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401(k) Plans vs. SIMPLE IRA Plans

Employee Benefits
Article
03/16/2018

Choosing the right retirement plan for your employees is an important decision, and requires ample research on which plans are available. To figure out which retirement plan to offer, such as 401(k) vs. a SIMPLE IRA, here are some key preliminary questions to ask:
•    Who and what type of employees are you trying to benefit?
•    What benefits do you want for the selected group of employees?
•    What benefits administration costs are you able to pay?
•    Will you provide these benefits to part-time employees?

After an employer factors in these questions, it’s time to investigate the difference between a 401(k) vs SIMPLE IRA plan. 

Tip: Simple Plans

A SIMPLE plan can apply for both 401(k) and IRA plans. Savings Incentive makes it possible for companies with as few as two employees to establish a 401(k) or IRA. SIMPLE plans are designed for business with 100 employees or fewer who earn $5,000 or more per year.   

What is a Traditional 401(k)?

A traditional 401(k) plan is a retirement investment option offered by an employer. It may offer you more flexibility than a SIMPLE plan. Most plan providers offer different levels of prototype plans or varying options available under a particular plan: for example, an automatic enrollment option or varied vesting schedules. With a traditional 401(k), you are not required to make employer contributions, and your employees can contribute up to an annual maximum as set by the Internal Revenue Service.

A traditional plan is subject to reporting obligations and tests:

  • Average Deferral Percentage (“ADP”) test
    • Compares employee deferrals of highly compensated versus non-highly compensated employees.
  • Average Contribution Percentage (“ACP”) test
    • Compares employer matching contributions and employee after-tax contributions of highly compensated versus non-highly compensated employees.
  • Top-Heavy Test
    • Compares the overall benefits in the plan of key employees such as owners and officers to non-key employees.

These compliance tests must be performed annually, and failing a test may require additional contributions or highly compensated employee distributions to bring the plan into compliance.

SIMPLE 401(k)Plans

The SIMPLE 401(k) plan is offered so that small business owners can have a cost-effective way to offer retirement benefits to their employees. The SIMPLE 401(k) is not subject to annual nondiscrimination testing and does allow for loans. Contributions to a SIMPLE 401(k) are immediately 100% vested, which means that an employee who meets the requirements to receive distributions from the plan may withdraw his/her entire account balance at any time. Also, the contribution limits are lower for a SIMPLE 401(k) plan than for a traditional 401(k) plan.

SIMPLE 401(k) plans have a few stipulations that employers and employees must follow:


1.    Eligible employers must have no more than 100 employees;
2.    Employees must have received at least $5,000 in compensation from the employer for the previous year; and
3.    Employers cannot maintain any other retirement plan for employees who are eligible to participate in the SIMPLE 401(k)— however, they may choose to maintain a second retirement plan to cover collectively bargained employees if they are excluded from the SIMPLE 401(k) plan.

What is a SIMPLE IRA?

Tip: SIMPLE IRA Employee Limits

These plans are typically for start-up employers who do not sponsor another type of plan and have fewer than 100 employees.

A SIMPLE IRA plan allows employees and employers to make contributions to Individual Retirement Arrangements (IRAs) set up for employees. 

Under a SIMPLE IRA plan:

  • the employer makes contributions to an individual account set up for each eligible employee;
  • employees defer a part of their salaries into the plan for retirement;
  • the plan is funded both by employer and employee contributions; and
  • each employee is always 100% vested in his or her SIMPLE IRA.

An employer is required to make a contribution to the plan and can choose to:

  • make a non-elective contribution of at least 2% of compensation for all eligible employees earning at least $5,000; or 
  • make a matching contribution of at least 100% up to the first 3% of compensation.

The SIMPLE 401(k) plan is offered so that small business owners can have a cost-effective way to offer retirement benefits to their employees. The SIMPLE 401(k) is not subject to annual nondiscrimination testing and does allow for loans. Contributions to a SIMPLE 401(k) are immediately 100% vested, which means that an employee who meets the requirements to receive distributions from the plan may withdraw his/her entire account balance at any time. Also, the contribution limits are lower for a SIMPLE 401(k) plan than for a traditional 401(k) plan.

Eligible employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the previous year. Employers cannot maintain any other retirement plan for employees who are eligible to participate in the SIMPLE 401(k); however, they may choose to maintain a second retirement plan to cover collectively bargained employees if they are excluded from the SIMPLE 401(k) plan.

Tip: Is a SIMPLE IRA pre-tax?

Yes, a SIMPLE IRA is pre-tax. However, distribution from a SIMPLE IRA is taxed.

What is the difference between a 401(k) and an IRA?

Traditional 401(k) SIMPLE IRA
Maximum Employee Deferral (For pretax and Roth) Maximum Employee Deferral (For pretax and Roth)
$18,500 $12,500
Roth 401(k) Contribution Option Roth 401(k) Contribution Option
Yes; subject to deferral limit No
Catch-up Contributions
(For participants 50 or Older)
Catch-up Contributions
(For participants 50 or Older)
$6,000 $3,000
Employer Contribution Employer Contribution
Optional 100% up to 3% match; or 2% non-elective contribution
Vesting Vesting
Options available Immediate
Loans Loans
Yes No
ADP/ACP Testing ADP/ACP Testing
Yes No
Top-Heavy Testing Top-Heavy Testing
Yes No
Investment Providers Investment Providers
Choice of many Single
Compatible with Money Purchase or Profit Sharing Plans Compatible with Money Purchase or Profit Sharing Plans
Yes No

Choosing a fitting retirement plan is one of the most important financial decisions a business owner can make. The retirement plan not only allows employers to claim a tax deduction for contributions, but can also attract and retain valuable employees. It may be best to consult with your financial or employee benefits advisor when choosing either a SIMPLE IRA or 401(k) plan.

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.
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