401(k) Advantages over SEP and SIMPLE IRAs
There are several retirement plan options a small business may want to consider. The main ones are a 401(k) plan, Simplified Employee Pension IRA known as the SEP IRA, or a Savings Incentive Match Plan for Employees IRA referred to as a SIMPLE IRA.
When you compare a 401(k) to SEP IRA and SIMPLE IRA options, the differences become clear. 401(k)s not only offer higher contribution limits, but also offer more flexibility in design to manage business costs, taxes, and enable penalty-free access to funds via a loan if an emergency arises. A summary of how these plan options vary includes:
| 401(k) | SIMPLE IRA | SEP IRA | |
|---|---|---|---|
| Who can contribute | Employee and employer. Employer contributions are optional. | Employee and employer. | Employer only; must contribute for all eligible employees. |
| Max employee contribution | $23,000 plus a $7,500 catch-up if you are age 50 or over. | $16,000 plus a $3,500 catch-up if you are age 50 or over. | Not applicable |
| Employer contributions | Optional, up to 25% of W-2 payroll with a $69,000 cap ($76,500 if over 50 years old) plus profit sharing options | Required match of 100% first 3% of participating employee contributions or 2% of all eligible employee salaries. | Optional, but only way to fund; up to 25% of W-2 payroll with a $69,000 cap. |
| Vesting timing for employer contributions | Multi-year options or immediate. | Immediate | Immediate |
| Access to funds before age 59½ | Penalty-free loans or 10% penalty for early withdrawal. | 25% penalty for withdrawing within first 2 years of participating; 10% thereafter. | 10% penalty for withdrawal before age 59½. |
| Roth contributions | Yes – up to $23,000 per year or $30,500 if age 50 or over; no income restrictions to contribute. | No | No |
A 401(k) may have a little more startup or administrative costs, but there are good low-cost providers such as ShareBuilder 401k that can make these negligible and these costs are typically tax deductible for the business. There aren't many reasons to consider anything other than a 401(k).