This retirement plan is less simple than the name implies

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Just about anyone who has been employed by a company has heard of retirement plans like a 401(k). One type that you might not be so familiar with is a Savings Incentive Match Plan for Employees, or a SIMPLE IRA for short.

Here's everything you need to know about a SIMPLE IRA, from how it can help you achieve your retirement goals, to whether it's the right choice for you.

SIMPLE IRA Definition

A SIMPLE IRA is an employer-sponsored retirement plan offered within small businesses that have 100 or fewer employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401(k) plan.

But some distinct rules apply to these accounts. Namely, with a SIMPLE IRA, the employer matching incentive is built into the plan. As such, the employer must either match the contributions that employees make to their plan, up to 3% (but no less than 1%) of their salary, or make contributions for employees amounting to a flat 2% of their salary, whether the employee chooses to contribute to the plan or not.

SIMPLE IRA vs. 401(k)

This plan type differs from the 401(k) plan. 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 to get cut. Employers who choose to offer SIMPLE IRAs are generally required to match, dollar for dollar, anywhere from 1% to 3% of the employee's salary.

In other respects, 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 Contributions to the plan are made pre-tax, and the money in the plan accumulates tax-deferred until it is withdrawn at retirement. If the money is withdrawn before age 59 1/2, you will pay both ordinary income tax and a 10% penalty on it (25% if you withdraw it within two years of enrolling in the plan).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 versus a 401(k) is often not so much about the size of your company or the number of employees, but how much cost and effort you want to invest to maintain the plan. Typically, SIMPLE IRAs don't impose a filing requirement on the employer, and operating costs are lower than those of 401(k) and other traditional retirement plans.

Generally, if you withdraw the money in a SIMPLE IRA before you reach the age of 59 1/2, you'll have to pay income tax and a penalty of at least 10% (but as much as 25%) on it depending on how long you've been participating in the plan.

Rules on SIMPLE IRA Contributions 

The contribution limits for a SIMPLE IRA are different from the 401(k) contribution limits. In 2022, employees can contribute $14,000 to a SIMPLE IRA, up from $13,500 in 2021. The catch-up contribution limit is $3,000, making the SIMPLE IRA contribution limit in 2022 at $17,000 for participants age 50 or older, up from $16,500 in 2021.

With a 401(k), individuals can save $20,500 in 2022, or up to $26,500 with a catch-up contribution, which is up from $19,500 or $25,500 in 2021. As you can see, you can put away more in a 401(k) plan.

But if you have a SIMPLE IRA, and you participate in any other type of employer retirement plan during the year—a 401(k), for example—the limit on how much you can contribute to all of the plans is $20,500 in 2022 (up from $19,500 in 2021).

If you're a highly paid small business owner, such as a doctor, dentist, or attorney, you might favor a 401(k) plan over a SIMPLE IRA because of the higher contribution limits offered by the former.

Rollovers With SIMPLE IRAs

SIMPLE IRA rollovers can be simple or a hassle, depending on how long you've been participating in the plan. If you've participated for less than two years, you can only roll funds from a SIMPLE IRA into another SIMPLE IRA. Otherwise, the amount will be considered a withdrawal, and you'll have to treat it as taxable income and pay a 25% tax on it (unless you're at least age 59 1/2 or qualify for another exception).

But if at least two years have passed since you began to participate in the plan, you can move the money into almost any type of IRA, or even an employer-sponsored retirement plan, such as a 401(k). A rollover to a Roth IRA, while permissible, is often ill-advised though, since you will have to include any earnings growth in your taxable income.

Key Takeaways

  • A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is an employer-sponsored retirement plan offered within small businesses that have 100 or fewer employees.
  • A SIMPLE IRA works a lot like a 401(k) plan, but there are some differences regarding company matching contributions and other factors.
  • SIMPLE IRA rollovers can be simple or a hassle, depending on how long you've been participating in the plan.

The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a financial professional to determine a suitable retirement savings, tax, and investment strategy.