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SIMPLE IRA VERSUS A SAFE HARBOR 401(K) SOLUTION

Please note, if you are making this comparison with a profit sharing safe harbor 401(k) plan in place already; it is rare for a company to transition to a SIMPLE IRA. This is simply because the plan sponsor retains more corporate tax flexibility in addition all participants can defer more to a traditional profit sharing 401(k) plan.

The plan design differences are subtle:

  • Eligibility - The SIMPLE IRA requires eligibility for any employee who has earned $5,000 in any two preceding years. The Traditional plan allows for certain eligibility requirements (such as 1,000 hours to become eligible and enter the plan).
  • Company Contribution - The required company contribution is 1% higher in the traditional plan (please note for small plans, especially less than five with two owners, the majority is going to the owners which is a benefit). In addition, the SIMPLE requires a company contribution, the traditional plan does not (although if the plan is a safe harbor it is required). The key to this discussion is flexibility to the plan sponsor/owners,
  • Participant Deferrals - The participants/owners can defer up to $5,000 - $8,000 more in the traditional 401(k).
  • Discretionary Profit Sharing - The traditional plan offers a discretionary profit sharing component. A SIMPLE does not.
  • Government Reporting - is 'technically' easier under a SIMPLE, a Form 5500 is not required for the SIMPLE, the traditional plan must file.
  • Compliance Tests - If the traditional plan is a safe harbor plan, the safe harbor plan receives a deemed pass on the ADP/ACP test and top heavy tests, hence there is no difference as compared to the SIMPLE (no tests required). If the traditional plan is not safe harbor, there is a significant difference, as the plan is subject to all compliance tests.
  • Participant Loans – The traditional plan allows loans, the SIMPLE does not.

If the owners want to max out their salary deferrals, simple math indicates they can defer $5,000 more in a traditional plan ($8,000 if they have reached age 50), which in most cases the immediate tax advantages far offset any administration costs related to the traditional plan.

One of the reasons some plans make this change is from the outside administrative fee perspective, as the administration costs for a SIMPLE IRA are typically $10 - $15 per participant as compared to $750 - $1,500 for the Safe Harbor plan. Having said that, this does not compare 'all in' costs including investment fees (fund fees, advisory fees, insurance/wrap fees, etc.).

If the plan design is working, from a corporate tax perspective and participant retirement planning, and the emphasis is on out of pocket fees, then we recommend:

  • Review the cost benefit analysis (benefits are the contributions to the owners, costs are the contribution to the non owners and service provider costs)
  • Review other service providers value propositions and fees (review out of pocket and ‘all-in’ fees)

The content of this website is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances.

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