Simple IRA vs. 401(k) - Which one is right for your company?

compare simple ira and 401k

There are a lot of options available to small companies when establishing an employer sponsored retirement plan. For companies that have employees in addition to the owners of the company, the question is do they establish a 401(k) plan or a Simple IRA?The right fit for your company depends on:

• What are the company's primary goals for establishing the plan?

• How much the owner(s) plan to contribute to the plan?

• How many employees does the company have?

• Do you want to restrict the plan to only full time employees?

• The cost of maintaining each plan?

• Does the company intend to make an employer contribution to the plan?

• Diversity of the investment menu

Below is a chart that contains a quick comparison of some of the main features of each type of plan:

simple ira vs 401K comparison chart

For many small companies it often makes sense to start with a Simple IRA plan and then transition to a 401K plan as the company grows or when the owner intends to start accessing the upper deferral limits offered by the 401(k) plan.

Simple IRA's are relatively easy to setup and the administrative fees to maintain these plans are typically lower in comparison to 401(k) plans. Most Simple IRA providers will only charge $10 - $30 to custody the accounts.

By comparison, 401(k) plans are ERISA covered plans which require a TPA Firm (third party administrator) to maintain the plan documents, conduct year end plan testing, and file the 5500 each year. The TPA fees vary based on the provider and the number of employees eligible to participate in the plan. A ballpark range is $1,500 - $2,500 for companies with under 50 employees.

However, the additional TPA fees associated with establishing a 401(k) plan may be justified if:

• The owners intend to max out their employee deferrals

• The owners are approaching retirement and need to make big contributions

• The company wants to maintain flexibility with the employer contribution

• The company would like to make Roth contributions, loans, or rollovers available

WARNING: Most investment providers are "one trick ponies". They will talk about 401(k) plans and not present other options because they either do not have a thorough understand of how Simple IRA plans work or they are only able to offer 401(k) plans. Before establishing a retirement plan it is important to work with a firm that presents both options, helps you to understand the difference between the two types of plans, and assist you in evaluating which plan would best meet your company's goals and objectives.

Michael Ruger

About Michael.........

Hi, I'm Michael Ruger. I'm the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Comparing Different Types of Employer Sponsored Retirement Plans

comparison of different types of retirement plans

Employer sponsored retirement plans are typically the single most valuable tool for business owner when attempting to:

• Reduce their current tax liability

• Attract and retain employees

• Accumulate wealth for retirement

But with all of the different types of plans to choose from which one is the right one for your business?   Most business owners are familiar with how 401(k) plans work but that might not be the right fit given variables such as:

• # of Employees

• Cash flows of the business

• Goals of the business owner

There are four main stream employer sponsored retirement plans that business owners have to choose from:

• SEP IRA

• Single(k) Plan

• Simple IRA

• 401(k) Plan

Since there are a lot of differences between these four types of plans we have included a comparison chart at the conclusion of this newsletter but we will touch on the highlights of each type of plan.

SEP IRA PLAN

This is the only employer sponsored retirement plan that can be setup after 12/31 for the previous tax year.   So when you are sitting with your accountant in the spring and they deliver the bad news that you are going to have a big tax liability for the previous tax year, you can establish a SEP IRA up until your tax filing deadline plus extension, fund it, and take a deduction for that year.

However, if the company has employees that meet the plan’s eligibility requirement, these plans become very expensive very quickly if the owner(s) want to make contributions to their own accounts.  The reason being, these plans are 100% employer funded which means there are no employee contributions allowed and the employer contribution is uniform for all plan participants.  For example, if the owner contributes 15% of their income to the SEP IRA, they have to make an employer contribution equal to 15% of compensation for each employee that has met the plans eligibility requirement.  If the 5305-SEP Form, which serves as the plan document, is setup correctly a company can keep new employees out of the plan for up to 3 years but often times it is either not setup correctly or the employer cannot find the document.

Single(k) Plan or “Solo(k)”

These plans are for owner only entities.  As soon as you have an employee that works more than 1000 hours in a 12 month period, you cannot sponsor a Single(k) plan.

The plans are often times the most advantageous for self-employed individuals that have no employees and want to have access to higher pre-tax contribution levels.  For all intensive purposes it is a 401(k) plan, same contributions limits, ERISA protected, they allow loans and Roth contributions, etc.  However, they can be sponsored at a much lower cost than traditional 401(k) plans because there are no non-owner employees.  So there is no year-end testing, it’s typically a boiler plate plan document, and the administration costs to establish and maintain these plans are typically under $400 per year compared to traditional 401(k) plans which may cost $1,500+ per year to administer.

The beauty of these plans is the “employee contribution” of the plan which gives it an advantage over SEP IRA plans.  With SEP IRA plans you are limited to contributes up to 25% of your income. So if you make $24,000 in self-employment income you are limited to a $6,000 pre-tax contribution.

With a Single(k) plan, for 2016, I can contribute $18,000 per year (another $6,000 if I’m over 50) up to 100% of my self-employment income and in addition to that amount I can make an employer contribution up to 25% of my income.  In the previous example, if you make $24,000 in self-employment income, you would be able to make a salary deferral contribution of $18,000 and an employer contribution of $6,000, effectively wiping out all of your taxable income for that tax year.

Simple IRA

Simple IRA’s are the JV version of 401(k) plans.  Smaller companies that have 1 – 30 employees that are looking to start a retirement plan will often times start with implementing a Simple IRA plan and eventually graduate to a 401(k) plan as the company grows.  The primary advantage of Simple IRA Plans over 401(k) Plans is the cost. Simple IRA’s do not require a TPA firm since they are self-administered by the employer and they do not require annual 5500 filings so the cost to setup and maintain the plan is usually much less than a 401(k) plan.

What causes companies to choose a 401(k) plan over a Simple IRA plan?

• Owners want access to higher pre-tax contribution limits

• They want to limit to the plan to just full time employees

• The company wants flexibility with regard to the employer contribution

• The company wants a vesting schedule tied to the employer contributions

• The company wants to expand the investment menu beyond just a single fund family

401(k) Plans

These are probably the most well recognized employer sponsored plans since at one time or another each of us has worked for a company that has sponsored this type of plan.  So we will not spend a lot of time going over the ins and outs of these types of plan.   These plans offer a lot of flexibility with regard to the plan features and the plan design.

We will issue a special note about the 401(k) market.  For small business with 1 -50 employees, you have a lot of options regarding which type of plan you should sponsor but it’s our personal experience that most investment advisors only have a strong understanding of 401(k) plans so they push 401(k) plans as the answer for everyone because it’s what they know and it’s what they are comfortable talking about.   When establishing a retirement plan for your company, make sure you consult with an advisor that has a working knowledge of all these different types of retirement plans and can clearly articulate the pros and cons of each type of plan. This will assist you in establishing the right type of plan for your company. 

Michael Ruger

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How to Create a Business Plan

How to Create a Business Plan

Starting your own business can be an exciting and rewarding experience. It can offer numerous advantages such as being your own boss, setting your own schedule and making a living doing something you enjoy. But, becoming a successful entrepreneur requires thorough planning, creativity, and hard work. After making the decision to start your own business, you'll need to be realistic about the sort of goals and targets you want to achieve at first. Businesses need targets though, so be sure to set some.  Meeting targets does usually indicate business growth and success, so that's why they are so important. As with any business though, it all starts with a solid plan...

Learn from those before you

Before you make the leap to start your own business, make sure you talk or work for the person that you want to be 5 years from now. Working in the industry before taking your leap of faith will most likely increase your success rate. On the surface some businesses seem simple and straight forward. No business ever is. You have to figure out how the successful companies in that industry currently make money, what are their margins, who are the customers, who are the competitors, and more importantly what are the missteps that you should avoid when building you own business.

You must be able to answer these questions

1. Why am I starting a business?

2. What kind of business do I want?

3. Who is my ideal customer?

4. What products or services will my business provide?

5. Am I prepared to spend the time and money needed to get my business started?

6. What differentiates my business idea and the products or services I will provide from others in the market?

7. Where will my business be located?

8. How many employees will I need?

9. What types of suppliers do I need?

10. How much money do I need to get started?

11. Will I need to get a loan?

12. How soon will it take before my products or services are available?

13. How long do I have until I start making a profit?

14. Who is my competition?

15. How will I price my product compared to my competition?

16. How will I set up the legal structure of my business?

17. What taxes do I need to pay?

18. What kind of insurance do I need?

19. How will I manage my business?

20. How will I advertise my business?

Do not spend a dime until you can clearly answer all of these questions otherwise you are leaving your fate to chance.

Write your business plan

Your business plan is your roadmap to success. Business plans typically forecast out 3 to 5 years. Any shorter than that and you will have no idea where you are going with the business. Any longer than that is irrelevant because you may need to make material adjustments to your plan within the first 3 years as obstacles present themselves and as the competitive landscape changes along the way. Here are the key elements that you will want include in your business plan:

Executive Summary: Your executive summary is a snapshot of your business plan as a whole and touches on your company profile and goals. Read these tips about what to include.

Company Description: Your company description provides information on what you do, what differentiates your business from others, and the markets your business serves.

Market Analysis: Before launching your business, it is essential for you to research your business industry, market and competitors.

Organization & Management: Every business is structured differently. Find out the best organization and management structure for your business.

Service or Product Line: What do you sell? How does it benefit your customers? What is the product lifecycle? Get tips on how to tell the story about your product or service.

Marketing & Sales: How do you plan to market your business? What is your sales strategy? Read more about how to include this information in your plan.Funding Request: If you are seeking funding for your business, find out about the necessary information you should include in your plan.

Financial Projections: If you need funding, providing financial projections to back up your request is critical. Find out what information you need to include in your financial projections for your small business.

Your Competitive Advantage: What makes your business unique? Determining this could help you stand out from the crowd and give you advantages over your competitors.

Appendix: An appendix is optional, but a useful place to include information such as resumes, permits and leases. Find additional information you should include in your appendix.

Surround yourself with a great team of advisors.

Most business should have an accountant to ensure your books are correct and that all of the money your business is involved with is accounted for. You will collaborate with an attorney.  You will also need a financial advisor. they will provide you with advice on where you can spend more money, what do you need to keep back or whether you need to reduce the money your spending on marketing for example. These professionals will help you to get your business established and help you with the key decisions that need to be made when you are establishing a business for the first time.

• How should I incorporate?

• What business expenses can I deduct?

• How much cash do I need to sustain my business on a monthly basis?

It is likely that many of these professionals will be working with a client in your industry so they can provide you with real world guidance on the pros and cons of the decisions that you have to make.

Rule #1: Make sure you trust and like who you are working with. Do not just select a firm because they have a big name or because your friend uses them. You are going to be busy building your business so you will rely heavily on your team of professional advisors to make sure from a legal, tax, and financial standpoint that you are maximizing your resources.

Michael Ruger

About Michael.........

Hi, I'm Michael Ruger. I'm the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.