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What is a
SIMPLE IRA Plan?
A SIMPLE IRA is similar to a 401(k) plan. The contributions made to this plan are with pre-tax dollars, and the money grows tax-deferred in the plan until the money is withdrawn at retirement.
Key Features
- Designed for U.S. small businesses with ≤100 employees earning ≥$5,000 in the prior year, offering an uncomplicated alternative to 401(k) plans.
- Employee salary-deferral limits: up to $16,500 (2025), $16,000 (2024), $15,500 (2023), or $14,000 (2022); catch-up limits for those ≥50: $20,000, $19,500, $19,000, and $17,000, respectively.
- Mandatory employer funding: either match employee deferrals dollar-for-dollar up to 3% of pay, or make a nonelective 2% contribution on every eligible employee’s compensation (capped at $350,000 in 2025).
- Contributions are pretax for employees and tax-deductible for employers; account growth is tax-deferred until withdrawal.
- Immediate vesting on all employer contributions and broad investment flexibility (stocks, bonds, mutual funds, etc.) similar to traditional IRAs.
- Early distributions ≤2 years after first deposit and before age 59½ incur a 25% penalty (drops to 10% after the two-year window), plus ordinary income tax.
- Rollovers prohibited to non-SIMPLE plans during the first two years but permitted afterward; required minimum distributions begin at age 72 under SECURE Act rules.
- Low start-up/administrative costs and minimal IRS filing—employers use Form 5304-SIMPLE (multiple custodians) or 5305-SIMPLE (single custodian) to establish the plan and must notify employees annually.
Eligibility
Who Can Open a SIMPLE IRA and who is eligible for a SIMPLE IRA Plan?
Employer Eligibility
- We need to have 100 or fewer employees who have earned at least $5,000 in the preceding year.
- Any other employer-sponsored retirement plan cannot be maintained.
Employee Eligibility
- Need to have earned at least $5,000 from the employer in any two preceding years.
- Must be expected to earn at least $5,000 in the current year.
How to Establish a SIMPLE IRA?
Most IRA providers offer SIMPLE IRAs that you can establish online. The process of opening a SIMPLE IRA is similar to opening a traditional IRA. But, if you are a business owner, you need to meet additional reporting requirements and submit relevant documents to set up the plan.
For employers or solo business owners, the IRS outline these steps for setting up a SIMPLE IRA plan
Let’s Get Started
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1
Choose the type of SIMPLE IRA plan by filing either:
- Form 5304-SIMPLE (if employees can choose their financial institution), or
- Form 5305-SIMPLE (if contributions go to a designated financial institution).
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2
Inform all eligible employees about the SIMPLE IRA plan.
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3
Use Form 5305-S or Form 5305-SA to establish a separate SIMPLE IRA for each eligible employee.
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4
Ensure employees complete a SIMPLE IRA adoption agreement to open their individual accounts.
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5
If you’re an employee, your employer sets up the account and submits the necessary forms.
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6
Once the plan is set up, employers are required to contribute every year unless the plan is terminated.
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7
Employers must choose between a:
- 3% matching contribution, or
- 2% mandatory nonelective contribution.
How It Works?
- A SIMPLE IRA allows small employers to help both themselves and their employees save for retirement. The plan combines employee contributions with required employer contributions.
- Employees contribute by choosing to have a portion of their salary deducted from their paychecks and deposited into their SIMPLE IRA. This reduces their taxable income for the year.
- Employers are required to contribute to each eligible employee’s account every year, using one of two methods:
- Match up to 3% of the employee’s salary (only if the employee contributes),
- OR make a nonelective 2% contribution for every eligible employee, regardless of whether they contribute.
- These contributions are limited based on a compensation cap ($350,000 in 2025).
- The plan is easier to set up and manage compared to a traditional 401(k) and doesn't involve complex reporting requirements. It can be opened through most financial institutions.
- To be eligible to set up a SIMPLE IRA, the business must have fewer than 100 employees, each of whom earned at least $5,000 in the previous year.
- Unlike traditional or Roth IRAs, which are opened and managed by individuals, SIMPLE IRAs are offered through employers as part of a workplace retirement plan.
IRS Rules
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ERISA Coverage
SIMPLE IRAs fall under the Employee Retirement Income Security Act (ERISA), which sets standards for eligibility, contributions, and plan operations.
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Customizable Eligibility
Employers may define eligibility, though a common rule is that employees age 21 or older with at least one year of service qualify. Some plans allow earlier or immediate eligibility.
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Timely Deposit of Deferrals
Any salary‐deferral contributions withheld from paychecks must be deposited into employees’ SIMPLE IRA accounts by the end of the month following the paycheck withholding month.
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Annual Contribution Limits
SIMPLE IRAs are subject to IRS‐set limits on employee salary deferrals and catch-up contributions (e.g., $16,500 plus $3,500 catch-up for those 50+ in 2025).
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Employee Investment Control
Unlike 401(k) plans, participants direct their own investments in a SIMPLE IRA, choosing from the full range of options offered by the IRA custodian.
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Two-Year Restriction Period:
- Begins on the date of the first contribution (employer or employee).
- Withdrawals before age 59½ during this period incur a 25% penalty.
- Rollovers are restricted: funds may only be rolled into another SIMPLE IRA until the two-year period elapses.
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Post-Two-Year Flexibility: After two years, participants may:
- Rollover or transfer assets into any eligible retirement plan (e.g., traditional IRA, 401(k)) or convert to a Roth.
- Bypass the 25% early‐withdrawal penalty on distributions taken before age 59½ (standard 10% penalty and ordinary income tax still apply).
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Plan Transfer Requirements
When moving assets after two years, the participant must submit:
- A new SIMPLE IRA adoption agreement.
- A copy of the original IRS Form 5304-SIMPLE or 5305-SIMPLE used to establish the plan.
Is a SIMPLE IRA Right for Me?
If You Are an Employer or a Business Owner
- If you’re a solo business owner or self-employed wanting to maximize your retirement savings, a SIMPLE IRA may not be the right option.
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Other plans with higher contribution limits include:
Solo 401(k):
- No employees required (spouse exception applies).
- 2025 limit: $70,000; catch-up: +$7,500 (50+) or +$11,250 (60–63).
SEP IRA:
- Employer‐only contributions.
- 2025 limit: up to $70,000 or 25% of compensation, whichever is less.
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If you are a small business owner with a few employees, a SIMPLE IRA might be attractive because:
- You can offer a retirement plan to employees.
- You avoid the extra administrative costs of a 401(k).
If You Are an Employee
- If you have access to an employer-sponsored SIMPLE IRA, maximize your savings by contributing enough to capture any employer match—otherwise you leave “free money” on the table.
- If your plan offers an automatic 2% employer contribution, you receive that contribution even without deferring salary.
- If your employer uses a matching formula, you must make salary-deferral contributions to qualify for the match.
- You can also contribute to other retirement accounts (traditional IRA, Roth IRA, HSA, etc.) in addition to your SIMPLE IRA.
Advantages and Drawbacks
Advantages from Employer Perspective
- Lower costs compared to setting up and operating a 401(k) plan, making it budget-friendly for small businesses
- Tax deduction benefits for all contributions made to employees' accounts
- Mandatory contribution requirement ensures consistent funding for employee retirement savings
Advantages from Employee Perspective
- Low eligibility requirements - qualify with just $5,000 compensation in any two preceding years and expected earnings of the same amount
- Immediate vesting - own 100% of employer contributions right away with no waiting period
- Pre-tax contributions that reduce current taxable income without being reported as income
- Flexibility to contribute to other retirement plans simultaneously
- Tax-deferred growth on earnings until withdrawal
- Automatic employer contributions available through the nonelective 2% option, even without employee salary deferrals
- Broader investment options than typical 401(k) plans, including stocks, mutual funds, bonds, and other investment vehicles
Disadvantages and Drawbacks
- Strict rollover restrictions - the 25% penalty applies to rollovers to non-SIMPLE IRA accounts during the first two years
- Lower contribution limits compared to other employer-sponsored retirement plans
- No Roth option available, limiting tax diversification strategies
- Required Minimum Distributions (RMDs) must begin at age 72 under current SECURE Act rules
- No loan provisions - cannot borrow against your SIMPLE IRA balance
- Severe early withdrawal penalties - 25% penalty (10% standard + 15% additional) for withdrawals before age 59½ and within the first two years of participation, plus income tax
Choose the right SIMPLE IRA plan for your future.
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