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401K va Simple IRA - The Basic Differences

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I am setting up a retirement account for two new employees in my twenty person company in Ohio. One of them asked about the difference between a 401K and a Simple IRA. I know that ERISA has some guidelines, but I’m not sure whether it requires one or the other in terms of a retirement plan. Please advise.

ERISA is called the Employee Retirement Income Security Act. The Act is guarded on a federal level, so your Ohio company must act within the same laws as a company in any other state. Basically, the ERISA is in place to ensure that employees receive the benefits that were promised to them. ERISA keeps an eye on two particular types of benefits: employee welfare programs (such as health insurance, life insurance, etc) and employee pension benefit plans. Currently, your two new employees are most interested in the pension aspect that the ERISA guards.

According to the terms of ERISA, the employee contribution plans (plans in which employees contribute a portion of their pay checks for retirement and other purposes) must be upheld when the employee retires. Most companies will have a 401K for their employees. However, small companies may offer benefits from a Simple IRA (not a Roth). The Simple IRA requires that the employee can only put away a percentage of the total revenue for the company annually. Usually, the Simple IRA is used by one-person companies while the 401K is the preferred solution for larger companies.

Keep in mind that while ERISA protect employee benefits, ERISA does not require that employee welfare programs be provided. However, there are state laws that may govern the employee benefits that your employees should receive.

Basically, to answer your employee’s question: the Simple IRA is usually used by free agents that work alone (or have very small businesses.) The 401K is a best practice retirement plan that is widely used. The Simple IRA funding is based on the net annual revenue for the company. The 401K contribution is based on a pre-determined amount that the employer agrees to in addition to the amount that the employee wishes to set aside from each pay check for the fund.