SIMPLE IRA Plans for Small Business Owners and Employees

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"SIMPLE IRA" is an acronym for Savings Incentive Match Plan for Employees Individual Retirement Account. This type of IRA makes sense for small businesses, in part because of its reduced cost and maintenance compared to other retirement plans.

The SIMPLE IRA works well as a start-up retirement plan for small employers who do not currently sponsor retirement benefits like a 401(k) plan or a 403(b) plan. Like other kinds of individual retirement accounts (IRAs), employees in the program can choose to make salary reduction contributions, and the employer makes matching or nonelective contributions.

How the Plan Works

In a SIMPLE IRA plan, the employer establishes an IRA for each employee. Both the employer and employees can then contribute to these accounts. Both the employer and the employees earn tax benefits at the time of contribution.

Employees are always 100% vested in the funds in their SIMPLE IRA accounts. In other words, if they leave their job, they can take all of the funds with them, including any contributions from the employer.

Qualifications for Establishing a SIMPLE IRA

SIMPLE IRAs are designed for small businesses. To qualify to establish one, a company can have no more than 100 employees who earn at least $5,000 per year. For companies that meet those qualifications, they only need to fill out forms with the IRS, establish IRA accounts for employees, and inform employees about their options regarding the SIMPLE IRA plan.

Advantages of a SIMPLE IRA

There are several advantages, both to employers and employees, in setting up a SIMPLE IRA plan. For one, the administrative costs to establish and maintain a SIMPLE IRA plan are lower compared to other alternatives. It's also an easy process to set one up.

As with other types of retirement accounts, employees covered by a SIMPLE IRA enjoy the advantage of making salary reduction contributions to their individual SIMPLE IRA account through regular payroll deductions. They will receive a tax break: Employee salary reduction contributions to a SIMPLE IRA, while not deductible on Form 1040, have the effect of a deduction as they're excluded from wages and other compensation listed on Form W-2 and therefore aren't reported as income on your Form 1040. What's more, the investments in the account can grow tax-deferred until withdrawn at retirement.

For employers, there's the advantage of flexibility for contributions. They can choose to either match the employee contributions to their individual SIMPLE IRA accounts, or the company can contribute a fixed percentage of all eligible employees’ pay to each account. Specifically, the employer can either match their employees’ contribution dollar-for-dollar up to 3% of pay, or they can choose to contribute a regular, nonelective 2% for each eligible employee.

If the employer chooses the latter, that can be another advantage for employees, because it means that even employees that don’t save anything from their paycheck will receive the 2% employer contribution into their SIMPLE IRA.

The employer who sponsors a SIMPLE IRA plan generally has no filing requirements with the IRS, which makes the system even easier for the employer. The financial institution that handles the investments for the SIMPLE IRA typically handles most of the work.

Employee salary reduction contributions aren't technically deductible but are excluded from W-2 income so have the effect of reducing your income as a deduction would.

Account Contribution Limits

Business owners who want to save more for retirement may find that the SIMPLE IRA contribution limits are more generous than other IRA options. That’s because both the company and the individual can contribute, meaning that even self-employed people get to benefit from SIMPLE IRAs. They can effectively match their own contribution, giving them the ability to contribute more than double the amount allowed by a traditional IRA retirement account.

For 2020 and 2021, employees can contribute up to $13,500 to a SIMPLE IRA. Employees who are 50 or older can make additional "catch-up" contributions of $3,000, for a total of $16,500. Additionally, if an employee participates in any other plan during the year and has elective salary reductions under those plans, the employee can contribute a maximum of $19,500 across all plans.

Make catch-up contributions of up to $3,000 to a SIMPLE IRA to reach your retirement savings goals faster.

SIMPLE IRA Withdrawals

Employees can make SIMPLE IRA withdrawals before retirement age, but not without serious repercussions. The IRS considers SIMPLE IRA withdrawals as income to the account holder, so the money will be subject to regular income taxes.

In addition to standard income taxes—as with a traditional IRA account—the IRS assesses a 10% penalty for early withdrawal on all SIMPLE IRA account withdrawals before the age of 59.5. If the employee makes those withdrawals within the first two years of participation in the SIMPLE IRA plan, the penalty tax rises to 25%.

There are some exceptions to this tax penalty, the most common of which may be unreimbursed medical expenses that exceed 10% of a person's gross adjusted income.

Article Sources

  1. IRS. "Choosing a Retirement Plan: SIMPLE IRA Plan." Accessed Nov. 9, 2020.

  2. IRS. "IRA-Based Plans." Accessed Nov. 9, 2020.

  3. IRS. "SIMPLE IRA Plan FAQs – Contributions." Accessed Nov. 9, 2020.

  4. IRS. "SIMPLE IRA Plan FAQs – Establishing a SIMPLE IRA Plan." Accessed Nov. 9, 2020.

  5. Internal Revenue Service. "Retirement Plans for Self-Employed People." Accessed Nov. 9, 2020.

  6. IRS. "2021 Limitations Adjusted as Provided in Section 415(d), etc," Pages 1–2. Accessed Nov. 9, 2020.

  7. IRS. "Retirement Topics – SIMPLE IRA Contribution Limits." Accessed Nov. 9, 2020.

  8. IRS. "SIMPLE IRA Withdrawal and Transfer Rules." Accessed Nov. 9, 2020.