The SIMPLE IRA has lower setup and administration costs compared to the 401(k) plan. It requires Paul’s Paint -N-Plumbing, Inc.’s employees to make contributions up to $13,500. Employees aged above 50 years can contribute up to $16,500. On the other hand, the 401(k) plan requires employees to contribute amounts up to $19,500 and up to $26,000 if they are over 50 years old. The low contributions in the SIMPLE IRA option mean that Paul’s Paint -N-Plumbing, Inc. can reduce its salary costs significantly since the entity does not need to offer high salaries to enable the employees to meet the contributions. In terms of administration, the SIMPLE IRA does not have yearly tax filing necessities provided Paul’s Paint -N-Plumbing, Inc. sends the annual plan details to its employees. On the contrary, a qualified plan such as a 401(k) plan would require the entity to undergo non-discrimination testing (Rosenbloom & Hallman, 2014) . The entity’s 401(k) plan would need to undergo annual compliance testing to guarantee that the plan does not favor workers with high remuneration. Such bureaucratic prerequisites make the 401(k) plan more complicated than the SIMPLE IRA option. The SIMPLE IRA is easier to run than qualified plans, including the 401(k) plan, since it does not require vesting schedules and tax reporting. The SIMPLE IRA is advantageous over the 401(k) plan since it allows employees to invest in a wide range of options such as mutual funds or bonds (Rosenbloom & Hallman, 2014) . In this scenario, Paul’s Paint -N-Plumbing, Inc.'s employees have an excellent opportunity of increasing their returns. The 401(k) plan restricts investment options to promote plan compliance.
However, the SIMPLE IRA requires Paul’s Paint -N-Plumbing, Inc. to make mandatory contributions. The entity must make a matching contribution of up to three percent of the worker's remuneration or a contribution equal to two percent of the worker's remuneration even if the worker does not contribute. On the other hand, contributions made by employers in the 401(k) plan are optional. In this case, if Paul’s Paint -N-Plumbing, Inc. had chosen a 401(k) plan, it would not be required to make contributions. Resultantly, it would preserve its cash resources. SIMPLE IRA is disadvantageous since the entity’s contributions vest immediately and, for this reason, employees do not need to continue working to benefit from the matching contribution (Rosenbloom & Hallman, 2014) . Under such a plan, employees can easily leave. A 401(k) plan would allow Paul’s Paint -N-Plumbing, Inc. to implement vesting periods ensuring that workers stay for a long time to benefit from matching contributions. The SIMPLE IRA does not permit workers to take loans from their accounts in case of an emergency. In this case, it is less appealing to employees compared to the 401(k) plans, which permit workers to take loans from their accounts.
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Contribution and Deductibility Limits
Phillip, aged 55 years, can contribute up to $7,000 to a traditional IRA in 2021. Given that he is above 50 years, he can contribute an amount of $6000 plus an additional $1000, which is regarded as a catch-up contribution. Phillip must have earnings from working at Paul’s Paint -N-Plumbing, Inc., and he cannot put more money than he earns into his traditional IRA. In addition, he would have two retirement plans, namely the traditional IRA and SIMPLE IRA, and as a result, his IRA contributions would be deductible. If Phillip's filing status is single and his gross income is $66,000 or less, he would receive a full deduction of $7000 in 2021. If Phillips earns between $66,000 and $76,000, he would receive a partial deduction. If Phillips receives a gross income of $76,000 or more, he would not receive any deduction.
Dollar Limits and Phase-Out Levels
In 2021, the annual dollar limits for making contributions to the SIMPLE IRA and traditional IRA are $13,500 and $6,000 for individuals aged below 50 years. If the individual is aged 50 years or above, the annual dollar limits rise to $16,500 and $7,000 for SIMPLE IRA and traditional IRA, respectively. For traditional IRA, the phase-out level for an individual with a single filing status is $66,000 in 2021. If the income is between $66,000 and $76,000, there is a partial deduction. If the income is above $76,000, there is no deduction. If the individual is married, filing jointly, and is covered by the retirement plan at his work, the deduction starts phasing out at $105,000. Between $105,000 and $125,000, there is a partial deduction. When the gross income is above $125,000, the deduction disappears. A full deduction starts phasing out at $198,000 if the individual is married, filing jointly, and the spouse is covered by the retirement plan at their work. There is a partial deduction when their income is between $198,000 and $208,000. There is no deduction when the income is more than $208,000.
Tax Implications
If Pete takes a distribution from his SIMPLE IRA, he will have to pay income tax plus 25% tax on the amount he withdraws from his account. He will have to pay income tax on the withdrawn amount based on the federal tax rates. In addition, he will have to pay 25% tax on the withdrawn amount since his withdrawal has been made within two years from when he started contributing to the SIMPLE IRA plan.
Reference
Rosenbloom, J., & Hallman, G. (2014). Private wealth management: The complete reference for the personal financial planner . McGraw-Hill.
