Simple 401k Retirement Plans – Advantages/Disadvantages, Eligibility, Deadlines

A Simple 401k plan is less well known than its counterparts Simple IRA and a traditional 401k but actually combines the best of benefits provided by both plans into 1 single plan, the Simple 401k. In this article, we explore some of the features provided by Simple 401k plans and advantages/disadvantages.

Advantages of Simple 401k Plans

i) No Testing – Traditional 401k plans require intensive testing to make sure the plan works in compliance with regulatory requirements set out by law. Such testing must be done by 401k professionals and can be very costly. On the other hand, Simple 401k plans do not require such testing and can be very appealing to small business owners who do not have the capital to expense to all the heavy testing that traditional 401k plans require.

ii) Borrow Loans – Simple 401k plans make it easier to borrow loans from one’s 401k and pay it back in the form of principal and interest payments.

Disadvantages of Simple 401k

i) Immediate Vesting – With traditional 401k plans, new employees may be required to work a minimum # of years or months before they can make contributions to the company’s 401k plan. This can work in the form of a contribution vesting schedule. With Simple 401k, contributions are vested 100% immediately. This means employees who meet the eligibility of taking distributions from their retirement accounts may do so at any time, even if it means withdrawing their entire savings account.

ii) Lower Contribution Limits – The contribution limits for Simple 401k plans are lower than those of traditional 401k plans. Here’s a comparison of salary deferral limits for both plans.

Year Simple Deferral Limit Traditional 401k Deferral Limit
2002 $7000 $11,000
2003 $8000 $12,000
2004 $9000 $13,000
2005 $10,000 $14,000
2006 $10,000 $15,500
2007 $10,500 $15,500
2008 $10,500 $16,500
2009 $11,500 $16,500
2010 $11,500 $16,500
2011 $11,500 $16,500
2012 $11,500 $17,000

iii) Limited Employer Matched Contributions – Employer matched contributions are limited to 3% of the employee’s compensation while this is up to 25% for traditional 401k plans.

iv) One Plan Limitation – An employer who participates in a Simple 401k plan cannot maintain any other retirement program for any of its employees that are eligible for Simple 401k contributions. On the other hand, an employer who maintains a 401k retirement program for its employees may also administer and have other defined-contribution plans, SEP IRAs, profit sharing and Roth IRA plans.

Eligibility for Participation

i) Every employer who is eligible to run a traditional 401k program for its employees is also eligible to administer Simple 401k. Examples include sole proprietors, partnerships and corporations. However, Simple 401k plans are limited to employers who have a maximum of 100 employees, each receiving compensation in excess of $5000 annual.

ii) Employees who have worked for their current employers for at least 1 year and who are 21 years or older must be allowed to participate in the Simple 401k plan.

Deadline?

A Simple 401k plan must be established between January 1st – September 30th of any year. This rule is waived for any businesses or corporations that go in to business after October 1st of the current year.

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