Unlocking the Power of SIMPLE IRAs

In today's fast-paced world, ensuring financial security during retirement is more crucial than ever. Thankfully, several retirement savings options are available out there—which includes the SIMPLE (Savings Incentive Match Plan for Employees) IRA. Today, we’ll explore the ins and outs of SIMPLE IRAs and discuss what they are, how they work, their benefits, contribution limits, and how to set one up. Let’s dive in.

What is a SIMPLE IRA?

A SIMPLE IRA is a retirement savings plan designed specifically for small businesses and self-employed individuals. As with a 401(k), a SIMPLE IRA is a tax-deferred vehicle: meaning you fund the account with pre-tax dollars and pay taxes on any withdrawals you make in the future. SIMPLE IRAs also allow employers to make contributions on behalf of their employees.

Who is eligible for a SIMPLE IRA?

To establish a SIMPLE IRA plan, your business must have 100 or fewer employees and you cannot maintain any other retirement plan—such as a 401(k), profit-sharing plan, or pension plan—during the same calendar year. Self-employed individuals or sole proprietors are also eligible for SIMPLE IRAs.

Employees who wish to participate must generally be 21, have earned $5,000 or more in any two preceding calendar years, and expect to earn the same in the year they become eligible.

However, employers can set less restrictive requirements such as a lower minimum compensation threshold or the ability to participate immediately upon hire.

Employer contributions

Employers have two options with respect to contributing to employees' SIMPLE IRAs: they can either match contributions dollar for dollar (up to 3% of each employee's compensation) or choose to make a non-elective contribution of 2% of this compensation, regardless of whether the employee makes any contributions. The figure of 2% is based on a maximum salary of $330,000 for 2023, meaning employers would contribute at most $6,600 to an individual account.

Not only do employers enjoy these contribution options, but they can also switch between them if they so desire: doing a dollar-for-dollar match one year and then making a 2% nonelective contribution the next. They can also drop their matching contributions to as low as 1% of compensation for 2 years within any given 5-year period (the 2% nonelective contribution cannot be changed or decreased unless the employer returns to a matching option).

With respect to timing, employers must contribute to SIMPLE IRAs by the due date—including extensions—of their federal income tax return for the year.

Employee contributions

Employees, meanwhile, select the percentage of their salary they wish to contribute during their employer’s annual election period (generally from November 2 through December 31).

For the 2023 tax year, employees can contribute up to $15,500 to their SIMPLE IRA (with those aged 50+ able to make an additional catch-up contribution of $3,500, boosting their total annual contribution to $19,000).

In 2024, these limits will increase due to the SECURE ACT 2.0—with changes based on employer size. Those whose employers have fewer than 26 employees can elect to contribute up to 110% of the annual limit established by the IRS, while employers with 26 to 100 employees must meet specific requirements to offer the additional limit.

Contributions must be made by April 15 of the following year for the previous year's contributions (e.g., the 2023 SIMPLE IRA contribution deadline is April 15, 2024).

SIMPLE IRA benefits for employers

They’re easy to set up and administer
SIMPLE IRAs are not only straightforward to establish and maintain but also come without the administrative burden and cost associated with traditional 401(k) plans—which is precisely why small businesses with limited administrative resources often consider them.

Employers can initiate the process by completing either IRS Form 5304-SIMPLE or 5305-SIMPLE to establish SIMPLE IRA plan documents. These forms outline plan terms and conditions.

They offer tax advantages
Contributions employers make to a SIMPLE IRA are tax-deductible.

They’re flexible
Employers can adjust how exactly they contribute to a plan, thus appreciating this level of flexibility during economic or organizational downturns.

SIMPLE IRA benefits for employees

They offer tax advantages
As with most other retirement savings accounts, SIMPLE IRAs provide tax-deferred savings: meaning the money you contribute is subject to federal income tax after you withdraw it during retirement.

They feature employer matching
For employees, the allure of employer contributions is a significant perk; with SIMPLE IRAs, employer contributions are mandatory (more on that later) and thus grant employees “free” money—akin to 401(k)s.

They offer immediate vesting
Employee SIMPLE IRA contributions are always 100% vested, meaning both the money employees contribute and employer contributions belong entirely to the employee from Day 1.

They allow for catch-up contributions
Individuals aged 50 and older can make catch-up contributions to their SIMPLE IRAs, helping them save even more for retirement.

They boast plenty of investment options
Choices often outnumber what’s typically offered with 401(k) plans.

SIMPLE IRA drawbacks

Contribution limits are lower than other workplace retirement plans
The 2023 401(k) employee contribution limit of $22,500 ($30,000 if you’re age 50 or older) is considerably higher than that of a SIMPLE IRA. Though this may not pose an issue for many employees, if it does, a SIMPLE IRA may not be the best choice for you or your business.

If you’re a sole proprietor or self-employed, a SEP IRA allows you to contribute 25% of your net earnings (or up to $66,000) in 2023.

Loans aren’t allowed
Participants cannot borrow money from their SIMPLE IRA, unlike with other retirement plans.

Steep early withdrawal penalties exist
Generally speaking, SEP IRA distribution rules mirror their traditional IRA counterparts with the exception of non-qualified withdrawals during the first two years of participation. Specifically, you’ll pay an additional 15% early withdrawal penalty on top of the standard 10% penalty—which doesn’t even include taxes on your withdrawal!

There are stricter rules regarding rollovers
If you change jobs while participating in a SIMPLE IRA plan, you can leave this with your former employer's financial institution; but if your new employer offers a SIMPLE IRA plan, you can transfer these existing funds to the new plan in the absence of any tax consequences. If you wish to roll over your SIMPLE IRA into a traditional IRA, however, there’s a two-year waiting period (with a failure to adhere to this rule resulting in a 25% penalty).

SIMPLE IRAs have RMDs
Upon reaching age 73, you must begin taking annual required minimum distributions (RMDs): the minimum amount of money one must withdraw from specific tax-deferred retirement accounts beginning at age 73 (age 75, starting in 2033).

Other SIMPLE IRA considerations

SIMPLE IRA withdrawals are taxed as ordinary income, which means your tax rate ultimately depends on your tax bracket at the time of withdrawal.

Moreover, some financial institutions may offer a Roth SIMPLE IRA option whereby contributions are made with after-tax dollars and qualified withdrawals are tax-free. Be sure to inquire about this option if it aligns with your own unique financial strategy.

Final thoughts: SIMPLE IRAs

In a world filled with complex financial options, the SIMPLE IRA is a straightforward and effective retirement savings strategy. Whether you're an employer looking to provide retirement benefits to your employees without lofty administrative costs or a high level of maintenance or an employee seeking a reliable way to save for the future, a SIMPLE IRA can help you achieve your goals.