Saving enough money for retirement can be challenging, especially if your employer does not offer a matching 401(k) plan. Many small businesses choose to avoid 401(k) plans because of the high administrative costs and associated IRS rules.
Many individuals are left saving for retirement through an IRA or individual retirement account. However, a SIMPLE IRA plan allows an employer to contribute to the employee’s account and is generally very light on required paperwork.
If you own or work for a small business, a SIMPLE IRA plan might be worth considering. Keep reading as we explain all the details of how they work and who is eligible.
What Is A SIMPLE IRA?
A SIMPLE IRA is short for Savings Incentive Match Plan for Employees. This type of plan allows small businesses with 100 or fewer employees to contribute to an employee’s retirement account through non-elective contributions or matching contributions.
Like a 401(k), a SIMPLE IRA is a tax-deferred retirement savings plan. Both employees and employers make contributions to the SIMPLE IRA account throughout the employee’s career. This is an excellent option for small employers who wish to provide a retirement plan for their employees but cannot afford the overhead expenses often associated with a pension plan or 401(k).
In addition to providing a benefit for the employee, an employer also receives a tax benefit for offering a SIMPLE plan with automatic enrollment.
- The employer may contribute 2% of the employee’s salary on a non-elective basis or up to 3% of their salary as matching contributions.
For example, suppose an employee makes $50,000 annually, and the company has chosen the non-elective contribution amount. In that case, the employer must contribute $1,000 to the account that year whether or not the employee makes any individual contributions.
Unlike a SEP IRA or Simplified Employee Pension, which a company of any size can establish, a SIMPLE IRA is specifically for smaller companies and small business owners.
- The SIMPLE IRA plan’s light paperwork and administrative requirements help encourage smaller companies to establish these savings plans for their eligible employees. This can be a big deciding factor when employers are choosing between an IRA and a 401(k).
To qualify for participation in this plan, an employee must have received at least $5,000 in compensation in any two of the previous calendar years and be expected to receive at least $5,000 in compensation in the current year.
The IRS maintains a complete set of SIMPLE IRA participation rules, but the compensation requirements are the biggest qualification.
KEY TAKEAWAYS
- A SIMPLE IRA plan allows an employer to make non-elective or matching contributions to an employee retirement account.
- An employer can deduct any contributions to an employee’s retirement account, lowering the business’s taxable income. This helps incentivize employers to contribute to the employee’s retirement.
- There are many investment options through a SIMPLE IRA; employees can invest in mutual funds, stocks, bonds, ETFs, CDs, and other investments.
How To Establish A SIMPLE Savings Plan
The process is fairly straightforward for employers looking to establish a SIMPLE savings plan. It typically requires only three steps, and those are laid out below.
SIMPLE IRA Rules and Contribution Limits
Just as with a traditional IRA, contribution limits and tax rules are associated with a SIMPLE IRA. Remember that a SIMPLE IRA is treated much like a conventional IRA, and a Roth option is unavailable. This means that employee contributions will be made on a tax-deferred basis. Income tax will be paid upon withdrawal of the money at retirement.
Remember that the main difference between a Roth and a traditional IRA is the timing of the income taxes. There are also early withdrawal penalties, which will be discussed in more detail later in this article.
Employee Contribution Limits For SIMPLE IRA in 2024
In 2024, an employee may contribute a maximum of $16,000 to their SIMPLE IRA. For employees aged 50 and older, an additional $3,500 per year may be deposited into the account as catch-up contributions. These limits are adjusted from year to year to account for inflation.
These contributions are tax-deductible and are not counted as income in the current year.
One drawback of a SIMPLE IRA is that the contribution limits, particularly for catch-up contributions, are lower than those of a 401(k) or SEP IRA.
Employer Contribution Limits For SIMPLE IRA in 2024
As mentioned, an employer may elect to contribute in several ways. They can deposit 2% of the employee’s salary into the account. If they choose this option, they cannot deposit more than that, but they must also deposit that amount.
An employer may deposit up to 3% of the employee’s compensation as matching funds. This means that the employer is not required to contribute if the employee does not contribute.
However, if the employee does contribute, they can receive higher contribution limits through the matching funds.
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SIMPLE IRA Investment Choices
A SIMPLE IRA offers many of the same investment options as a traditional IRA. SIMPLE IRA contributions may be invested in mutual funds, stocks, bonds, ETFs, FDIC-insured CDs, and other investments. The specific investment types available depend primarily on the brokerage you selected as your account’s trustee.
One of the benefits of a traditional IRA is the fact that the investment options are almost unlimited. You can choose to invest in real estate, gold coins, silver, or other commodities often not allowed in a 401(k) investment portfolio.
Luckily, most of these options also exist for participants in a SIMPLE IRA who are saving for their own retirement. You may choose to invest in real estate with your plan contributions or invest in other non-traditional items.
How Much Do Maintenance and Fees For A SIMPLE IRA Cost?
The cost of maintenance and fees for these plans varies depending on the brokerage. However, in most cases, the fees for a SIMPLE IRA plan are pretty low. Most principal online brokerages, like Fidelity and others, do not charge an opening or start-up fee.
In addition, many do not require a minimum opening balance. You can even find some plans that do not charge ongoing maintenance fees. You can usually make trades with no commissions in your IRA.
If you elect to purchase certain mutual funds or index funds, then some tiny fees may apply to those funds. They are typically a small percentage of your funds or even a flat quarterly fee in some cases. Most are $50 or less per quarter, which is usually a good deal when you may have thousands of dollars in your account.
TIP
Offering a traditional 401(k) plan can be expensive and time-consuming for a small business owner. A SIMPLE IRA plan is a great alternative to remain competitive with your benefits offerings while avoiding the higher costs associated with a 401(k).
SIMPLE IRA Plan Withdrawal Rules
Withdrawal rules for a SIMPLE IRA plan are much the same as those for a traditional IRA or 401(k). Withdrawals may be taken penalty-free after age 59 1/2.
If a withdrawal is made before then, the IRS will assess an additional 10% penalty in addition to the standard income taxes. You might be able to take an early withdrawal without a penalty from your 401(k), but your options are limited with the SIMPLE IRA.
One particular rule that applies to a SIMPLE IRA is this. If a withdrawal is made before age 59 1/2 and before participating in the plan for over two years, the penalty will be 25% instead of 10%. This penalty will be paid when it comes time to file your tax return for the year.
You might decide that you want to wait to begin taking withdrawals, but you can only wait so long. Upon age 73, the IRS requires you to take a “required minimum distribution” from your account. You must withdraw a certain amount of money each year from the account.
You should consult your personal finance professional or tax advisor on how to best approach these distributions to avoid a big tax bill.
The Bottom Line
If you work for a small company or are a small business owner, you still have options for retirement savings besides a 401(k).
A SIMPLE IRA allows your employer to contribute towards your retirement without the complicated paperwork and administrative costs associated with more complex retirement plans.
These can be a great way to grow your savings quickly and be in a strong financial position when you reach retirement age.
Frequently Asked Questions
A SIMPLE IRA works like a traditional IRA because you can contribute pre-tax dollars to this retirement account. The money in the account can grow tax-free until you begin making withdrawals at retirement age.
The major advantage of a SIMPLE IRA is that your employer can also contribute to your account (either a non-elective 2% contribution or up to 3% in matching contributions).
Upon retirement, you withdraw the money and pay regular income taxes on the withdrawals. Depending on the brokerage selected to manage the account, you may have many investment choices, from traditional stocks and bonds to more unconventional investments like real estate or gold.
First, the employer sponsoring the plan must have 100 or fewer employees. Next, any employee of that business who earned at least $5,000 in compensation the previous year and is expected to earn at least $5,000 in the current year may participate.
Once the employer has filed the proper paperwork, individual employee accounts can be opened, and contributions can be made immediately.
If you own a business and are the only employee, then a solo 401(k) is probably your best option.
There are many benefits of a SIMPLE IRA. First, your contributions are tax-deductible in the current year. Those contributions can grow in the account tax-free until retirement age.
In addition, you do not pay any taxes on the contributions made by your employer in the current year either, and those contributions grow tax-free as well. Your employer can also receive a tax credit for sponsoring these retirement accounts.
The maximum contribution limit for an employee to a SIMPLE IRA in 2024 is $16,000. Employees aged 50 and older may make a catch-up contribution of an additional $3,500.
The maximum amount an employer may contribute to your account is 3% of your compensation for the year.
The signup process may vary by employer, but your Human Resources department should be able to tell you exactly how to enroll.
Some employers offer automatic enrollment, so your account becomes active as soon as you are eligible. As long as your employer participates and has filed the proper paperwork, you can begin making contributions immediately.
The paperwork and administrative requirements for the employer are intentionally simple and lightweight to encourage more small businesses to participate in this type of savings plan.
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