By Trent Derrick, CMT
When growing a small business, it’s usually a positive sign when your business has grown enough to be ready to set up a retirement plan. The difficulty can sometimes be in the details, though, trying to figure out whether to go with a 401(k) or a SIMPLE IRA.
The good news is that it sounds more complicated than it really is. A brief side-by-side comparison is usually enough to get a good handle on which direction will make the most sense for your situation. Let’s take some of the mystery out of these two retirement plans and simplify that decision.
Help With Taxes
When looking at these two retirement savings options, you quickly see a couple of strong similarities between them. First of all, both are treated very much the same way for tax purposes. The money you put into (called contributions) either one is considered pre-tax. This means that any money placed into them during a calendar year reduces how much the government considers you have made. Less income means lower tax liability.
It should be noted, however, that this is technically just a tax deferment. When you take out payments within retirement, you will be taxed at whatever the applicable tax rate is at that time. The advantage to doing this is in allowing you to front-load as much as possible so you can theoretically start earning interest as soon as possible. The idea is that the growth from the investments should far exceed the cost of the taxes down the road.
Help With Growing Wealth
To help get your nest egg growing as quickly as possible, both types of investment accounts allow employee matching, although they do have different limitations on these matches. For a 401(k), there is no limit on the percentage of matching allowed, only a limit on the overall contributions made in the account for the year.
A SIMPLE IRA is more limited on how an employer may do a match. The SIMPLE IRA allows only a 3% matching contribution, or a 2% non-elective contribution. Non-elective means that the employer will make the contribution regardless of employee participation.
Both account types also allow “catch-up” contributions for employees over the age of 50. That limit is $6,500 into a 401(k) and $3,000 into a SIMPLE IRA.
Another similarity between a 401(k) and a SIMPLE IRA is that they both have contribution limits for any given year, although those limits are somewhat different. A 401(k) has a higher contribution limit than a SIMPLE IRA. The 401(k), for example, has an employee contribution limit of $19,500 in 2021.
Also, in 2021 the total 401(k) annual contribution limit with employee contributions and the company match is a combined $58,000, or $64,500 if making catch-up contributions. Compare that to the SIMPLE IRA, which only allows a total of $13,000.
Help Making A Decision
The final decision for which option will work best for you comes down to which account has features that suit your small business’s needs. The SIMPLE IRA is appropriately named, trying hard to be a simple solution for small business situations. They require much less administrative maintenance and provide an easy option to get started right away. If your business only has you or perhaps a few employees to benefit from, this might be a good fit to get the ball rolling.On the other hand, a 401(k) has higher limits and may be more beneficial for companies with a larger employee pool. If you anticipate high tax liabilities in the near future, you may want to consider going that route. If you want to make sure you aren’t buying a lemon, you take your prospective car to a mechanic. If you want to make sure that you are getting your retirement plan set up on the right foundation, the best bet is to get advice from a financial expert. I can help you evaluate your options and establish a retirement plan that allows you to experience pride and confidence in your financial future. Book a consultation with me directly by clicking here, or email me at firstname.lastname@example.org.