The abbreviation SIMPLE stands for Savings Incentive Plan for Employees and there are two types of SIMPLE plans available, namely SIMPLE IRA and SIMPLE 401(k) plans. A SIMPLE 401(k) plan is essentially a cross between a traditional 401(k) plan and the SIMPLE IRA providing some benefits of both.

The SIMPLE 401(k) plan can be offered only by businesses that have fewer than 100 employees where each employee receives more than $5,000 in that calendar year. Also, to be eligible, the company should not offer any other retirement plans. For the employees to be eligible, the same rule of traditional 401(k) applies. The rule states that an employee must be of age 21 and older and should have completed one year of service with the company.

The pros and cons of a SIMPLE 401(k) are as follows.

• Pros

In traditional 401(k) plan, the employer has to undertake ADP/ACP testing and top-heavy testing to make sure that the 401(k) plan is in accordance with the regulatory requirements. Such testing requires hiring qualified professional which tend to be costly. SIMPLE 401(k) plans are exempted from these testing, making the operations of the plan lighter on the employer’s pocket. This enables the employer to avail of the features of the traditional 401(k) plan without the additional higher costs.

SIMPLE 401(k) plan allow loans. This is an attractive feature for business owners and employees alike because the loan feature of qualified plans allow them to borrow from their own savings, saving them other hassles like credit check.

• Cons

Contributions made to SIMPLE 401(k) plan become 100% vested immediately. This poses a problem of high employee turnover and also employees who qualify for distributions may withdraw all amounts at any time. Contrary to this, in the traditional 401(k), contributions made by the employer can be subjected to vesting schedule.

The contribution limits for SIMPLE 401(k) are lower than traditional 401(k) plan. The contribution limit for traditional 401(k) for 2010 is $16,500 for employees of age 49 and below and employees of age 50 and above can contribute an additional ‘catch-up’ amount of $5,500. In case of SIMPLE 401(k), for employees of age 49 and below the limit is $11,500 for the years 2010 and 2011 and employees of age 50 and above can contribute an additional ‘catch-up’ of  $2,500.

Unlike traditional 401(k) plan, in SIMPLE 401(k) plans, the employer must make a contribution. However the contribution limits for employers are low as well. The employer can make a dollar to dollar match only up to 3% of employee contribution (with traditional 401(k) it is up to 25%). Or the employer can choose to make a non-elective contribution of 2% of each eligible employee’s pay.

Also, the employer cannot offer any other plans to the employee. On the contrary, if certain requirements are met, employers offering traditional 401(k) plan can also offer SEP, other defined contribution plans or profit sharing plans along with traditional 401(k) plan to eligible employees.

SIMPLE 401(k) plan is a good option for small businesses as they are simple to administer and also are not costly to operate.