Safe Harbor 401(k) or Simple IRA – Which retirement plan is best for my small business?

It’s one of the most frequent discussions we have with new dental practice owners: “What retirement plan should I choose for my new practice? A friend recommended a Simple IRA and another colleague has a 401(k). Which is right for me?”

The right answer usually comes down to a single question: How much do the owner(s) plan to save? Let’s take a look at the steps we walk through in the selection process.

Identify the practice owners’ retirement savings budget. In our plan design process, we work to identify the total annual budget available to work toward their goals. After prioritizing their goals and dividing the budget between retirement, debt repayment, emergency reserve funding and insurance plans to protect their income, we isolate the retirement savings budget to help us choose the best plan.

Review suitable options. Many retirement plans restrict the owner’s contributions based on the staff’s average savings rate, even if this is well below the annual maximum. However, two plan types avoid this: the Simple IRA and the Safe Harbor 401(k). Because each plan offers a predetermined company contribution or matching contribution, owners contributions aren’t limited by the staff’s savings rate. Each plan has its own set of pros and cons, but we see a majority of new practices come down to these two options.

Evaluate benefits of each plan.

• Pros of Simple IRA
  • Generally no administrative cost. Simple IRAs are usually inexpensive to administer because they don’t require annual tax filing, which is required for most 401k plans and completed by a third party administrator.
  • Lower company contribution requirements. Simple IRAs currently require a 3% match or a 2% company give to each eligible employee vs. 4% match or 3% give in a Safe Harbor 401(k).
• Pros of a Safe Harbor 401(k)
  • Higher contribution limit = higher potential tax savings. In 2019, a dentist with a $250,000 wage offering a matching Safe Harbor 401(k) could contribute $29,000 ($19,000 salary deferral + 4% match) vs. just $20,000 in a matching Simple IRA ($12,500 salary deferral + 3% match). In a 35% tax bracket, this saves an additional $2,625 in taxes.
  • Doesn’t complicate Roth conversions. This is a commonly overlooked benefit. Dentists earning more than $122,000 (single) or $193,000 (married filing jointly) will have their Roth IRA contributions reduced or eliminated, which makes the Roth conversion an attractive option. Funds held in any pre-tax IRA, including a Simple IRA, make at least a portion of each conversion taxable. 401(k) funds aren’t counted as IRA funds and don’t count against you in this conversion. 
  • Allows Roth 401(k) contributions. For practice owners looking to boost tax-free income in retirement, particularly younger docs or new practice owners with large current deductions, the 401(k) allows for Roth savings. These funds, including any gains, are tax free when withdrawn after 59.5 years of age.
  • Allows optional profit-sharing. Some practice owners looking to boost their savings may benefit from the additional profit-sharing allowed in 401(k) plans. These aren’t required and are we help evaluate these each year along with your third-party administrator and CPA.

Choose the best plan. Using our starting question, the answer usually becomes clear. A Simple IRA is a great start for a dentist with tight cash flow looking for a plan that allows their employees to save with minimal cost to the practice. A Safe Harbor 401(k) is a great choice for dentists who have cash flow to start focusing on their own retirement. Among our clients, the Safe Harbor 401(k) has been the most common solution to balance cost effectiveness and savings ability. 

As always, we recommend this selection process to be a part of a comprehensive financial plan. A retirement plan is an great tool, but the big picture financial plan is an invaluable guide to help make sure your savings strategies are working toward the real goal: financial independence – that magic day when you can choose to keep practicing but no longer need the paycheck.