRA: Picking the plan for your company
Selecting the right retirement plan for your company is tricky business. It’s more complex than just 401k or IRA, there are a lot of moving parts to be aware of and keep track of.
Making the right choice is more than looking at the corporate tax deduction. The right plan helps draw in the right talent and push your company up to the next level. Happy employees are loyal employees. Selecting a 401k or IRA starts with some key decisions:
- Who are the employees you are trying to benefit?
- What benefits do you want for the employees?
- What administration costs are you able to pay?
In this article we are going to take a look at the SIMPLE IRA, the SIMPLE 401k, and Traditional 401k.
SIMPLE plans (Savings Incentive Match Plan for Employees) are built with companies with less than a 100 employees in mind. If your company has 2-100 employees who earn $5000 or more per year, there is an option for a SIMPLE 401k or IRA plan. As a rule of thumb, SIMPLE plans are less complex to administer and less cost intensive than their traditional counterparts.
A SIMPLE IRA plan is an Individual Retirement Arrangement that start-ups can set up for their employees. Employers and employees make contributions to the account. Companies using these plans are ones who don’t already have a plan and have less than 100 employees.
Under this plan:
- The employer contributes to an individual account setup for each eligible employee;
- The employees defer a part of their salaries into the plan for retirement;
- Each employee is immediately vests 100% in his or her SIMPLE IRA.
The company is required to make contributions to the plan and can chose to:
- Make a non-elective contribution of at least 2% of the employee’s compensation for all eligible employees earning at least $5,000; or
- Make a 100% matching contribution up to the first 3% of the employee’s compensation.
As is with all IRA’s loans are not allowed.
The SIMPLE 401k plan offers small business owners a cost-effective way to offer retirement benefits to their employees.
The main differences between this and a traditional 401k include:
- The contribution limits are lower for a SIMPLE 401k plan than for a traditional 401k plan. At this time the limit is $11,500 per year.
- Under this plan, the contributions made immediately vest. Which is a way of saying that employee’s that meet the requirements may withdraw the entire balance at any time.
- The SIMPLE 401k is not subject to annual nondiscrimination testing and does allow for loans.
To be eligible, companies cannot exceed 100 employees that receive $5000 or more in compensation for the previous fiscal year. Also, the company cannot maintain another retirement plan option for employees who are eligible to participate in the SIMPLE 401k plan.
That being said, companies have the option of maintaining a second retirement plan that covers employees with a collective agreement if these employees are excluded from the SIMPLE 401k plan.
Companies that use these plans like them because they are much simpler to administer. They don’t require much of the testing that Traditional 401k plans require and are less expensive for the company.
The main advantage of the Traditional 401k plan over the SIMPLE plan is more flexibility. With one of these plans:
- Most plan providers offer different levels of plans. Or varying options available under a particular plan. As an example, an automatic enrollment option or various vesting schedules.
- With a traditional 401k your employees can contribute up to an annual maximum as set by the Internal Revenue Service. At this time, that amount is $16,500 per year.
- Employer contribution is optional. The company can contribute anywhere between 0% to 25% of the employee’s annual compensation into the account..
A traditional 401k plan is subject to reporting obligations and tests:
- ADP Test: The Average Deferral Percentage test compares employee deferrals of highly compensated versus non-highly compensated employees.
- ACP Test: The Average Contribution Percentage test compares employer matching contributions and employee after-tax contributions of highly compensated versus non highly compensated employees.
- Top-Heavy Test: This test compares the overall benefits in the plan of key employees such as owners and officers to non-key employees.
All of these tests will be performed annually. Failing a test may require additional contributions. Or possibly require 'highly compensated employee' distributions to bring the plan into compliance. Traditional 401k plans are compatible with Money Purchase or Profit Sharing Plans.
To Conclude: 401k or IRA
Selecting the 401k or IRA retirement plan that best fits the requirements of the company is not a choice that management should make lightly. The right plan can attract and retrain all-star employees. It also allows them to claim tax deductions for contributions from the calendar year in which they were made.
SIMPLE 401k or IRA plans are attractive to small business owners because of they reduce administrative complexity and costs. However, these are not the only factors to weigh. It’s worth consulting with a tax or financial adviser when making the choice of which plan to adopt.