What is a SIMPLE IRA?

Saving for retirement is crucial for professionals in all stages of their career. With a variety of retirement solutions and accounts available, choosing the best fit for your financial situation can be a daunting challenge.

One of these solutions comes in the form of a SIMPLE IRA, or Savings Incentive Match Plan for Employees.

Simple IRA

A SIMPLE IRA is a retirement plan that can be established by employers and self-employed individuals. Under a SIMPLE IRA, eligible employees are allowed to contribute part of their pretax compensation to the plan, and these contributions are matched by employers.

This retirement savings solution is easy to open, easy to maintain, and comes with some excellent benefits. Consider the facets of SIMPLE IRA and decide if this retirement option is well-suited to your business or personal finances.

What are the Contribution Limits for a SIMPLE IRA?

SIMPLE IRAs have higher contribution limits than both traditional and Roth IRAs. Contribution allowances vary by year. During the 2021 tax year, employees can generally contribute up to $13,500 to a SIMPLE IRA ($16,500 if over 50), or up to 100 percent of their compensation—whichever is lower.

This contribution allowance varies based on catch-up contributions. A catch-up contribution is a type of retirement savings contribution that allows anyone over 50 to make additional contributions. This provision was created by the EGTRRA, or Economic Growth and Tax Relief Reconciliation Act of 2001, in order to help older individuals set aside enough savings for their retirement.

The catch-up contribution limit for SIMPLE IRAs in 2021 is $3,000, which means employees 50 and over can stash away up to $16,500 per year. However, this is only available in companies that allow for catch-up contributions.

Employers can lower the matching contribution to 1 or 2 percent of total compensation in any two of five years the SIMPLE IRA plan is in effect. In the remaining three years, an employer must make either a 3 percent match or 2 percent flat contribution, but you must notify employees of the change.

2021 SIMPLE IRA Contribution Limits
Individual Under 50 $13,500
Individual Over 50 $13,500 + $3000 catch up contribution
Total Contributions for Individuals with Simple IRA + Another Retirement Account $19,500
Employer Contribution Option 1 $1 for $1 excluding contributions in excess of 3% of pay
Employer Contribution Option 2 2% of total gross pay per individual employed

Who can contribute to a SIMPLE IRA?

This retirement solution is available to small businesses that have 100 or less employees. Each employee must earn more than $5,000, and this rule applies to all employees that have worked for the company at any point during the calendar year. Employees cannot contribute to a SIMPLE IRA if they already have a retirement plan.

Employees that work in a company that offers a SIMPLE IRA qualify to contribute so long as:

  • They’ve earned at least $5,000 a year during any two years prior to the plan setup
  • They expect to earn at least $5,000 in the current calendar year

Unlike SEP IRAs, a SIMPLE IRA allows employees to make contributions alongside their employer. Employees aren’t required to contribute to the account, while employers are.

SIMPLE IRAs require an employer to make a contribution on behalf of the employee—this contribution may constitute a dollar for dollar match of up to 3 percent of salary, or a flat fee of 2 percent of pay.

When are SIMPLE IRA contributions taxed?

Contributions to a SIMPLE IRA are made pre-tax. The money in your plan accumulates tax deferred, until you choose to withdraw the amount after retirement.

Can a SIMPLE IRA be a Roth account?

No. Roth IRAs allow individuals to set aside funds after-tax. SIMPLE IRA contributions go into the account tax-free, and taxed when the amount is withdrawn. Use this chart to assess the differences between a traditional IRA and Roth IRA.

Does my business qualify to establish a SIMPLE IRA?

To establish a SIMPLE IRA plan, your business needs to meet these three conditions:

  • You currently offer no other retirement plans to employees
  • You currently have less than 100 employees
  • You fill out one or two forms

It really is that simple to begin this type of retirement plan solution for your business.

What are the penalties for early withdrawal from a SIMPLE IRA?

Should you withdraw the money in your SIMPLE IRA before you turn 59 1/2, you’ll be subject to a 10 percent penalty fee. This penalty is added to any income tax charged on the amount you withdraw at this time.

There are certain exceptions. You may not have to pay this penalty on an early withdrawal if your withdrawal is made under the following circumstances:

  • Correcting a mistake
  • Undoing contributions from a plan with auto enrollment features
  • To cover any qualified higher education expense
  • To pay health insurance premiums while you’re unemployed
  • To pay medical expenses that exceed 10 percent of your AGI
  • To pay off an IRS levy of the plan
  • If you are totally and permanently disabled

What are employer benefits of the SIMPLE IRA?

Simple setup: This retirement solution is ideal for small business owners, as it’s cheaper to set up and maintain a SIMPLE IRA than it is to use more traditional methods, including 401(k) retirement plans and SEP IRAs.

Shared responsibility: Both employer and employee share responsibility for funding a SIMPLE IRA, giving employees some degree of control over how much and when their SIMPLE IRAs are funded. This can be an added bonus for employees, and an attractive incentive during the hiring process.

Tax Deductions: As with other employer plans, the SIMPLE IRA allows employers to take a tax deduction for any contributions they’ve made to a SIMPLE IRA Plan.

Self-employed individuals: If you work alone but have plans to expand your business and add full-time employees in the near future, a SIMPLE IRA may be the right solution. With simple setup and easy add-on features, SIMPLE IRAs can take much of the hassle out of setting up employer-matching retirement solutions.

Portability: Unlike a 401(k), an IRA stays with the employee after they exit the organization, which removes resource constraints on a business and allows the employee to continue to save in the retirement account

• Unlike a 401(k), no fiduciary liability

How a SIMPLE IRA Compares to Other Retirement Accounts

To understand how a SIMPLE IRA stacks up against other retirement plan solutions, consider this chart of some of the most popular and commonly used retirement plans. This chart lists the contribution limits and includes details on sponsorship type for each solution.

Plan Type Sponsorship Contribution Limit in 2021
SIMPLE IRA Private Employer $13,500 / $16,500 if over 50
401(k) Private Employer $19,500 / $26,000 if over 50
SEP IRA Self-Employed and Business Owners $58,000* or 25 percent of an employee’s compensation
Traditional IRA Individual $6,000 / $7,000 if over 50
Solo 401(k) Self-employed $19,500 / $26,000 if over 50

*Elective salary deferrals and catch-up contributions are not permitted in SEP plans.

I employ more than 100 employees. Can I still establish a SIMPLE IRA?

Unfortunately, if you have more than 100 employees who received $5,000 or more in compensation during the preceding calendar year, you cannot establish a SIMPLE IRA. When counting employees, keep in mind that you must include every person employed at any time during the past calendar year; this includes employees who don’t meet the SIMPLE IRA plan’s eligibility requirements.

However, if you’ve already been enrolled in a SIMPLE IRA, don’t leave the plan the moment you hire your 101st employee. If you already maintain a SIMPLE IRA plan, and you satisfied the 100-employee provision in the given calendar year, you’re considered to meet the limitation for the following two years as well.

Are SIMPLE IRAs maintained on a fiscal year basis?

No. You are required to maintain your SIMPLE IRA on a calendar-year basis. If your company uses the fiscal tax year and makes contributions during this timeframe, you can deduct SIMPLE contributions only in the tax year within which your company’s fiscal year ends.

Do SIMPLE IRAs have withdrawal penalties or other limitations?

SIMPLE IRAs have an added limitation, called the two-year rule. This is the time where you cannot move money from your SIMPLE IRA to a non-SIMPLE IRA. If you take distribution during this time, it is not rollover eligible unless it is to another SIMPLE IRA.

If you do move it to a non-eligible account, the IRS will treat it as a taxable distribution or in other words, a taxable withdrawal. After the two-year period, you can roll your money into other types of IRAs; however, if you put the money into a Roth IRA, you’ll have to pay income taxes.

The 10 percent penalty on early withdrawals is increased to 25 percent during the first two years following the first employer contribution. There are a few exceptions, typically in the case of disability-related circumstances or medical emergencies.

You don’t have to pay the additional 10% or 25% tax if:

  • You’re age 59½ or older when you withdraw the money
  • Your withdrawal is not more than:
    • Your unreimbursed medical expenses that exceed 10% of your adjusted gross income (7.5% if you or your spouse is age 65 or older),
    • Your cost for your medical insurance while you’re unemployed,
    • Your qualified higher education expenses, or
    • The amount to buy, build or rebuild a first home (up to $10,000)
  • Your withdrawal is in the form of an annuity
  • Your withdrawal is a qualified reservist distribution
  • You’re disabled
  • You’re the beneficiary of a deceased SIMPLE IRA owner
  • The withdrawal is the result of an IRS levy

This two-year rule prohibits rollover and transfer of the funds in your SIMPLE IRA account; you cannot transfer the money in this account to a different type of retirement plan during the first two years. However, you may choose to rollover your funds to another SIMPLE IRA plan during that period.

If you leave your job during that two-year period, you have a few options:

1. Leave the money where it is until the two-year period is over
2. Roll the amount into another SIMPLE IRA that you can access
3. Withdraw your money and take the tax penalties

Where can I open a SIMPLE IRA?

SIMPLE IRAs are relatively simple to apply for, and easy to open. There are a wide range of institutions that offer SIMPLE IRA accounts, including banks, savings and loan associations, investment companies, federally insured credit unions, brokerage firms, mutual fund companies, deep-discount online brokers, and insurance companies.

Opening a SIMPLE IRA with GuidedChoice is quick and efficient. Our team of experts can help you examine the merits of this retirement savings solution, and help you decide whether or not this is the right option for your small business.

What if my employees want to stop their SIMPLE IRA contributions?

Your employees may terminate their salary reduction contributions to your SIMPLE IRA plan at any time. If they choose this course of action, the SIMPLE IRA may preclude them from resuming salary reduction contributions until the start of the following calendar year. However, if you’re making non-elective employer contributions, you must to continue to make these on behalf of your employees.

Note: You cannot suspend or modify your employer matching contributions mid-year. You must make the contributions that you promised your employees in the SIMPLE IRA plan notice.

At GuidedChoice, you can find the retirement solutions that benefit you most. Consider a SIMPLE IRA for your business and let our team of professionals provide invaluable guidance on this retirement savings plan.