Employers are considering whether 401 (k) plan is now a better option than SIMPLE IRA or SEP IRA. Why?
SECURE 2.0, by introducing several enhancements and incentives, makes 401(k) plans more attractive and accessible for both employers and employees. Here are the key reasons:
Increased Tax Credits for Small Businesses
SECURE 2.0 significantly increases the tax credits available to small businesses for starting new 401(k) plans. Businesses with up to 50 employees can receive a credit covering 100% of the administrative costs of setting up a 401(k) plan, up to $5,000 per year, for the first three years. Additionally, a new credit is available for up to $1,000 per employee for employer contributions, phased down gradually for businesses with 51 to 100 employees. These credits make the initial cost of establishing a 401(k) plan much more affordable compared to SIMPLE or SEP IRAs, which have fewer available incentives.
Greater Contribution Flexibility and Limits
401(k) plans allow both employer and employee contributions, with higher contribution limits and more flexibility in structuring these contributions. Employees can defer up to $23,000 in 2024 ($30,500 if age 50 or older with catch-up contributions), which is higher than the limits for SIMPLE IRAs of $16,000 in 2024 ($19,500 if age 50 or older). This offers employees the potential for higher retirement savings through greater contribution limits and diversified company contribution options. Employers can also make additional contributions, including profit-sharing, and these contributions are not limited to a specific formula like those required for SEP IRAs, where every eligible employee will be rewarded the same way. This flexibility can be especially appealing for companies looking to reward certain employees who have made more valuable contributions than others and to offer more robust retirement savings options to employees.
Employer contributions
401(k) plans provide more flexibility with company contributions, including both matching contributions and profit-sharing options, and allow employers to contribute up to 25% of an employee's compensation, subject to annual limits. In contrast, SIMPLE IRAs require employers to either match employee contributions up to 3% of their salary or provide a non-elective contribution of 2% of compensation for all eligible employees, which offers less flexibility. SEP IRA, though allows the same up to 25% employer contribution, the contribution should be the same % for all eligible participants and fully vested.
Vesting schedule
401(k) plans allow employers to implement a vesting schedule for their contributions, meaning employees may need to remain with the company for a certain period to fully own those contributions. This can range from immediate vesting to graded schedules over several years. SIMPLE IRAs, on the other hand, require immediate vesting of all contributions, which means employees own the funds as soon as they are contributed. This flexibility in vesting schedules makes 401(k) plans more appealing for employers looking to encourage long-term retention.
Roth and After-Tax Options
The SECURE 2.0 Act enhances the attractiveness of 401(k) plans by expanding Roth options. While SIMPLE IRAs and SEP IRAs now also allow Roth contributions under SECURE 2.0, 401(k) plans have a long-established history of offering both pre-tax and Roth contributions, as well as in-plan Roth conversions.
New Withdrawals and Emergency Savings Provisions
SECURE 2.0 introduces new provisions for penalty-free withdrawals for emergencies, terminal illnesses, and domestic abuse, as well as the creation of emergency savings accounts linked to 401(k) plans. These features provide greater flexibility and access to funds in unexpected situations, which are not typically available in SEPs or SIMPLE IRAs.
This is just a highlight of why employers are considering replacing their SIMPLE IRA/SEP IRA plans. If you’re interested in pursuing a 401(k) Plan, talk to your certified employee benefit specialist (CEBS) to help determine if moving to a 401(k) Plan is right for your business. Keep in mind that it’s best to get the wheels in motion a few months before you want the plan to go live – in order to meet the required participant notification requirements. And, if your new plan will benefit from certain 401(k) Plan provisions, such as safe harbor or automatic enrollment – those require advance participant notification as well.
Securities offered through Registered Representatives of Cambridge Investment Research Inc., a broker-dealer, member FINRA/SIPC. Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Cambridge does not offer tax or legal advice. Cambridge and American Financial Alliance, Inc. are not affiliated.
Sources:
1) https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit
2) https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits
3) https://www.irs.gov/newsroom/secure-2-point-0-act-impacts-how-businesses-complete-forms-w-2