For businesses with less than 25 employees, the allure of adopting a SIMPLE IRA as their employer-sponsored retirement plan is very tempting. Simple to set up – just set up an IRA for each eligible employee; and there is no administration. The required matching contribution is only 3 percent, and only on actual salary deferrals. It’s a quick and easy way to satisfy the obligation employers feel towards their employees as well as themselves to provide an important and generally expected benefit. However, for some employers, especially those which are top-heavy with highly compensated employees, it would be important to look beyond the simplicity and lower cost of a SIMPLE IRA to consider their limitations as well as the advantage of alternative plans, such as a Safe Harbor 401k.
In addition to cost, employers need to consider the plan’s deferral limits, eligibility requirements, required contributions and its flexibility in light of their own objectives, the company’s objectives, the demographics of the business and their business outlook. When considering each of these parameters, employers may not want to be too quick to jump into a SIMPLE IRA, simply because of its limitations and requirements:
- The maximum salary deferral is $12,500 (2015)
- Eligibility extends to any employee who earned more than $5,000 in the prior two years is eligible (which would include part-time employees)
- Although it does allow a either a matching contribution of at least 3 percent, or a profit sharing of 2% for all eligible employees, no other contributions may be made on an employee’s behalf
- Once a SIMPLE plan is adopted, no other plan can be adopted during that plan year
- After terminating a SIMPLE plan, no other plan may be established until the next year
The Advantages of a Safe Harbor 401k Plan
It should be stated right up front that a Safe Harbor plan is more expensive to establish and administer however, in the right circumstances, the benefits will far outweigh the costs.
Generally, the Safe Harbor plan is more flexible than other simple plans (SIMPLEs & SEPs), which may be important for smaller businesses that experience a lot of change and growth in their early stages. Plans can actually have a Safe Harbor Maybe Election that allows the plan to decide if the contribution will be made, or can be stopped in any given year depending on the employer’s circumstances at the time. Also, because it is built on a profit sharing structure, profit sharing contributions, which are discretionary, can be determined each year.
Higher Deferrals and Contributions for Highly Compensated Employees
The employee deferral contribution limit for Safe Harbor 401k plans is $18,000 (plus $6,000 catch up for employees over 50). However, employees can have total combined contributions of up to $53,000 ($59,000 for employees over age 50). This $59,000 limit can include additional matching or profit sharing contributions on top of the safe harbor contributions.
Tax and Cash Flow Management
The profit sharing component is determined each year, and employers can wait to make the contribution until the actual due date of the tax return in order to take the deduction for that year. This affords employers the opportunity to optimize cash flow.
Although the minimum required matching contribution is higher than a SIMPLE plan (4 percent vs. 3 percent), under Safe Harbor plan rules, employees can be required to meet up to the IRS statutory eligibility requirements. This IRS maximum is set at 1 year of service, attainment of age 21 and entry on a semi-annual basis. With 1 year of service being completion of 1000 hours during the relevant computation period. This excludes many part-time and seasonal employees from being eligible for the plan. Whereas a simple plan has to let any employee in who made at least $5,000 in the 2 preceding years and is expected to make at least $5,000 in the current year.
In addition, any profit sharing contributions made to employees can be subject to up to a 6-year vesting schedule which means only 20 percent is vested each year beginning with the 2nd year and each credited vested year can require up to 1000 hours.
Of course, there are several factors that need to be considered, including the costs to administer the plan. However, if there is at least one other eligible employee aside from the employer, the plan qualifies for a $500 tax credit during the first three years. But, for the substantially enhanced benefits to the employer and its highly compensated employees, it may be better to be SAFE than SIMPLE.