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SIMPLE 401(k): Rules & if it can work for your business

Business owner on tablet
Tom Werner/Getty Images

If you own a small business or are employed by one, you know it has some perks. For instance, you're never lost in the crowd like some people are when they work at large corporations.

But a common question is how small businesses can compete with big employers when it comes to benefits—especially retirement plans. Small businesses actually have a few options when it comes to helping employees save for retirement.

Let's take a look at how it works for employers and employees, as well as who can take advantage of these plans and contribute to their retirement savings just like people at larger companies.

What is a SIMPLE 401(k)?

It's a retirement plan right-sized for small business. A SIMPLE 401(k)—short for Savings Incentive Match PLan for Employees—resembles traditional 401(k) plans, but it costs less and is easier to administer. They are designed to suit the unique needs and resources of small businesses. Like a traditional 401(k), the SIMPLE version gives employees a way to save and invest a portion of their income, in pretax dollars, for retirement. Money in the account—including employer contributions, employee contributions and earnings—can accumulate tax-deferred until the account holder makes withdrawals, which usually occurs during retirement.

For the employer, maintaining a SIMPLE 401(k) plan doesn't involve an excessive amount of work. Every year, you must submit Form 5500 to the IRS and provide your employees with deferral notices that explain their participation rights.

Who is eligible for a SIMPLE 401(k)?

Many types of small businesses, including sole proprietors, partnerships and corporations, are eligible to offer a SIMPLE 401(k). Employers only need to satisfy a few requirements, and employees must meet certain criteria to participate.

Employer eligibility to offer a SIMPLE 401(k)

  • Have 100 or fewer employees who earned at least $5,000 from your business during the previous year (If you're in growth mode, don't worry. You have a two-year grace period in which you can keep offering the plan if your staff exceeds that 100-employee limit.)
  • Offer no other retirement plans to employees who are eligible to participate (You can, however, offer an alternate plan for ineligible employees).

Employee eligibility to use a SIMPLE 401(k)

  • Must be older than age 21; those younger should consider other retirement savings options until they reach age 21
  • Have worked for the business for one year or longer
  • Have logged at least 1,000 hours within one year

What are the differences between a traditional and SIMPLE 401(k)?

While traditional and SIMPLE 401(k) plans are similar in many ways, there are important distinctions. For starters, all SIMPLE 401(k) contributions are immediately fully vested. That means that once an employee becomes eligible to make qualified withdrawals, their entire balance is available. That's not necessarily true with a traditional 401(k), which may require a waiting period before the account holder is fully vested.

SIMPLE 401(k) plans also are not subject to traditional 401(k) rules that require all eligible employees to receive the same benefits. This can allow a small business owner to skip potentially costly testing processes that otherwise might be necessary for compliance.

SIMPLE 401(k) contribution limits for employers & employees

Unlike a traditional 401(k), a SIMPLE 401(k) requires that the employer contribute to employees' accounts. There are two options:

  • Matching contributions, up to 3% of each participating employee's pay
  • Nonelective contributions of 2% of each eligible employee's pay

Matching contributions equal what a participant puts in from their own paycheck, while nonelective contributions are provided regardless of how much an employee contributes. Whichever employer contribution method you choose, the money is over and above your employees' earnings. It does not reduce anyone's paycheck. Additionally, you're not allowed to make any other employer contributions.

Contribution limits may change from year to year. In 2024, an employee can contribute up to $16,000 to their SIMPLE 401(k). Participants age 50 and older may increase that with a catch-up contribution of up to $3,500. It's worth noting that those amounts are considerably lower than the maximum allowed for a traditional 401(k), which sits at $23,000 with a $7,500 catch-up contribution.

How SIMPLE 401(k) withdrawals and loans work

Typically, a SIMPLE 401(k) plan's funds remain in the account until the employee retires. At that point—or any time after the employee reaches age 59½—withdrawals (aka distributions) are taxed at the account owner's current income tax rate. Withdrawals made before an employee reaches age 59½ will likely be subject to a 10% penalty, unless an exception applies.

If you've left the employer and have turned 73, you need to take distributions by year-end. For the first year only, you can delay until April 1st of the following year. If employees are still working for you soon after they turn 73, they can hold off until shortly after they retire, as long as they own less than 5% of the business.

SIMPLE 401(k) plans also permit employees to take loans from their accounts without incurring an early withdrawal penalty. Generally, repayment is due within five years or when the employee leaves the job, whichever occurs first.

Benefits for employers and employees alike

For many small business owners and employees, a SIMPLE 401(k) makes sense. Plan participants can use their own pretax dollars, plus employer contributions, to build up retirement savings. It's a key way for smaller businesses to offer a valuable perk that helps them stay competitive with larger companies in attracting and retaining employees.

To explore this and other small business retirement plan options—such as a SIMPLE IRA—connect with a Thrivent financial advisor.