SIMPLE 401(k)

A SIMPLE 401(k) is a type of defined-contribution plan that employers can offer to their employees. The SIMPLE in SIMPLE 401(k) is short for Savings Incentive Match Plan for Employees of Small Employers. This type of 401(k) has very specific rules about what kind of contributions and vesting schedule the employer must use.

SIMPLE 401(k) can also be known as a safe-harbor plan, because the employer doesn’t have to worry about constructing a plan that complies with many rules and restrictions. 

How Does It Work?

A SIMPLE 401(k) is much like the traditional 401(k), except that it has fewer rules than the latter. It gives the employer more freedom to design a plan for his or her employees’ retirement needs.

For example, an employer could offer SIMPLE 401(k)s to his entire staff or just some employees; traditional 401(k)s, on the other hand, must be offered to all full-time employees.

The SIMPLE 401(k), like the traditional 401(k), is funded by both employee and employer contributions. It can have a salary-deferral arrangement where the employee defers a portion of their wages to be withheld and placed in the SIMPLE 401(k).

Who Can Participate in a SIMPLE 401(k)

The SIMPLE 401(k) must be made available to all employees who work at the company, regardless of their age or employment status.

Employers also have the option of excluding employees from SIMPLE 401(k) par

Benefits of a SIMPLE 401(k)


  1. It is simple to maintain and administer: Administrators must be aware of their SIMPLE 401(k) responsibilities at all times.
  2. It is simple to design: SIMPLE 401(k)s can be designed and adopted quickly and easily, with little or no assistance from qualified financial professionals.
  3. It is simple for employees to understand: SIMPLE 401(k)s follow the same rules as traditional 401(k)s so employees do not have to learn a new system.
  4. It is simple (and legal) to fund: SIMPLE 401(k)s allow employers to make simple, on-time, and complete contributions for their employees’ benefit.

Drawbacks of a SIMPLE 401(k)

  1. Taxes: SIMPLE 401(k)s must meet Internal Revenue Service (IRS) SIMPLE 401(k) requirements to ensure that the simple 401(k) is qualified and that contributions are untaxed until withdrawn from the simple 401(k).
  2. Contributions: SIMPLE 401(k)s must perform very specific actions, such as making simple employer contributions to the SIMPLE 401(k), in order to be qualified.
  3. Vesting: SIMPLE 401(k) participants may not have the same vesting schedules as traditional 401(k) participants. It is important that employees understand how SIMPLE 401(k) vesting differs from traditional 401(k) vesting before they participate in a SIMPLE 401(k).

Alternative For a SIMPLE 401(k)

Here are some possible alternatives to the SIMPLE 401(k):

  1. Traditional 401(k): The employer must make required contributions to the SIMPLE 401(k), but employees have lower contribution limits, greater flexibility in investments and more complex transactions than SIMPLE 401(k) plans.
  2. SIMPLE IRA: Participants in a simple IRA cannot contribute more than $12,000 per year, which is significantly lower than the SIMPLE 401(k) contribution limit for small businesses, which is $54,000 per year.
  3. SEP (Simplified Employee Pension): This SIMPLE IRA is for small businesses with 100 or fewer employees. It has simple, lower contribution limits than SIMPLE 401(k) plans but may require the employer to make more complicated contributions.

The Bottom Line

Although SIMPLE 401(k)s are simple to administer, they may not be simple for employees, especially when it comes to paying taxes on SIMPLE 401(k) contributions. Employers must also comply with SIMPLE 401(k) plan rules in order to maintain their qualified status and avoid taxes on the SIMPLE 401(k).

If you are not sure how SIMPLE 401(k)s work, do not have the time or resources to research SIMPLE 401(k) requirements, or are looking for an easier way to administer SIMPLE 401(k) contributions, consider using another employer-sponsored retirement plan.

A SIMPLE 401(k) is a simple, tax-deferred retirement plan designed to make it simple for small business owners & employees to save for retirement.
A SIMPLE 401(k) is much like the traditional 401(k), except that SIMPLE 401(k)s have fewer rules than traditional 401(k)s. The simple 401(k) gives the employer more freedom to design a plan for his or her employees' retirement needs.
Employers can contribute simple pretax dollars to your simple 401(k), which reduces their taxable income & employees can grow their simple retirement account with compound interest, tax-free until they withdraw the simple 401(k).
SIMPLE 401(k)s are simple for simple employers to adopt, but employees must wait until they are 59 ½ years old to withdraw money without a 10% early withdrawal penalty. In addition, simple 401(k) contributions are subject to income tax when withdrawn from the simple retirement account.
A SIMPLE IRA is an alternative to a SIMPLE 401(k), with lower contribution limits, less investment flexibility, and more complicated transactions.

401(k) Plan | A Complete Beginner's Guide

401(k) Meaning

The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k).

Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.

Traditional 401(k) vs Roth 401(k)

There are two types of 401(k) plans: Traditional and Roth 401(k)s.

The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978.

With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn.

Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006.

Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free.

Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings.

Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.

Contributing to Your 401(k) Retirement Plan

Contributing to a 401(k) plan is traditionally done through one’s employer.

Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion.

If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade.

If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion.

To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn.

With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them.

Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire.

If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term.

You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket.

On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true.

In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up.

Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change.

A smart move may be to hedge your bets and divide your contributions between the two types of IRAs.

If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each.

In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other.

When you do decide which avenue to take, make sure to thoroughly evaluate your decision.

Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible.

Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky.

You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.

Pension vs 401(k)

Pensions are similar to a 401(k), but are a liability to a company.

If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement.

There is typically no option to grow this amount, but it also does not require any financial investment from the employee.

Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer.

401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.

How Much Should I Contribute to My 401(k)?

Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k).

There are limits on how much you can contribute to it that are outlined in detail below.

There are two methods of contributing funds to your 401(k).

The main way of adding new funds to your account is to contribute a portion of your own income directly.

This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)).

The system mandates that the majority of direct financial contributions will come from your own pocket.

It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return.

The second method comes from deposits that an employer matches.

Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee.

However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan.

This is especially important to keep in mind if you want to utilize both types of plans.

A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year.

For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000.

If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions.

The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.

Plan in Advance

Allow us to help you prepare and plan for your retirement ahead. Contact a financial advisor in St Helena, CA or visit our financial advisor page for other details.

401(k) Plan FAQs

Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.