Saving enough money for retirement can be a challenge, 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 IRS rules associated with them. Many individuals are left saving for retirement on their own through an IRA, or individual retirement account. However, a SIMPLE IRA plan allows an employer to make contributions to the employee’s account, and it is generally very light on required paperwork. If you are a small business or work for one, then 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, and this type of plan allows small businesses with 100 or fewer employees to contribute to an employee’s retirement account either through non-elective contributions or matching contributions. Just 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 a great 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 providing a SIMPLE plan with automatic enrollment. The employer may decide to contribute 2% of the employee’s salary on a non-elective basis or up to 3% of their salary as matching contributions. For example, if an employee makes $50,000 per year and the company has chosen the non-elective contribution amount, then 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 can be established by a company of any size, a SIMPLE IRA is specifically for smaller companies and small business owners. The light paperwork and administrative requirements of the SIMPLE IRA plan are used to 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 vs 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. They must also 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.
How To Establish A SIMPLE Savings Plan
For employers looking to establish a SIMPLE savings plan, the process is fairly straightforward. It typically requires only three steps, and those are laid out below.
- Select a Financial Institution
First, you will need to select the bank or credit union you wish to act as trustee of the employees’ funds. Most any bank or savings and loan institution is qualified to hold the funds in a SIMPLE plan. The employer can decide on the institution or the employee may be allowed to select which institution they wish to use. Depending on whether the employer or employee selects the bank, a different setup form is used.
- Complete the Proper Paperwork
Before you begin using the plan, you must complete, adopt, and sign the proper plan documentation. If the employer will be selecting the bank to hold the funds, then you simply need to complete IRS Form 5305-SIMPLE. If the employees will choose their own bank, then you can complete IRS Form 5304-SIMPLE. Once these plan documents are completed, then provide employees with notice and details about the plan. You can start this type of plan any time during the calendar year from January 1 through October 1.
- Set Up the IRA Accounts
Now that the paperwork has been filed, simply establish individual IRA accounts for each employee. These are the accounts where the funds will be deposited. The contributions must be made to each individual account, as they are not deposited to a general fund.
SIMPLE IRA Rules and Contribution Limits in 2021
Just as with a traditional IRA, there are contribution limits and tax rules associated with a SIMPLE IRA. Remember that a SIMPLE IRA is treated much like a traditional IRA, and a Roth option is not available. 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 2021
In 2021, an employee may contribute a maximum of $13,500 into their SIMPLE IRA. For employees age 50 and older, an additional $3,000 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 SIMPLE IRA contribution limits, particularly when it comes to catch-up contributions, are lower than a 401(k) or SEP IRA.
Employer Contribution Limits For SIMPLE IRA in 2021
As mentioned previously, an employer may elect to make contributions in a couple of ways. They can elect to deposit 2% of the employee’s salary into the account. If they choose this option, they cannot deposit more than that, but they are also required to deposit that amount. An employer may also choose to deposit up to 3% of the employee’s compensation as matching funds. This means that if the employee does not contribute, then the employer is not required to contribute either. However, if they do contribute, they can receive higher contribution limits through the matching funds.
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 types of investments. The specific investment types available depend largely on the brokerage that you selected as trustee of your account.
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 that are 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, the fees for a SIMPLE IRA plan in most cases are quite low. Most of the major online brokerages like Fidelity and others do not charge an opening or start-up fee at all. In addition, many do not require a minimum opening balance. You can even find some plans that do not charge ongoing maintenance fees. In most cases, you are allowed to make trades with no commissions in your IRA. If you elect to purchase certain mutual funds or index funds, then some small fees may apply to those funds. They are typically a very 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.
SIMPLE IRA Plan Withdrawal Rules
Withdrawal rules for a SIMPLE IRA plan are much the same as they are 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, an additional 10% penalty will be assessed by the IRS in addition to the normal 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 special 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 more than 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 reaching age 72, the IRS requires that you begin taking a required minimum distribution from your account. This means that 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 getting hit with a big tax bill. You can choose to roll over a SIMPLE IRA into another SIMPLE IRA, but you cannot roll over into a Roth IRA account.
The Bottom Line
If you work for a small company or you are a small business owner, there are still 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 types of retirement plans. These can be a great way to grow your savings quickly so that you are in a great financial position when you reach retirement age.
Frequently Asked Questions
How does a SIMPLE IRA work?
A SIMPLE IRA works much like a traditional IRA in that 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 to a SIMPLE IRA is that your employer can also make contributions to your account (either a non-elective 2% contribution or up to 3% in matching contributions). Upon reaching retirement age, you withdraw the money and pay regular income taxes on the withdrawals. Depending on the brokerage selected to manage the account, you may have a wide range of investment choices from traditional stocks and bonds to more unconventional investments like real estate or gold.
Who is eligible for a SIMPLE IRA?
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 proper paperwork has been filed by the employer, the individual employee accounts can be opened and contributions can start right away. If you own a business and you are the only employee, then a solo 401(k) is probably your best option.
What are the benefits of a SIMPLE IRA?
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.
What is the maximum contribution limit?
The maximum contribution limit for an employee to a SIMPLE IRA in 2021 is $13,500. For employees age 50 and older, an additional $3,000 may be contributed to the account as a catch-up contribution. The maximum amount that an employer may contribute to your account is 3% of your compensation for the year.
How do I sign up for a SIMPLE IRA?
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, then you can begin making contributions right away. 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.