What is a SIMPLE IRA?
A SIMPLE IRA is an acronym that stands for a Savings Incentive Match Plan for Employees. These are plans that are employer-sponsored and that are meant for smaller businesses that have fewer than 100 workers. Businesses may choose to set up a Savings Incentive Match Plan for Employees because they are easier and less expensive to set up than traditional 401(k) plans.
SIMPLE IRAs have specific rules for companies that want to set them up. One key difference between a SIMPLE IRA and a 401k plan is that a SIMPLE IRA company match is built into the plan. Businesses must contribute either 3 percent of an employee’s annual salary or a 2 percent flat rate whether there are employee contributions or not. With 401(k) plans, company contributions are optional.
SIMPLE IRA statistics
At the second quarter’s end in 2018, people held $9.3 trillion in IRAs in the U.S. This represented one-third of all of the different types of retirement assets held by people in the U.S. Of that number, 5.9 percent of the IRAs that were held in the U.S. were employer-sponsored plans, including SIMPLE IRAs and SEP IRAs.
A total of 7.8 million households had SEP IRAs or SIMPLE IRAs as of June 30, 2018. These employer-sponsored plans for retirement are offered by smaller employers instead of 401(k) plans so that the employers can offer a retirement benefit to their workers at a lower cost.
How do SIMPLE IRAs work?
SIMPLE IRAs work in a similar manner as 401(k) plans. Employee contributions are made on a pre-tax basis. The elective deferrals grow on a tax-deferred basis until people begin withdrawing it after they retire. If people withdraw money before they reach age 59 1/2, they will face a 10 percent penalty. Since employee contributions are made on a pre-tax basis, you will be taxed at your current income tax rate at the time that you start making withdrawals.
With these plans, the SIMPLE IRA employer match is mandatory. The company must either match employee contributions dollar-for-dollar up to 3 percent of the employee’s annual salary or contribute a flat 2 percent. The SIMPLE IRA employer match contributions are 100 percent vested at the time that they are made and are not optional.
Who is eligible for a SIMPLE IRA?
Companies that have fewer than 100 workers are eligible to start a SIMPLE plan. These plans are meant for companies at which the workers will make the bulk of the contributions for their retirement.
All workers who earned at least $5,000 from a company in any two preceding years and that are expected to earn at least $5,000 during the upcoming year are eligible to participate and to make elective deferrals. Company sponsors must make contributions to an eligible employee’s plan even if he or she makes no contributions of his or her own.
Advantages and disadvantages of a SIMPLE IRA
SIMPLEs have several advantages for workers and businesses. Workers can take the employer contributions with them whenever they leave even if they do not stay at their jobs for very long because the contributions vest immediately. This might mean that it makes sense as a part of your retirement strategy to participate and contribute to a SIMPLE plan at your job. The annual SIMPLE IRA contribution limits are relatively high at $13,000 for people who are younger than age 50 and catch-up SIMPLE IRA contribution limits of $3,000 per year after age 50. However, the limits are lower than they are for 401(k) plans.
Businesses also can enjoy some benefits. The plans are less expensive than 401(k) plans and do not require complicated vesting schedules and other complex rules. Companies with these plans are able to claim a tax credit for the first three years of the plans.
There are also some disadvantages of SIMPLE plans. Workers will be taxed on their withdrawals after they have retired, which is a consideration for retirement planning. If they are in a higher tax bracket at that time, they may pay more in taxes than if they had made after-tax contributions to another type of plan such as a Roth IRA. Workers are also unable to take loans against their savings, and they do not have a Roth option.
Businesses might not like the mandatory contributions or automatic 100 percent vesting. Businesses must also consider that they can only continue the plan if they keep their worker totals under 100. If they anticipate growing beyond that size, a SIMPLE plan might not be an appropriate option.
SIMPLE IRA limits
The SIMPLE IRA limits for workers are currently $13,000 per year if you are under the age of 50. If you are 50 or older, you can add an additional $3,000 per year as a catch-up contribution.
To be eligible to participate in your company’s SIMPLE plan, you must have earned a minimum of $5,000 in any two previous years working for the business. You must also be anticipated to earn at least $5,000 during the upcoming year.
SIMPLE IRA deadlines
Companies that want to set up SIMPLE plans need to be aware of the deadlines for doing so. If your business wants to start a plan for this year, it will need to do so between Jan. 1 and Oct. 1. If your business began operating after Oct. 1, it can still open a plan that will count for the current year as long as you start it as soon as it is administratively feasible.
Workers who are eligible to participate in their company’s SIMPLE plan must have their IRAs established in time to receive the initial contributions from the company that is sponsoring it. The workers are not required to make contributions, but the company is required to do so. Worker deferral contributions that are made must be deposited to the worker’s IRA by the 30th of the following month. Sole proprietors may be considered to be both the employer and the worker and may make the annual contributions allowed for workers as well as the matching contributions.
Investment options
There are a variety of different investment options for SIMPLE plans. The particular investment choices that will be available to an owner of the IRA will depend on the financial institution and the SIMPLE plan.
Some of the potential investment choices that might be available include the following:
- Mutual funds
- Bonds
- Stocks
- Coins that meet an exception
- Real estate
- Money market funds
SIMPLE plans are not allowed to invest in most collectibles. Coins can be included in the investments as long as they meet an exception as follows:
- U.S. gold coins
- Bullion that is gold, silver, platinum, or palladium
- Silver coins from the U.S. Treasury
Withdrawals, distributions, penalties, and RMDs
Like 401(k) plans and traditional IRAs, you cannot make withdrawals from your SIMPLE plan before you reach age 59 1/2. If you do, you will incur a 10 percent penalty. The penalty may be increased to 25 percent if you make an early withdrawal within two years of when you first made a contribution.
There is also a required minimum distribution date for a SIMPLE plan. You must start taking contributions when you reach age 70 1/2. You are also not able to continue contributing to your plan after that age.
People who think that they will not need to use the money in their plans and want to continue contributing to leave the money as a legacy for their families might want to consider rolling their SIMPLE plans into Roth IRAs. Roth IRAs do not have a required minimum distribution when they reach age 70 1/2 and can continue contributing well past that age.
Comparisons to other IRA plans
When you are writing your retirement plan and are trying to figure out more about what a SIMPLE IRA is, comparing these types of plans to others can be helpful. Before you decide to open a SIMPLE plan at your company or to contribute to a plan that is sponsored by the company for which you work, you might want to compare a SIMPLE plan to other types of accounts. This can help you to choose the option that might meet your needs, goals, and retirement strategy the best.
SIMPLE IRA vs traditional IRA
A few differences emerge when you compare a SIMPLE IRA vs traditional IRA. The limits are higher for a SIMPLE plan than they are for a traditional plan. Here is a table that can let you see how a SIMPLE IRA is both similar and different from the traditional account when you are considering them as a part of your retirement plan.
| SIMPLE plan | Traditional IRA |
|---|---|
| Pre-tax contributions | Pre-tax contributions |
| Pay taxes when money withdrawn | Pay taxes when money withdrawn |
| For self-employed people and their workers | For any individual |
| Maximum contributions of $13,000 if younger than 50 | Maximum contributions of $6,000 if younger than 50 |
| Catch-up contributions of $3,000 | Catch-up contributions of $1,000 |
| Penalties on withdrawals before 59 1/2 | Penalties on withdrawals before 59 1/2 |
SIMPLE IRA vs 401k
One way to understand more of what a SIMPLE IRA is and is not, is to compare it to a 401(k) account. There are similarities and differences between a SIMPLE IRA vs 401k. A 401k plan has a higher annual contribution amount than a SIMPLE plan. Here is a table that lets you see how a SIMPLE IRA is different from a 401(k) account.
| SIMPLE IRA | 401k |
|---|---|
| Pre-tax contributions | Pre-tax contributions |
| Pay taxes when money withdrawn | Pay taxes when money withdrawn |
| For self-employed people with fewer than 100 workers | For businesses and their employees |
| Maximum contributions of $13,000 if younger than 50 | Maximum contributions of $19,000 if younger than 50 |
| Catch-up contributions of $3,000 | Catch-up contributions of $6,000 |
| Penalties on withdrawals before 59 1/2 | Penalties on withdrawals before 59 1/2 |
| No Roth 401(k) contribution option | Has a Roth 401(k) contribution option |
| Company contribution 100 percent up to 3 percent or 2 percent for non-elective | Company contribution optional |
| No loans | Loans allowed |
SEP IRA vs SIMPLE IRA
When comparing a SEP IRA vs SIMPLE IRA, there are a few key differences. SEP IRAs are more similar to pensions, and the sponsoring businesses make 100 percent of the contributions. Here is a table so that you can see how a SIMPLE IRA is different from a SEP account.
| SIMPLE IRA | SEP IRA |
|---|---|
| Workers fund the bulk of their savings | Companies make contributions for themselves and to benefit their workers |
| For businesses with fewer than 100 workers | For businesses of any size that want to give a tax-free fringe benefit to workers |
| Worker contribution maximum is $13,000 if younger than 50 | Company contributions limited to $56,000 or 25 percent of an employee’s compensation |
| Catch-up contributions of $3,000 | All contributions are made by the business |
| Penalties on withdrawals before 59 1/2 | Penalties on withdrawals before 59 1/2 |
SIMPLE IRA vs Roth IRA
A SIMPLE IRA vs Roth IRA reveals several differences that are important for retirement planning. Roths have lower contribution amounts, but the withdrawals are not taxed and can be made before people reach age 59 1/2 without penalties. Here is a look at how a SIMPLE IRA is different from a Roth account.
| SIMPLE IRA | Roth IRA |
|---|---|
| Pre-tax contributions | After-tax contributions |
| Pay taxes when money withdrawn | Distributions are not taxed |
| For self-employed people and their workers | For any individual |
| Contributions limited to $13,000 if younger than 50 | Contributions limited to $6,000 if younger than 50 |
| Catch-up contributions of $3,000 | Catch-up contributions of $1,000 |
| Penalties on withdrawals before 59 1/2 | No penalties on early withdrawals |
| Business required to contribute 100 percent up to 3 percent of salary or 2 percent | Account for individuals |
| Worker must earn at least $5,000 per year | Single people must have a Modified Adjusted Gross Income of less than $137,000; Married people must have a combined MAGI of less than $203,000 |
Rollovers
Several rollover rules apply to roll over money in your SIMPLE account to other types of accounts as well as rolling over other accounts into your SIMPLE account. It is important that you understand these rules so that you can avoid incurring penalties and taxes.
You are able to roll over your SIMPLE account into another IRA or an employer-sponsored plan other than a Roth IRA. During the first two years from the date of your initial participation in the SIMPLE plan, you are only allowed to roll over the account into another SIMPLE plan. After the two years have passed, you are able to roll over your account into the following types of plans:
- Traditional IRAs
- 401(k)
- 457(b)
- 403(b)
You are also able to roll the funds over into a Roth IRA after the two years have elapsed, but you must include any portion that has not been taxed in your income for the year.
If you do not follow the rollover rules, the amounts that you take out of your SIMPLE plan will be counted as withdrawals. If you are younger than age 59 1/2, you will have to pay a 10 percent penalty plus taxes. If the withdrawals are made before the initial two-year period is over, you will be assessed an additional 25 percent penalty.
Terminating a SIMPLE IRA plan
If you are a business owner who has decided that your SIMPLE plan is not working for your company, there are a few steps that you need to take to terminate the plan. Once you start a SIMPLE plan, you must continue it for the entire calendar year. You are not able to terminate a SIMPLE plan in the middle of the year.
You must notify all of your workers by Nov. 2 that you will terminate the plan if you want the effective date to start on the subsequent year’s Jan. 1. If you wait until after Nov. 2, you will have to continue the plan until the following year’s Jan. 1. After you have notified your workers, you must then notify the financial institution that you will no longer be making SIMPLE contributions beginning in the following year.
Creating, operating and maintaining a plan
There are several steps that you should take to create, operate, and maintain a SIMPLE plan. You will first start by choosing the plan and adopting it through a Form 5304-SIMPLE or Form 5305-SIMPLE. Once you have chosen a plan, you will then need to choose the financial institution that will act as a trustee to hold your worker’s IRA assets.
Once you have created a plan, you will then need to operate and maintain it correctly. Any worker who has made at least $5,000 during any two previous years and who you expect to make at least $5,000 in the upcoming year is eligible to participate and should be included. Workers can choose to contribute up to the contribution limits to their accounts. You can choose to either match their contributions dollar-for-dollar up to 3 percent of their salaries or to contribute a flat 2 percent to their accounts.
Examples
Here are two examples of contributions when workers choose to contribute and when they do not.
Option 1 – John works at a company that has decided to start a SIMPLE plan for its workers. The company has decided to match contributions up to 3 percent of their salaries. Mike earns $70,000 per year and contributes the annual maximum of $13,000. The company must match up to 3 percent of John’s salary, or $2,100. If John chooses to make no contributions, the company will not have to make any, either.
Option 2 – John works at a company that has started a SIMPLE plan for its workers. The company has chosen to contribute a flat 2 percent of each worker’s salary. John earns $70,000 per year. The company will have to contribute 2 percent of John’s salary, which is $1,400, even if John contributes nothing.
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