A SIMPLE 401(k) plan is a cross between a SIMPLE IRA and a traditional 401(k) plan. SIMPLE stands for Savings Incentive Match Plan for Employees, and the plan allows certain employers the ability to provide retirement income for employees. If certain requirements are met, employers are exempt from taxation. In other words, they can deduct contributions made to the plan, while employees are not taxed on the contributions until they take distribution of the funds. Self-employed people are also eligible to participate in a SIMPLE 401(k) plan.
Types of Funding
A SIMPLE 401(k) plan is comprised of three types of funding:
Employer Matching Contributions or Employer Non-Elective Contributions + Employee Elective Contributions + Investments Earnings (or Losses) = Accumulated Retirement Funds
Who Can Adopt a SIMPLE 401(k) Plan?
SIMPLE 401(k) plans are available to employers with 100 or fewer employees who received at least $5,000 of annual compensation in the prior calendar year. For employers who adopt a SIMPLE 401(k) but grow beyond 100 employees, the IRS allows a two-year grace period to maintain the plan.
NOTE: To adopt a SIMPLE 401(k) plan, an employer may not maintain any other qualified retirement plans.
Why Adopt a SIMPLE 401(k) Plan?
SIMPLE 401(k) plans are simpler to administer because nondiscrimination rules do not apply. Instead, other compliance rules for qualified plans will apply. Typically, a SIMPLE 401(k) plan is only advantageous for employers with a few employees and a business owner who is not highly compensated.
Benefits of a SIMPLE 401(k) Plan
SIMPLE 401(k) plans are attractive to small employers for a variety of reasons:
- Contributions made to the plan are tax deductible.
- Having the plan in place attracts and retains qualified employees.
- The plan allows small employers to be competitive with other firms that offer qualified plans.
Employers often ask how much they can contribute to a SIMPLE 401(k) plan. There are two options for calculating contributions. When adopting the plan, employers will choose one of these two methods:
1. Matching Contribution Formula: Employers must generally match employee contributions on a dollar-for-dollar basis, up to 3% of the employee’s compensation for the calendar year.
2. Non-Elective Contribution Formula: Instead of making matching contributions, the employer may contribute 2% of compensation for each eligible employee who earns at least $5,000 of compensation in the calendar year. For this formula, compensation for each eligible participant is capped at $200,000.
In our next blog post, we’ll get into more detail about SIMPLE 401(k) plans – who directs the investment allocations, how much can be contributed and more.
If you have any questions about SIMPLE 401(k) plans in the meantime, please call our office at 206-386-5455. We’d love to answer your questions or invite you in for a no obligation consultation.
To your wealth,
Joe Maas, CFA, AVA, CFP®, ChFC, CLU®, MSFS, CCIM
President of Synergetic Finance