Why This Retirement Plan Is Less Simple Than the Name Implies

two businesswomen looking at a simple ira on a tablet

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Just about anyone who has been employed by a company has heard of retirement plans like a 401(k) or an individual retirement account (IRA). One you might not be so familiar with is called a SIMPLE IRA.

But what exactly is a SIMPLE IRA, how can it help you achieve your retirement goals, and is it the right choice for you? Here's everything you need to know about it.

SIMPLE IRA Definition

A SIMPLE IRA is an employer-sponsored retirement plan offered within small businesses that have 100 or fewer employees. SIMPLE stands for "savings incentive match for employees." Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401(k) plan. But there are some distinct rules.

With a SIMPLE IRA, the employer matching incentive is built into the plan. The employer must either match the contributions employees make to their plan, up to 3% of salary, or make contributions for employees of a flat 2% of salary, whether or not the employee chooses to participate in the plan.

SIMPLE IRA vs 401(k)

This differs from 401(k) plans. An employer offering a 401(k) plan can choose whether to match employee contributions. Many do, but in difficult economic times, matching programs can be among the first benefits cut. Employers who choose to offer SIMPLE IRAs are generally required to match, dollar for dollar, from 1-3% of the employee's salary.

A SIMPLE IRA works a lot like a 401(k) plan. Contributions to the plan are made pre-tax, and the money in the plan accumulates tax-deferred until the money is withdrawn at retirement. If the money is withdrawn before age 59 1/2, you will pay a 10% penalty fee (25% if you withdrew within two years of enrolling in the plan).

Within a SIMPLE IRA, your employer will likely offer a wide variety of stock and bond mutual funds. If you are a small business employer, the decision to offer a SIMPLE IRA vs a 401(k) is often not so much about the size of your company or the number of employees, but how much you as the owner want to put into the plan. The contribution limits for a SIMPLE IRA are different than 401(k) contribution limits.

SIMPLE IRA Rules on Contributions 

In 2020, employees can generally contribute $13,500 to a SIMPLE IRA. The catch-up contribution limit is $3,000, making the SIMPLE IRA contribution limit $16,500 for participants age 50 or older.

That means if you are age 50 or older and your employer allows catch-up contributions, you can put an additional $3,000 into the SIMPLE IRA this year (contact your employer to confirm).

If you have a SIMPLE IRA and you participate in any other type of employer retirement plan during the year (such as a 401(k), for example), the limit on how much you can contribute to all of the plans is $19,500.

With a 401(k), individuals can save $19,500 in 2020 or up to $26,000 with a catch-up contribution. So, you can see, there is a big difference in the amount you can sock away in a 401(k) plan.

Small-business owners who are highly paid professionals, such as doctors, dentists or attorneys, tend to favor small-business 401(k) plans over SIMPLE IRAs because of the higher contribution limits offered with a 401(k).

Rollovers With SIMPLE IRAs

SIMPLE IRA rollovers are anything but simple if you have been invested in the plan for less than two years. If two years have passed since you've begun participating in the plan, you can move the money into a rollover IRA or new employer 401(k). If you've participated for less than two years, you can only roll it into another SIMPLE IRA or leave the money in the former employer's plan.

Disclaimer: The information included here is not professional financial advice. It is intended for guidance only. Any private (non-governmental) websites linked to from this piece are included for informational purposes and cannot be verified. While we every effort is made to ensure that this information is correct, it may vary depending on your own personal circumstances.

Article Sources

  1. Internal Revenue Service. "Choosing a Retirement Plan: SIMPLE IRA Plan." Accessed July 8, 2020.

  2. Internal Revenue Service. "Operating a SIMPLE IRA Plan." Accessed July 8, 2020.

  3. Internal Revenue Service. "SIMPLE IRA Plan FAQs - Distributions." Accessed July 8, 2020.

  4. Internal Revenue Service. "Retirement Topics - SIMPLE IRA Contribution Limits." Accessed July 8, 2020.

  5. Internal Revenue Service. "Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits." Accessed July 8, 2020.

  6. Internal Revenue Service. "SIMPLE IRA Withdrawal and Transfer Rules." Accessed July 8, 2020.