SIMPLE IRA, SEP or 401(k): Which Fits Your Business?

The short version before the details

These three plans differ in three ways: who is allowed to contribute, how much you are required to put in, and how much administrative work lands on your desk. Most employers choose based on those three things, not on investment menus.

In broad strokes, a SEP IRA is funded only by the employer and is the lightest to run. A SIMPLE IRA lets employees save from their paychecks and requires you to contribute every year. A 401(k) is the most flexible and the most involved.

This guide is general education, not tax or legal advice. Plan rules have details and exceptions, so confirm anything you plan to act on with a licensed advisor or tax professional.

SEP IRA: employer-funded and simple to start

With a SEP, only the employer contributes. Employees do not defer part of their own pay into the plan. You decide each year whether to contribute at all, and if you do, the contribution generally has to be the same percentage of pay for every eligible employee, owners included.

Setup is usually quick, ongoing paperwork is minimal, and contributions belong to the employee right away. That makes a SEP appealing for owner-only businesses, very small teams, or companies with uneven profits that want room to skip a year.

The tradeoffs are worth knowing. Because staff cannot contribute through payroll, a SEP does little for employees who want to save on their own. And once you have a larger team, the cost of contributing for everyone eligible can grow quickly with payroll.

• Who contributes: the employer only
• Required contribution: none in a given year, but equal treatment of eligible employees if you contribute
• Admin load: light
• Often suits: owner-only or very small employers

SIMPLE IRA: shared savings with light administration

A SIMPLE IRA is built for smaller employers. Generally you need 100 or fewer employees, and you generally cannot run another retirement plan alongside it in the same year. Employees choose how much to defer from their paychecks, and you must contribute too.

Your required contribution takes one of two forms: a match for employees who defer, or a set contribution for all eligible employees whether or not they defer. Employee and employer contributions vest immediately. You also have annual notice and election-period requirements to keep track of.

Contribution limits are set each year and are generally lower than those of a 401(k), so check the current figures. There are also special tax rules for early withdrawals, which is worth explaining to employees up front.

A SIMPLE IRA often fits employers who want a real payroll-deferral benefit without the testing, filings and plan documents of a 401(k).

401(k): the most flexible and the most to manage

A 401(k) lets employees defer from pay and gives you options. You can offer a match, add profit-sharing contributions, set a vesting schedule, and in many plans offer Roth contributions and participant loans. Annual limits are set each year and are generally higher than for the other two plans.

That flexibility comes with responsibility. Plans typically involve a recordkeeper or administrator, an investment lineup, annual filings such as Form 5500, and fiduciary duties for the people who oversee the plan. Traditional designs also require annual nondiscrimination testing, which can limit what higher-paid employees and owners may defer.

Safe harbor designs can avoid much of that testing in exchange for a required employer contribution. Recent federal law has also added start-up tax credits for some small employers and automatic enrollment rules for many new plans. Confirm what applies to you before you commit.

• Who contributes: employees, and the employer if you choose
• Required contribution: none in a standard plan, yes in a safe harbor plan
• Admin load: highest of the three
• Often suits: growing employers, or owners who want higher savings room

California considerations and questions to ask yourself

California requires many employers above a certain size that do not offer a retirement plan to register with the state-sponsored savings program. Offering a qualifying plan can satisfy that requirement. Check current size thresholds and deadlines, since they have changed over time.

Before comparing plan documents, answer a few practical questions about your own business. Your answers usually narrow the field fast.

• Do you want employees to be able to save through payroll, or only to receive employer contributions?
• Can you commit to an employer contribution every year, even in a slow one?
• Do you want a vesting schedule to encourage longer tenure?
• How much do the owners want to save personally?
• Will headcount cross 100 in the next few years?
• How will you explain the plan to a bilingual, shift-based, or seasonal workforce?

Practical next steps this month

You do not need to pick a plan in one sitting. You do need enough information to compare options realistically. Start with the basics and build from there.

If it helps, a benefits review with an advisor is one way to walk through plan types alongside your health and other benefits, so the pieces fit together.

• Check whether you already have a plan and what rules it carries, especially if you are considering a switch
• Count current employees and estimate headcount for the next two or three years
• Decide what you could comfortably contribute in a strong year and a weak one
• List your priorities: ease of administration, employee savings, owner savings, or retention
• Ask your payroll provider what they can integrate with
• Confirm California registration requirements for your size
• Talk to your tax professional about deductions and timing before you choose

This article is general education for employers, not legal, tax or plan advice. Benefit rules and options depend on your group size, location and plan, so talk with a licensed advisor before making changes. Sixth Man Employer & Insurance Services, CA Insurance License #0I01929.