SIMPLE IRA

What Is a SIMPLE IRA?
How Much Can I Contribute to a SIMPLE IRA?
Who Can Open a SIMPLE IRA?
How SIMPLE IRA Works?
What Are the Advantages and Drawbacks of a SIMPLE IRA?
How to Establish a SIMPLE IRA?
What are the SIMPLE IRA Rules?
Rollovers With SIMPLE IRAs
Is a SIMPLE IRA Right for Me?

What Is a SIMPLE IRA Plan?

A SIMPLE IRA Plan (Savings Incentive Match Plan for Employees Individual Retirement Account) is a retirement plan designed for small businesses in the United States. It allows both employees and employers to contribute to individual retirement accounts with simplified rules and contribution options. This plan provides a convenient and accessible method for small employers to help their employees save for retirement while enjoying potential tax advantages

Learn more about what is simple IRA and how it works?

A SIMPLE IRA has an employer matching incentive built-in. The employer can either match the employee contributions, up to 3% of the employee’s salary, or the employer can make contributions of a flat 2% of the employee salary, whether or not the employee chooses to participate in the 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made to this plan are with pre-tax dollars, and the money grows tax-deferred in the plan until the money is withdrawn at retirement.

How Much Can I Contribute to a SIMPLE IRA Plan?

Employees can contribute up to 100% of compensation, up to a maximum of $16,000 for 2024, $15,500 for 2023 or $14,000 for 2022. The maximum contribution increases periodically to account for inflation. If the employee is 50 years or over, the maximum contribution is up to $19,500 in 2024, $19,000 in 2023 and $17,000 in 2022.

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 Does a SIMPLE IRA Work?

The SIMPLE IRA plan offers small employers a straightforward approach to contribute to both their employees’ and their own retirement savings. Workers have the option to contribute a portion of their salary, while the employer is obligated to make either matching or nonelective contributions.

A SIMPLE IRA is fundamentally different from a traditional IRA or Roth IRA.
While the latter IRAs are established by employees for themselves, with different plan rules, annual contribution limits, and purposes, a SIMPLE IRA is more like a 401(k), but it’s easier for the company to open and manage it.

Employers are free from complex federal reporting requirements, and they can set up a SIMPLE IRA through a financial institution, which operates it.

The IRS allows employers/self-employed with fewer than 100 employees earning at least $5,000 in the preceding year to open up a SIMPLE IRA.

Like a traditional retirement plan, the employees are allowed to get their wages deducted from their paycheck to contribute to a SIMPLE IRA.

Employers have to contribute to their employees’ SIMPLE IRA accounts, but they have two options:

Match employees’ contributions, up to 3% of employees’ earnings.
OR
Make nonelective contributions of up to 2% of employees’ compensation up to the annual compensation limit of $345,000 for 2024 & $330,000 for 2023.

What Are the Advantages and Drawbacks of a SIMPLE IRA?

Advantages of SIMPLE IRA from the perspective of employers:

The cost of starting up and operating a SIMPLE IRA is usually lower than setting up a 401(k) plan.
Employers get a tax deduction for the contributions they make to their employees’ accounts.

Drawbacks of SIMPLE IRA from the perspective of employees:

With a SIMPLE IRA, employers must contribute to employee accounts.
The eligibility requirements for an employee to participate in the plan are low. You are eligible if you have had the compensation of at least $5,000 during any two preceding calendar years, and you expect to earn at least the same amount during the calendar year of participation. Even if the employees don’t meet the standards, the IRS may allow employers to offer these accounts.
If the employer chooses the nonelective 2% contribution option, employees don’t have to go for salary deferrals to get employer contributions. If the employer chooses the elective salary reduction/matching method, the employee must contribute to get the match.
Employer contributions are vested immediately. Because there is no vesting period, you can own 100% of your money in your SIMPLE IRA.
SIMPLE IRA offers more investment choices than a 401(k). You can choose to invest in stocks, mutual funds, bonds, and any other investment vehicles offered by the IRA provider.
You can contribute to other retirement savings plans while being invested in a SIMPLE IRA.
While you can’t deduct your SIMPLE IRA contributions on your tax returns, these contributions are not reported as income. This means you are able to contribute with pre-tax income.
Earnings can grow tax-free until they’re withdrawn.

Don’t fall in love with the idea of opening a SIMPLE IRA. Not yet.

Consider some of its disadvantages:

The contribution limits are lower than other employer-sponsored retirement plans.
There is no Roth version of the SIMPLE IRA. So, it’s a big drawback considering the benefits a Roth has to offer.
You cannot take a loan from your SIMPLE IRA.
Similar to traditional IRAs, early withdrawals from a SIMPLE IRA attract a steep tax penalty. However, for non-qualified withdrawals done within the first two years of your participation, you’ll be charged a standard 10% penalty, and over and above, there will be an extra 15% early withdrawal penalty. This means that if you withdraw the money from a SIMPLE IRA before you turn 59 ½ years, and before you’ve had the plan for two years, you’ll be charged a penalty of 25% of the money you withdraw. Plus, the income tax.
Rollovers to other employer-sponsored retirement plans or other IRA are subject to strict rules. The 25% penalty (mentioned above) is applicable even if you do a rollover into anything other than another SIMPLE IRA before the two-year period of plan participation.
A SIMPLE IRA falls under the IRS’s required minimum distributions (RMDs) rules. This means you must withdraw funds from your SIMPLE IRA when you reach a certain age. The newly implemented SECURE Act has raised the age for RMDs to 72 years.

How to Establish a SIMPLE IRA?

Opening 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:

Choose the type of SIMPLE IRA plan you want by filing either IRS Form 5304-SIMPLE (if your employees are allowed to choose a financial institution for the account) or IRS Form 5305-SIMPLE (if you’re depositing your contributions at a designated financial institution).
Inform eligible employees about the SIMPLE IRA plan.
Use Form 5305-S or Form 5305-SA to establish a separate SIMPLE IRAs for each eligible employee.
If you are an employee at a company that offers a SIMPLE IRA, your employer will fill out one of the forms mentioned above and set up your account.

Other points to consider:

Employees have to complete a SIMPLE IRA adoption agreement to open their individual accounts.
Once the plan is set up, employers have to contribute to it each year unless the plan is terminated. However, employers can choose between a 3% matching contribution or a 2% mandatory contribution.

What are the SIMPLE IRA Rules?

Just like other employer-sponsored retirement plans, SIMPLE IRAs are covered under ERISA (Employee Retirement Income Security Act).

These ERISA rules are applied to SIMPLE IRAs:

Enacted in 1974, ERISA outlines the requirements for establishing and managing employer-sponsored retirement plans. For SIMPLE IRAs, ERISA dictates the eligibility of the employees and how employee contributions are handled by the company

Employers are given the flexibility to customize the eligibility requirements, but usually, employees who have put in at least one year of service and are 21 years or above are eligible for the plan. However, some employers may decide to make their employees eligible sooner or, in some cases, even immediately.
ERISA defines key issues while handling employee contributions. For example, with a SIMPLE IRA, the salary deferral contributions have to be deposited in the account by the end of the month following the month in which the funds were withheld from the employee’s paycheck. SIMPLE IRAs are subject to contribution limits. You can find the details here.
When it comes to investment choices, a SIMPLE IRA functions like any other IRAs. It means the employee has full control of the investment choices for their accounts, unlike a 401(k) plan where the employer offers a limited option from which the employees have to choose.

In the first two years of opening the SIMPLE IRA, you cannot roll over money from a SIMPLE IRA to a traditional IRA. However, there’s an exception – the two-year waiting period does not apply if you decide to transfer or rollover from one SIMPLE IRA to another SIMPLE IRA.

The two-year time frame begins the day you and your employer make the first contribution to the SIMPLE IRA.

If you take any distributions from your SIMPLE IRA during this two-year period, and you are less than age 59½ at the time of the withdrawal, then the distributions are subject to an early-distribution penalty of 25%.

Since you can roll over money from your SIMPLE IRA to another SIMPLE IRA, you can consider this option when you are no longer employed with the company that sponsored the plan. You can either leave the assets with your ex-employer until the two-year period is over, or rollover the money to another SIMPLE IRA at another financial institution.

Once the two-year period is over, you have the freedom to move the money from your SIMPLE IRA to any other eligible retirement plan. This can be a transfer or a rollover (a direct rollover) or a Roth conversion, depending on whether or not you are still employed with the company that sponsored your SIMPLE IRA.

To get the transfer done, you need to submit a SIMPLE IRA adoption agreement and a copy of the Form 5304-SIMPLE or Form 5305-SIMPLE that your employer had filled out initially to open the SIMPLE IRA. The transfer takes place once the new account is established.

Is a SIMPLE IRA Right for Me?

It depends on whether you are an employer or an employee.

If you are an employer or a business owner:
a. If you’re a solo business owner or self-employed wanting to maximize your retirement savings, SIMPLE IRA may not be the right option for you. There are other retirement savings plans that have higher contribution limits, which can help you save more. Some of the beneficial options could be:
- Solo 401(k): If you have no employees, a solo 401(k) will allow you to contribute up to $69,000 in 2024. And if you are over 50 years, you can make a catch-up contribution of an additional $7,500. However, the exception to the no-employees rule is if your spouse earns the income from your business.
- SEP IRA: A SEP IRA (Simplified Employee Pension Individual Retirement Account) is similar to a SIMPLE IRA, but has higher contribution limits like a solo 401(k). With a SEP IRA, you can make a contribution of up to $69,000 in 2024, or 25% of compensation, whichever is less.
b. If you are a small business owner with a few employees, a SIMPLE IRA might be an attractive option. You can offer your employees a retirement plan and also avoid the extra administrative costs that usually come with a 401(k).
If you are an employee:
If you have access to the employer-sponsored plan, you should maximize your saving by contributing to the account. If you don’t take advantage of employer contribution, you are just leaving free money on the table.
If your plan offers an automatic 2% employer contribution, you’ll get that money into your account even if you choose not to divert part of your salary. However, if the employer contribution is a match, then you must contribute a portion of your salary to get the match from the employer. Always remember, in addition to a SIMPLE IRA, you can also contribute to other types of retirement savings accounts.

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