SIMPLE vs. Safe Harbor 401(k): Which Option Is Right for You?

As a small business owner or a sole proprietor, it’s important that you secure the proper retirement plan for yourself and your employees. With so many options available, the choice may seem confusing. SIMPLE 401(k) and a safe harbor 401(k) plan are two options that employers may find beneficial.

While both plan types are suitable choices, a safe harbor 401(k) plan may prove to be just what you need, and we’ll help you understand why.

What is a SIMPLE 401(k) and how does it work?

As the name implies, a SIMPLE 401(k) plan, (Savings Incentive Match Plan for Employees), is a less complex 401(k) account for small businesses. To qualify for a SIMPLE 401(k) plan, the business must have 100 or fewer employees who earn more than $5,000 per year. Like a typical traditional 401(k) account, plan participants contribute to their accounts using pre-tax dollars.

Employers must match employee contributions, which are immediately vested. Employers sponsoring a SIMPLE 401(k) plan cannot offer other types of retirement plans in the same year.   

Employees are eligible to enroll in this plan if they are:

• 21 years old or older
• Employed with the company for at least one year with 1,000 hours or more
• Earned at least $5,000 in the past year

What are the contribution limits to a SIMPLE 401(k)?

The most that a participant can contribute to their SIMPLE 401(k) account is $16,000 per year as of 2024. And participants who are age 50 or older can contribute an additional $3,500 catch up contribution.  

What are the pros and cons of a SIMPLE 401(k) plan?

A SIMPLE 401(k) plan can prove to be a great option for small to medium-sized business owners.  Advantages of enrolling your employees in a SIMPLE 401(k) plan include:

• Fully vested funds: Unlike traditional 401(k) plans that may require an employee to work a certain amount of time before becoming fully vested, employer contributions are fully vested at the time of allocation.
• The ability to make catch up contributions: Participants aged 50 or older can make catch up contributions and contribute a maximum of $19,500 per year (2024 limits)
• The ability to take out loans: If your employees are in need of cash, a SIMPLE 401(k) can be set up to allow them to take out a loan.

While a SIMPLE 401(k) account may prove to be the most cost-effective plan option, it’s not without its limitations. One drawback to enrolling in a SIMPLE 401(k) plan is its lower contribution limits than a 401(k) plan.  Unlike a 401(k) which allows for maximum employee contributions of $23,000, a SIMPLE 401(k) only allows $16,000.

The IRS also requires employers to provide participants with a SIMPLE 401(k) notice, which states, an employer must notify eligible employees within 60 days of the election period or on the day the election period starts, that they can make a cash or deferred election or modify prior to election. The notice must also state whether the employer will make matching contributions or nonelective contributions to the participant’s account.

What is a Safe Harbor 401(k) and how does it work?

A safe harbor 401(k) plan is a retirement plan option that can not only help you and your employees save for retirement but can also help protect the interests of your business.

Safe harbor plans allow businesses to skip certain non-discrimination tests that compare the contributions of highly compensated employees and non-highly compensated employees. For this reason, a safe harbor plan is a popular choice among small and medium-sized businesses.

There are two types of safe harbor 401(k) plans:

• Auto-enrollment: An employee can be automatically enrolled in a safe harbor plan via a Qualified Automatic Contribution Arrangement (QACA). Participants may opt out of contributions, and if the opt-out happens within 90 days of enrollment, may request a withdrawal of funds contributed.
• Traditional: A traditional safe harbor plan requires employers to contribute to employee accounts. This can be done in the form of a matching percentage of the employee’s salary or a non-elective contribution. Any funds that are contributed to an employee’s account are immediately vested.   

Additionally, employers are required to provide contributions to employee accounts to be considered a safe harbor plan. There are three types of contribution options.

1. Basic Safe Harbor Match: An employer will match 100% of the first 3% of an employee’s contribution, followed by 50% of the next 2% of contributions. To receive an employer match, the employee must contribute part of their paycheck to the account.
2. Enhanced Match: Like the basic match, employees are required to contribute funds to their account. With an enhanced match, employers can choose to match on a tier system of 100% of up to 4%, 5%, and 6%.
3. Non-Elective Contribution: Employers are required to make contributions to participant accounts whether the employee contributes to their own account or not. The minimum employer contribution is 3% of the participant’s salary.

Employers are required to notify plan participants of plan details within 30 days (and not more than 90 days) of the start of plan year.

The notice document must detail items including:

• The safe harbor employer contribution method in use
• Other contribution types in the plan
• Compensation information for deferrals
• How to make deferral elections and timeframes to do so
• The plan that will receive contributions
• Provisions regarding vesting and distributions
• Where to obtain additional information

What are the pros and cons of a safe harbor 401(k) plan?

There aren’t many downsides to adopting a safe harbor 401(k) plan for your company. It is a beneficial option for both employers and plan participants, with higher contribution rates and 100% vesting. 

Additionally:

• Vesting schedules can also be implemented by employers for employer contributions that are not safe harbor contributions.
• Plan participants may be able to take out loans against their safe harbor plan and the interest will be paid back to their account.

Conclusion:

A SIMPLE 401(k) plan may be cost-effective; however, a safe harbor 401(k) plan can offer you (and your employees) more bang for your buck. This could result in a feeling of security within the company and promote employee loyalty.