Content of the material
- What is a SIMPLE IRA?
- SIMPLE IRA Tax Implications
- SIMPLE IRAs vs. Other Popular Retirement Plans
- Setting Up a SIMPLE IRA Plan
- Easy setup and maintenance
- Related Questions
- How Does a SIMPLE IRA Work?
- SIMPLE IRA Rules
- Contribution Limits
- Required Minimum Distributions (RMDs)
- Basic Withdrawal Rules
- Filing and Notice Requirements
- Rollovers With SIMPLE IRAs
- Key Takeaways
What is a SIMPLE IRA?
A SIMPLE IRA is a type of individual retirement account (IRA) that allows employers with 100 or fewer employees to contribute to the retirement funds of their employees without the startup or operating costs of other conventional retirement accounts. Self-employed individuals can also set up and contribute to a SIMPLE IRA.An employer must contribute to an employee’s SIMPLE IRA in one of two ways:
Through Matching Contributions Here, an employer matches the contribution of an employee to their SIMPLE IRA account. SIMPLE IRA rules require that the employer match should not exceed 3% of the employee’s annual compensation. For example, an employee named Mr. A — whose annual compensation is $10,000 — contributes $1,000 to his SIMPLE IRA each year. His employer will match that contribution up to $300 (3% of $10,000). Mr. A can stop such contributions at any time and still enjoy non-elective contributions. However, depending upon the rules of his SIMPLE IRA, he might not be able to resume making his own contributions until the next calendar year. Through Non-Elective Contributions If an employee chooses not to individually contribute to the plan, SIMPLE IRA rules dictate that the employer must still contribute an amount equal to 2% of the employee’s compensation up to annual limits ($305,000 in 2022). To continue our example scenario from above, an employee named Mrs. B also earns $10,000 annually but decides not to contribute to her SIMPLE IRA plan. In this case, her employer will still make its own contribution of up to $200 annually to her plan (2% of $10,000).
All the funds held in a SIMPLE IRA are owned by the employee. Moreover, the employee makes the investment decisions for their own account and, if the employer permits, can change the financial institution in charge of the account.
The available investment assets are the same as any other traditional IRA: stocks, bonds, mutual funds, ETFs, REITs and certificates of deposit (CDs).
Those looking to invest in more nontraditional assets, like cryptocurrencies and real estate, might instead consider a self-directed IRA.
SIMPLE IRA Tax Implications
Any contributions by an employee to a SIMPLE IRA grow tax-free. The contributions are only taxed at the time of withdrawal.
Contributions by an employer to a SIMPLE IRA are tax-deductible. The SECURE Act of 2019 grants a maximum $500 tax credit annually for employers that use a SIMPLE IRA with automatic enrollment. According to the IRS, automatic enrollment allows the “employer to automatically deduct a fixed percentage or amount from an employee’s wages and contribute that to the SIMPLE IRA plan, unless the employee has affirmatively chosen to contribute nothing or to contribute a different amount.”
SIMPLE IRAs vs. Other Popular Retirement Plans
Understanding SIMPLE IRAs requires differentiating them from other similar retirement plans.
First, how do they differ from a 401(k)?SIMPLE IRAs vs. 401(k)s
UsersWhile a SIMPLE IRA is generally only suitable for small businesses with 100 or fewer employees, any business with any number of employees can offer a 401(k). MatchingEmployers can decide whether to contribute to a 401(k) plan. Employers who opt for a SIMPLE IRA must contribute. Under a SIMPLE IRA, only the employees have the option not to contribute.Contribution Limits401(k) plans have higher contribution limits than SIMPLE IRAs.EligibilityAnyone who is 21 years or older and has worked for a year is eligible for a 401(k). Employees must have earned $5,000 over any two-year period before the current calendar year and must be on course to earning at least $5,000 in the current year to qualify for a SIMPLE IRA.
How do SIMPLE IRAs differ from traditional IRAs?SIMPLE IRAs vs. Traditional IRAs
Set UpThe former are set up by employers while the latter are set up by individuals without regards to their employers.ContributionsConsequently, while both employers and employees can contribute to the former, only employees contribute to the latter.Contribution LimitsSIMPLE IRAs have higher contribution limits.EligibilityAs long as you earn income, you can open and operate a traditional IRA with your custodian. With a SIMPLE IRA, you must make a certain amount of money to qualify.
What about SEP IRAs? Though alike in many ways, SIMPLE IRAs do carry key differences.SIMPLE IRAs vs. SEP IRAs
MatchingOnly the employer contributes to a SEP IRA. On the other hand, a SIMPLE IRA allows both employers and employees to contribute. No one is mandated to contribute to a SEP IRA, while employers are mandated to contribute to a SIMPLE IRA. Contribution LimitsSEP IRAs have higher contribution limits when compared to SIMPLE IRAs.
Setting Up a SIMPLE IRA PlanThe ease of setting up SIMPLE IRAs is one of the main advantages. Most banks and financial institutions have IRS-approved prototype plans you can use. This means you may be able to set up your specific plan with just one form.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.
Easy setup and maintenance
SIMPLE IRAs were 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 accounts and you don’t have to file annual plan reports with the IRS.
Employees can choose a variety of investment options for their SIMPLE IRAs, including stocks, bonds, exchange-traded funds, mutual funds, and CDs. Employees do not need to meet a minimum investment in order to start a SIMPLE IRA. However, not all fund families offer mutual funds that are approved for SIMPLE IRAs with no minimum investment requirement.
Once employers have set up a SIMPLE IRA plan, they must announce which contribution method they have chosen during an election period of at least 60 days from November 2 to December 31. During that period, employees also choose the amount of their salary they wish to contribute in the coming year. Typically, any employee who has earned more than $5,000 in 2 preceding years is eligible to join the plan, but employers can also design a plan that’s open to employees who have earned less than $5,000.
Have questions about this account? Here are responses to some of the most common questions we hear. If you have a specific question that’s not answered here, please call us at 800-435-4000.
- How do I establish a SIMPLE IRA account?
Get detailed instructions on how to Establish Your Plan, or call us at 800-435-4000 if you have questions.
- Who is SIMPLE IRA for?
A SIMPLE IRA may be appropriate for businesses with 100 or fewer employees seeking a low-cost plan that’s easy to administer and maintain. If you are self-employed or own a business with 100 or fewer employees, you are eligible to establish a SIMPLE IRA plan, as long as it is the only retirement plan you fund. Companies maintaining another employer-sponsored retirement plan in the same year are not eligible. You must generally include all employees age 21 and over if they received at least $5,000 in compensation during any two prior years and if you reasonably expect that they will receive at least $5,000 in the current year.4
- What are SIMPLE IRA tax advantages?
Employer contributions are tax-deductible. Earnings grow tax-deferred, and you pay no taxes on assets until you withdraw them in retirement.
- How is SIMPLE IRA funded?
The plan is funded with contributions deducted from employees’ salaries, as well as annual employer contributions. Each eligible employee can decide whether or not to participate and how much to contribute, but employer contributions are mandatory.
- What are the SIMPLE IRA contribution limits?
Employees can contribute up to 100% of compensation or a maximum of $13,500 for 2021 or $14,000 for 2022. If the employee is age 50 or over, they may contribute up to $16,500 in 2021 and $17,000 in 2022.
- When should I establish and fund my SIMPLE IRA?
New plans must be established by October 1. Employer contributions must be made annually by the employer’s tax-filing deadline, including extensions. Employee contributions are deducted from employees’ salaries and must be deposited at least monthly.
- What do I need to know about administering a SIMPLE IRA?
- SIMPLE IRAs are easy to set up and maintain. IRS filing, tax reporting, and compliance testing are not required.
- Schwab reports all contributions and end-of-year fair market value on Form 5498 by May 31 each year.
- Full vesting is immediate
- What are the rules for withdrawing from a SIMPLE IRA?
Withdrawals are penalty-free after age 59½. If you do not start Required Minimum Distributions (RMDs) by age 70½ (if you were born before July 1, 1949) or age 72 (if you were born on or after July 1, 1949), you will face a 50% penalty on the total amount of the distribution. Withdrawals before age 59½ are subject to a 10% penalty, and the penalty is increased to 25% if the withdrawal occurs within the first two years of participation in the SIMPLE IRA. There are certain exceptions for which you can withdraw funds before age 59½ without taking a 10% penalty, including:
- Rollover of distributions to another IRA or employer plan
- Higher education expenses for you or family members, including tuition, fees, books, supplies, and room and board (must be enrolled at least half-time)
- First-time home purchase expenses ($10,000 lifetime limit) to buy, build, or rebuild a first home for you or your parents, children, or grandchildren (Note: You must not have owned a home within the past two years.)
- Death or disability
- Birth or adoption expenses
- Certain medical expenses, including qualifying health insurance costs for certain unemployed individuals and nonreimbursed expenses exceeding 7.5% of adjusted gross income
- Withdrawals made in equal installments over the account holder’s life expectancy
- What are the SIMPLE IRA rules?
SIMPLE IRAs offer an easy way for business owners to contribute to a retirement plan while offering one to employees as well. These plans are low cost, easy to administer and maintain with no need to file with the IRS. You and your employees can contribute up to a maximum of $13,500 a year (for tax year 2021) and $14,000 a year (for tax year 2022), whichever is less. If you or your employees are over age 50, you can contribute an additional $3,000 (for tax year 2021 and 2022). With the matching option, you match the employee contribution dollar for dollar up to 3%, not to exceed the salary deferral limit for that year. In any two out of five consecutive years, you may match a smaller percentage, not less than 1%. You only contribute to the retirement accounts for the eligible employees who make salary deferral contributions.
The nonelective contribution option requires that you contribute 2% of each eligible employee’s compensation up to a maximum of $5,800 (for tax year 2021) and $6,100 (for tax year 2022). Employees do not have to make contributions themselves
- What are the eligibility requirements for SIMPLE IRA?
As an employer, you must employ 100 people or fewer, each of whom earned at least $5,000 during the previous year. This includes all employees, regardless of whether or not they are eligible to participate in your SIMPLE IRA plan. Employees who earned $5,000 are eligible for the SIMPLE IRA. Employees who are not eligible, or who can be excluded from the eligible category, include those who belong to organized unions and any nonresident alien employees who received no U.S. wages, salaries or other personal services compensation from you. You must establish a new SIMPLE IRA plan between January 1 and October 1 of the tax year unless your business is established after October 1. You may not maintain any other retirement plans such as SEP-IRAs, profit-sharing or 401(k) plans. (Unionized employees are an exception to this rule.) If the number of people you employ goes over 100, you can still maintain your SIMPLE IRA plan for two years after the first year the 100-employee limit is exceeded. After two years, if you still employ more than 100 people, you are no longer eligible to maintain a SIMPLE IRA plan.
How Does a SIMPLE IRA Work?With a SIMPLE IRA, you and your employees can put a percentage of pay aside for retirement. The money will grow tax-deferred until it’s withdrawn at retirement. So, you won’t have to pay taxes on your investment growth, but you will have to pay income taxes when you take out money.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.1If 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 $3,000.2SIMPLE 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
SIMPLE IRA Rules
As with any form of retirement account, there are rules that must be followed. One of the advantages of SIMPLE IRAs is that they typically have fairly straightforward rules, regulations and requirements.
Employees can contribute up to $14,000 a year to a SIMPLE IRA in 2022, which is a $500 increase from 2021. Employees who are 50 and older can make contributions of up to $17,000 a year.
For comparison, employees can contribute up to $20,500 to a 401(k) plan in 2022. SIMPLE IRA contribution limits have risen by $500 each year since 2019.
Required Minimum Distributions (RMDs)
Your required minimum distribution (RMD) is the smallest amount of money you can take out of your account each year once you begin making withdrawals. You can choose to withdraw more than this amount each year but can’t take out any less.
To calculate your minimum distribution, you take the balance of the account at the end of the previous year and divide it by the distribution period.
For SIMPLE IRAs, you must begin withdrawing your required minimum distribution when you are 70 ½ years old if you were born before July 1, 1949, and when you are 72 if you were born on or after that date.
Basic Withdrawal Rules
You will have to pay income tax once you begin making withdrawals from your SIMPLE IRA. There are also additional tax rates if you make withdrawals early.
You will owe an additional 10% tax rate if you make withdrawals from your SIMPLE IRA before you are 59 ½ years old. If you opt to make withdrawals within two years of when you first participated in the SIMPLE IRA, then you will owe a 25% tax rate.
There are some exceptions to the additional tax rates under certain circumstances.Examples of Exceptions to Additional SIMPLE IRA Taxes
- Your withdrawal is an annuity
- You are disabled
- You are the beneficiary of someone else’s SIMPLE IRA
Filing and Notice Requirements
There is generally no filing requirement for the employer when it comes to SIMPLE IRAs. When reporting on a W-2 as an employee, a SIMPLE IRA can be reported by checking the retirement plan box.
Rollovers With SIMPLE IRAs
SIMPLE IRA rollovers can be simple or a hassle, depending on how long you’ve been participating in the plan. If you’ve participated for less than two years, you can only roll funds from a SIMPLE IRA into another SIMPLE IRA. Otherwise, the amount will be considered a withdrawal, and you’ll have to treat it as taxable income and pay a 25% tax on it (unless you’re at least age 59 1/2 or qualify for another exception).
But if at least two years have passed since you began to participate in the plan, you can move the money into almost any type of IRA, or even an employer-sponsored retirement plan, such as a 401(k). A rollover to a Roth IRA, while permissible, is often ill-advised though, since you will have to include any earnings growth in your taxable income.
Key Takeaways A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is an employer-sponsored retirement plan offered within small businesses that have 100 or fewer employees.A SIMPLE IRA works a lot like a 401(k) plan, but there are some differences regarding company matching contributions and other factors.SIMPLE IRA rollovers can be simple or a hassle, depending on how long you've been participating in the plan.
The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a financial professional to determine a suitable retirement savings, tax, and investment strategy.