Simple 401k vs Traditional 401k

Both the simple 401k and traditional 401k have some potential benefits for you when saving for retirement. However, they each have unique features that could make them desirable to you individually. Here are a few things to consider about the simple 401k and traditional 401k. 

Traditional 401k

A traditional 401k is typically considered a retirement account option for large companies. This is a retirement account that is often offered as a benefit to employees. With this type of account, the employee can contribute a percentage of her salary to the account. She is allowed to contribute as much as $16,500 per year to her account. In addition to the contributions the employee makes to her own account, the employer can contribute money to the account. With a traditional 401k, the employer can contribute as much as 25 percent of an employee's annual salary to the account.

Simple 401k

The simple 401k is a retirement account option that smaller companies can take advantage of. In order to qualify for the simple option, you must have fewer than 100 employees. With this type of account, employees can make contributions out of their pay. However, they are allowed to contribute only as much as $11,500 per year. Employers are also allowed to make contributions to their employees' accounts. With the simple 401k, employers can choose to contribute as much as 3 percent of the employees' salary.

Similarities

These accounts have some similarities between them. Both accounts allow you to contribute pretax money. Therefore, with either option, you can take advantage of tax incentives and save more money for your retirement. Once the money is in the accounts, you are free to invest into the financial markets in order to increase your retirement funds. The money that you make from returns is allowed to grow tax-free as well. Then when you reach the age of 59 1/2, you can start withdrawing money from the account. At that point, you will start paying income taxes on the money that you withdraw.

Employers will be able to benefit by making contributions to either account. For each dollar that they contribute to an employee's account, they will get to deduct that amount from their taxable income at the end of the year. These accounts also help employers attract good employees and retain them over the long term.

Differences

These accounts also have a few distinct differences. The simple plan is much easier to administer than the traditional 401k. Traditional 401k's require regular testing in order to make sure that they are not getting top-heavy. If a 401k is being taken advantage of only by top employees, then the plan might lose its tax advantages. With a simple 401k, none of this testing is required. Using a simple 401k will also be less expensive for a business owner. There are fewer fees and less paperwork to worry about.



How do you qualify for a simple 401k?



In order to qualify for a simple 401k, you have to be a sole proprietorship, partnership, or a corporation. In addition to that, you have to be a business that has fewer than 100 employees. To qualify for this plan, you cannot have more than 100 people that made more than $5000 in the previous year. If you work for an employer that offers a simple 401k, you have to be at least 21 years old and you have to have worked for the company for at least one year before you can start making contributions.



What is the maximum contribution for a simple 401k?



If you participate in a simple 401k, you have the option to make tax deferred contributions to your account every year. For each year, you have a maximum amount of money that you can contribute. As of 2010, you can contribute a maximum of $11,500 per year to your account. If you are over the age of 50, the IRS allows you to make an additional catch-up contribution of $2500. This allows you to put away more money towards your retirement as you are getting closer to being able to retire. Your employer also makes matching contributions to your account.

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