Understanding the SIMPLE IRA

Many retirement plans that do good for large companies aren’t useful for small business, which often require plans with lower costs and responsibilities. If you’re a small business owner, you should consider a retirement savings plan known as a SIMPLE IRA.


SIMPLE stands for Savings Investment Match Plan for Employees, which reflects that both employers and employees make contributions to the plan. Employees choose to defer a portion of their salaries into their retirement account, then they have an option of matching a percentage of their employees’ contributions, or contributing a fixed percentage of employees’ salaries to their accounts. 


SIMPLE IRAs are limited to business with 100 employees or less. They can also provide tax benefits for employers. For instance, employer contributions to SIMPLE IRAs can be considered a tax-deductible business expense. 


Flexibility and choice in contribution levels

SIMPLE IRAs offer employees the tax benefits of a 401(k) with a personal IRA. Employees can choose how much of their salary they would want contributed to their accounts every year. Their contributions are automatically deducted from their paychecks before federal income tax, reducing taxable income while creating the opportunity for future tax-deferred growth on that money.


The employer match components adds another incentive which employees can contribute to. SIMPLE IRA plans require employers to contribute to their employees’ accounts in 2 ways. The employer can match their employees’ contributions of up to 3% of annual pay, or make a non-elective contribution of 2% of employees’ salaries.


If you choose to match up to 3% of your employees’ salary reduction contributions, the 2020 contributions limits to a SIMPLE IRA is $13,500 for employees who are under 50 years old and $16,500 for employees over 50. The 2% non-elective contribution is based on a maximum salary of $285,000 for 2020, which means that you wouldn’t contribute any more than %5,700 to an employee’s account.


You also have a choice of reducing the percentage of the matching contribution to as low as 1% of annual compensation. The percentage can only be decreased for 2 years within any given 5-year period. If the employer wants the 2% non-elective contribution, the percentage cannot be changed.


Simple setup and maintenance

SIMPLE IRAs are designed for small businesses that don’t have the resources to handle the administrative duties involved with larger retirement plans. 


Many administrative details are shouldered by the financial institution that manages the account and you do not have to file annual plan reports to the IRS.


Employees can choose many investment options for their SIMPLE IRA, including bonds, stocks, mutual funds, CDs, and exchange-traded funds. Employees don’t need to meet a minimum investment in order to start a SIMPLE IRA. Although, not all fund families offer mutual funds that are approved for SIMPLE IRAs without minimum investment requirement.


Once employers set up a SIMPLE IRA plan, they have to announce which contribution method they have chosen during an election period of at least 60 days from November 2 to December 31. During this period, employees also choose the amount of their salary they wish to contribute in the coming year. Any employee who has earned more than $5,000 in 2 preceding years is eligible to join the plan generally, employers can also design a plan that’s open for employees that earn less than $5,000. 


Rules for long-term savings

Employer contributions to SIMPLE IRAs are immediately vested to the employee. SIMPLE IRAs are designed to discourage account holders from taking money out before retirement. The basic rules that govern withdrawals and rollovers are:

  • Withdrawals before age 59 ½ incur a 10% penalty
  • Starting at age 72, participants must take required minimum distributions
  • Account holders can roll SIMPLE IRA assets into another SIMPLE IRA
  • The penalty for withdrawals before age 59 ½ increases to 25% if the withdrawal happens within the first 2 years of making the account.
  • Account holders can roll a SIMPLE into a traditional IRA (tax-free) or Roth IRA (income tax due) after 2 years.


If you’re a small-business owner and you’re not offering your employees a retirement savings plan, the SIMPLE IRAs flexibility can help you achieve important goals. The plans offer tax advantages for employers and employees, they’re easy to maintain, and encourage employees to save for retirement. They enable all parties to manage changing financial circumstances and still save for retirement.