A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a type of traditional IRA for small businesses and self-employed individuals. As with most traditional IRAs, your contributions are tax deductible, and your investments grow tax deferred until you are ready to make withdrawals in retirement.
Unlike SEP IRAs, SIMPLE IRAs allow employees to make contributions. What makes a SIMPLE IRA unique is that the employer is required to make a contribution on the employee's behalf - either a dollar-for-dollar match of up to 3% of salary or a flat 2% of pay - regardless of whether the employee contributes to the account.
SIMPLE IRAs have higher contribution limits than traditional and Roth IRAs, and it's cheaper to set up and run a SIMPLE IRA plan than it is to administer many other workplace retirement plans.
With so many different small business retirement plans to choose from, it can be hard to decide which one is best for you. That’s why it’s important to know what each one offers. If you’re wondering, “What is a SIMPLE IRA?” it turns out it’s what it sounds like. It’s an easy-to-manage savings plan that lets you put tax-deferred money aside for retirement. Money in this account gets invested in a similar way to traditional IRAs.
Many small employers use SIMPLE IRAs because they’re easy to set up and the costs to manage them are low. But these types of plans also have to follow specific rules set by the IRS. Whether SIMPLE IRAs are the best choice for you and your employees depends on your business.
How Does a SIMPLE IRA Work?
As with other retirement savings plans, there is a limit to how much you can put into your SIMPLE IRA. In 2020, you or your employees can’t put more than $13,500 into this type of account.1
If you’re age 50 or older, your SIMPLE IRA plan may let you make catch-up contributions. This means you’re allowed to put more money into your retirement savings account. In 2020, the IRS limited catch-up contributions for SIMPLE IRAs to $3,000.2
SIMPLE IRAs require employers to match employee contributions:
- Up to 3% of your employee’s compensation
- At least 1% for no more than two out of five years
Your business can also make a 2% non-elective contribution to your employees’ SIMPLE IRA accounts. This means your business makes a contribution to all employees, even if they don’t contribute themselves.
Pros and Cons of a SIMPLE Retirement Plan
Pros of SIMPLE IRAs:
- Minimal paperwork to set up: Depending on the provider, you may be able to set up a SIMPLE IRA online. If you have to fill out paperwork, it’s generally less than what you’d complete to set up another account, such as a 401(k) plan.
- Low startup and maintenance costs: Some retirement plans charge costly fees to open and maintain accounts. With SIMPLE IRAs, your business typically has lower upfront and managing costs.
- Money put into the plan is tax deductible: You and your employees can deduct contributions on tax returns.
- No IRS filing requirements: Your plan provider handles reporting requirements to the IRS.
Cons of SIMPLE IRAs:
- Employer-matching requirement: The IRS requires businesses to match employee contributions dollar for dollar, up to a certain percentage.
- Lower contribution limit: Other retirement accounts have higher contribution limits. For example, the 2020 contribution limit for 401(k) plans is $19,500 and $6,500 for catch-up contributions.3
- Withdrawing requirements: You can’t withdraw money from your SEP IRA until you reach age 59½. If you take money out before then, you’ll have to pay a 10% penalty and income taxes on your withdrawal.
- No Roth contributions: There’s no option to have a Roth version of your SIMPLE IRA. So, you can’t fund your account with post-tax money to avoid paying taxes when you withdraw the money.
Setting Up a SIMPLE IRA Plan
Otherwise, you may have to complete:
- Form 5304-SIMPLE: Allows your employees to choose their own financial institution for receiving SIMPLE IRA contributions.
- Form 5305-SIMPLE: Designates one financial institution all SIMPLE IRA contributions will go to.
After your SIMPLE IRAs are set up, you and your employees can choose to make regular pre-tax contributions through payroll deductions. You can also pick how your money gets invested. For example, you can set up your account to invest in mutual funds. Your SEP IRA grows tax-deferred until you make withdrawals.
1, 2 IRS, “Retirement Topics – SIMPLE IRA Contribution Limits”
3 IRS, “401(k) contribution limit increases to $19,500 for 2020; catch-up limit rises to $6,500”
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