What Is a SIMPLE 401k and How Does It Work?

A Savings Incentive Match Plan for Employees, or SIMPLE 401(k), is a retirement savings plan tailored for small businesses. It is designed to be less complex and more affordable to manage than a traditional 401(k), making it an accessible option for employers who might not otherwise offer retirement benefits. This plan structure merges features from SIMPLE IRAs and traditional 401(k)s. The design provides a straightforward retirement savings vehicle without the extensive administrative requirements of more complex plans.

Employer and Employee Eligibility

For an employer to establish a SIMPLE 401(k), the business must have 100 or fewer employees who earned at least $5,000 in compensation during the preceding calendar year. If a company grows beyond this limit, it can generally maintain the plan for a two-year grace period. An important rule is that the employer cannot maintain any other retirement plan for the same employees.

Employee eligibility to participate is also defined by specific criteria. Generally, an employee can participate if they are at least 21 years old and have completed one year of service with the employer, which includes working at least 1,000 hours. An employer has the flexibility to set less restrictive eligibility rules but cannot make the requirements more stringent than these federal standards.

Contribution and Vesting Rules

Employee contributions, known as salary deferrals, are made on a pre-tax basis directly from their paychecks. The Internal Revenue Service (IRS) sets annual limits on these contributions. An employee can defer up to $17,600. Employees age 50 or over are permitted to make additional “catch-up” contributions to save more. The standard catch-up contribution is $3,500, though a higher catch-up amount of $5,250 is available for participants ages 60 through 63.

A defining feature of a SIMPLE 401(k) is the mandatory employer contribution. The employer must choose one of two contribution formulas each year. The first option is a dollar-for-dollar matching contribution on employee deferrals, up to a maximum of 3% of the employee’s compensation. The second option is a non-elective contribution of 2% of compensation for every eligible employee, regardless of whether the employee chooses to contribute.

A significant benefit for employees is immediate vesting. All contributions, including the employee’s salary deferrals and the employer’s contributions, are 100% vested from the moment they are deposited. This means the employee has full ownership of the account balance and will not forfeit employer contributions if they leave the company. A SIMPLE 401(k) plan may also permit participant loans, an optional feature determined by the employer.

Establishing a SIMPLE 401k Plan

The process of setting up a SIMPLE 401(k) involves several steps that must be completed within specific timeframes. For an existing business, the plan must generally be adopted by October 1 of the year it is to become effective. This deadline ensures that employees have adequate notice before the start of the plan year.

Next, the employer must select a financial institution to act as the plan’s trustee and administrator, which will hold the plan’s assets in a trust. The employer then completes and signs a formal plan document outlining the plan’s rules. Most financial institutions provide a prototype plan document that meets IRS requirements, simplifying this task.

Once the plan document is in place, the employer must inform all eligible employees about the new benefit. This involves distributing a formal notification or a Summary Plan Description (SPD), which explains the plan’s features, contribution options, and eligibility requirements. This notification must be provided to employees before the plan’s effective date.

Operating the Plan Annually

After a SIMPLE 401(k) is established, the employer has ongoing administrative responsibilities. A primary duty is to ensure that employee salary deferrals and employer contributions are deposited in a timely manner. Employee contributions should be deposited as soon as they can be reasonably segregated from company assets, but no later than the 15th business day of the month following the month they were withheld.

Employers with a SIMPLE 401(k) are generally required to file Form 5500, Annual Return/Report of Employee Benefit Plan, with the Department of Labor each year. The specific version of the form, such as Form 5500-SF for small plans, depends on the number of participants. The deadline for this filing is the last day of the seventh month after the plan year ends, which is typically July 31 for a calendar-year plan.

The plan administrator must also manage distributions for employees who retire or terminate their employment. This involves processing the necessary paperwork to pay out the vested account balance or to facilitate a direct rollover into another retirement account. The administrator is also responsible for providing participants with a Summary Annual Report (SAR), which is a synopsis of the information filed on the Form 5500.