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Attention Business owners: When is it time to stop using a SIMPLE IRA Plan, and open a 401k?

There comes a time in all of our lives, when we realize we have to grow up. My wife and I are starting to plan for a family, and the days seem to be numbered for my beloved 2003 Jeep Wrangler with over 150,000 miles on it. It still runs great and gets me where I want to go, but from a practical standpoint, my wife and I have outgrown it. While it certainly has served its purpose, it’s now time to get a more family oriented car. As I meet more and more business owners, I’m finding that many of them are starting to feel the same way about their current retirement plan…that maybe they have outgrown it.

Business owners I’ve spoken with are frustrated that they “pay too much in taxes” and at the same time worry that they “do not have more saved for retirement.” If you are a business owner and have been using a SIMPLE IRA Plan, you may have outgrown it! Let’s go through some of the telltale signs.

SIMPLE IRAs EXPLAINED
When it comes to investing and planning for retirement, it’s rare that the word “simple” can be used to describe anything. In this case however, the SIMPLE IRA does live up to its moniker, as these retirement plans are fairly cheap to maintain, easy to set up and require very limited ongoing administration from the employer. The paperwork needed to start the plan is fairly easy to fill out and yearly filings are minimal. If you’re just starting a new business and need a retirement plan, the SIMPLE Plan can be a great option.

While I’m a huge believer in KISS (keep it simple, stupid) there comes a time when the effort that comes with creating a 401k plan may, in fact, be worth it. The other day I was meeting with a business owner and they started to vent their frustration with their SIMPLE Plan. They were very weary of the cost and extra liability that comes with a 401k plan, but as we talked more the decision became fairly obvious. The ease of a SIMPLE plan can be the same reason that a business owner finally realizes they have outgrown it.

Here’s a list of some of the short comings that come with a SIMPLE:

LIMITATIONS OF SIMPLE IRAs


Employee Contribution Limits are much less than 401k plans
This is one of the topics most often mentioned, because a SIMPLE plan limits employee contribution limits to $12,500 for those who are under 50 years old, and rises to $15,500 for those over age 50. However, the 401k contribution limits max out at $18,000 for those under 50 and then rises to $24,000 for those over 50!

If a business owner was able to maximize their employee 401k contributions from age 50 to 65, assuming no change in the current contribution limits, they would be able to sock away an extra $136,000 during those years compared to a SIMPLE Plan! For those business owners who are worried that they haven’t saved enough for their own retirement, think about what that extra $8,500 a year in retirement savings could do to your retirement projections.

Employer Contribution are less flexible compared to 401k plans
The first limitation with employer contributions and a SIMPLE Plan is the inability to institute a vesting schedule. Helping your employees achieve their retirement goals is an admirable goal, but you still may want the flexibility that comes with a 401k plan that allows you to manage your costs effectively while still retaining quality talent.  The ability to institute a vesting schedule with your retirement plan maybe attractive, given your type of work and the employees you hire.

The second limitation once again applies to caps on how much can be contributed to the retirement plan, in this case by the employer. Employer contributions in the SIMPLE plan are limited to two main choices, a 2% non-elective contribution on behalf of all eligible employees or a 100% match on the employee’s 3% contribution. Compared to the options that a 401k offers employers, this simplicity may not be enough for you as the business owner. 401k plans can offer higher matches and just as important, they can also allow for profit sharing contributions. Again, depending on the type of business you are in, the increased flexibility of employer contributions for a 401k plan may be more attractive.

No Loan options
While we try to discourage folks from tapping their retirement accounts at all costs, we acknowledge that there may be times when having this option can be beneficial. Again, the lack of flexibility here for the SIMPLE can cause business owners to look to 401k plans as a viable option.

SIMPLE Plans do not offer a ROTH option
I believe this option is a tremendously powerful tool for many business owners, and one that may just be compelling enough to make them feel as if they have outgrown their SIMPLE plan. As you may know, the ability to fund a regular ROTH IRA phases out as one’s adjusted gross income rises. In addition, even if you can use a ROTH, there is still a limit on the amount you can contribute ($5,500 in 2015; $6,500 for those aged 50 or older).

We’ve discussed in the past the decision the difference between a traditional 401k and a ROTH, check out this link if you need an in depth refresher. The key point is that a ROTH 401k has NO income phase out limits! Thus for extremely successful business owners, the ROTH 401k maybe their only ability to fund these tax-free withdrawal types of retirement accounts.

Much like my family’s decision that perhaps we’ve finally outgrown my Jeep, there’s no seminal moment for a business owner to identify when they have outgrown their SIMPLE Plan. It’s a cumulative effect, as the little changes that have been made to options available to 401ks start to make it a more compelling decision. It’s also about changes in the marketplace for retirement plans. The fees associated with starting and running a 401k plan have come down dramatically. In fact, if you have a 401k and haven’t reviewed your pricing in a while, now is a great time to do so.

If you’d like help to decide if now is the right time to switch your current retirement plan, feel free to contact me at damey@strategicpoint.com, I’m happy to help!
Derek Amey serves as Managing Director and Portfolio Manager at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail him at damey@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.