Small Business Retirement Plan Options: 401(k)s vs. SIMPLE and SEP IRAs

Defined contribution (DC) plans, such as 401(k) plans, are the most popular type of workplace retirement plan in the United States today. According to Department of Labor statistics, there are 633,021 DC plans in the U.S. (516,293 of which are 401(k) plans), covering more than 90 million total participants.

These figures are impressive, but nearly half of U.S. private sector employees—roughly 55 million—work for a business that does not offer a retirement plan at all. That’s a problem. Why? Workers generally save less when they can’t make contributions to a workplace retirement plan automatically by payroll deduction.

401(k)s are not the only retirement plan option for small businesses - IRA-based alternatives exist. These alternatives should be considered when a business does not need the key virtues of a 401(k) plan – high contribution limits and design flexibility – but wants to help employees save for retirement. Like a 401(k) plan, these alternatives offer automatic payroll deduction, making retirement savings easy.

Small businesses should consider all of their options when deciding to offer a retirement plan to its employees. When they don’t, they can be more inclined to offer no plan at all, making it more difficult for employees to save sufficiently for retirement.

Retirement plan options

Small businesses have 3 basic retirement plan options today – 401(k), SIMPLE IRAs, and SEP IRAs. To help choose the right plan for your business, you need to understand their features and match them to your priorities (e.g., higher contributions or simpler administration).

1. 401(k) plans

Pros	Cons
Highest employee contribution limits - $23,000 + $7,500 catch-up for 2024 Highest total contribution limits - $69,000 ($76,500 including catch-up contributions) for 2024 Employees can make pre-tax or after-tax (Roth) contributions Most flexible eligibility, contribution, vesting and distribution options Employee loans and hardship withdrawals available	Administrative costs generally higher than IRA alternatives More complex ERISA compliance requirements, including annual discrimination testing (non-safe harbor plans only) and Form 5500

2. Savings Incentive Match Plans for Employees (SIMPLE IRAs)

Pros	Cons
Easy and inexpensive to set up and operate Employees share responsibility for their retirement No discrimination testing or Form 5500 required	Lower employee contribution limits – $16,000 + $3,500 catch-up for 2024 Inflexible employer contributions – employer must make either a 3% matching contribution or 2% nonelective contribution Employer contributions must be 100% immediately vested Employer cannot have any other retirement plan

3. Simplified Employee Pension Plans (SEP IRAs)

Pros	Cons
Easy to set up and operate Low administrative costs Flexible annual contributions – good plan if cash flow is an issue High contribution limits – Maximum contribution is the lesser of: 25% of the employee's compensation, or $66,000 (for 2024) No discrimination testing or Form 5500 required	Employee contributions are not allowed Employer must contribute equally for all eligible employees

All three of these options offer the following benefits to your business and employees:

Business benefits

• • Employer contributions are tax-deductible.
  • Tax credits and other incentives for starting a plan may reduce costs.
  • A retirement plan can attract and retain better employees.

Employee benefits

• • Employee contributions can reduce current taxable income.
  • Contributions and investment gains are not taxed until distributed.
  • Contributions are easy to make through payroll deductions.
  • Compounding interest over time allows small regular contributions to grow to significant retirement savings.

Three simple questions

When choosing between a 401(k) or an IRA-based plan, you should answer three questions:

1. 1. Do my employees need the higher contribution limits offered by a 401(k) plan?
   2. Does my business need the design flexibility of a 401(k) plan?
   3. Do my employees need access to their account prior to retirement for emergencies?

If you answered yes to all three of these questions, a 401(k) plan is likely the best choice for your business.

Know your options

All small business retirement plan types have pros and cons. Understanding their differences is an important exercise. Sponsoring the wrong plan type can be a costly mistake. Choosing an IRA-based plan over a 401(k) plan can cost your business key employee talent while making the opposite choice can cost you unnecessary time and expense.

If a 401(k) plan is right for your small business, the next step is determining the professional help your plan needs. Too many small businesses start shopping for a 401(k) plan before they know their options.