If you’re exploring retirement plans, you may be wondering, what is a SIMPLE IRA? A SIMPLE IRA is one type of tax-advantaged retirement savings plans to help self-employed individuals and small business owners put money away for their future.
You may already be familiar with traditional individual retirement accounts (IRAs). A SIMPLE IRA, or Saving Incentive Match Plan for Employees, is one type of IRA.
What Is a SIMPLE IRA?
SIMPLE IRA plans are employer-sponsored retirement accounts for businesses with 100 or fewer employees. They are also retirement accounts for the self-employed. If you’re your own boss and self-employed, you can set one up for yourself.
For small business owners, SIMPLE IRAs are an easy-to-manage, low-cost way to contribute to their own retirement while at the same time helping employees to contribute to their savings as well.
How Does a SIMPLE IRA Work?
Now that you know the answer to the question, what is a SIMPLE IRA?, you are probably wondering how this plan works. A SIMPLE IRA is one of the different types of retirement plans available. In order for an employee to participate, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, and they must expect to make $5,000 in the current calendar year.
It is possible for employers to set less restrictive rules for SIMPLE IRA eligibility. For example, they could lower the amount employees are required to have made in a previous two-year time. However, they cannot make participation rules more restrictive.
Employers can exclude certain types of employees from the plan, including union members who have already bargained for retirement benefits and nonresident aliens who don’t receive their compensation from the employer.
💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with a traditional IRA. The money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).
SIMPLE IRA vs Traditional IRA
When it comes to a SIMPLE IRA vs. Traditional IRA, the two plans are similar. However, there are some key differences between the two. A SIMPLE IRA is for small business owners and their employees. A traditional IRA is for anyone with an earned income.
The eligibility criteria is different for the two plans. To be eligible for a SIMPLE IRA, an employee must have earned at least $5,000 in compensation over the course of two years prior — and expect to make $5,000 in the current calendar year. With a traditional IRA, an individual must have earned income in the past year.
And while both types of IRAs are tax deferred, a traditional IRA allows individuals to make tax deductible contributions, while only an employer or sole proprietor can make tax deductible contributions to a SIMPLE IRA.
One of the biggest differences between the two plans is the contribution amount. Individuals can contribute $6,500 in 2023 to a traditional IRA (or $7,500 if they are age 50 or older) and $7,000 in 2024 (or $8,000 if they are 50 or over), while those who have a SIMPLE IRA can contribute $15,500 in 2023 and $16,000 in 2024 (plus an extra $3,500 for those age 50 and older for both 2023 and 2024).
SIMPLE IRA vs 401(k)
SIMPLE IRAs have some similarity to 401(k)s. Both are employer-sponsored plans that eligible employees can contribute to. Contributions made to both are made with pre-tax dollars, and the money in the accounts grows tax-deferred. Both types of plans give the employer the option to make matching contributions to employees’ plans.
One major difference between the two plans is that while self-employed individuals can’t open a 401(k), they can set up a SIMPLE IRA for themselves.
Additionally, individuals can contribute much more to a 401(k) than they can to a SIMPLE IRA. In 2023, those with a 401(k) can contribute $22,500 to the plan, plus an extra $7,500 for those 50 and older. In 2024, they can contribute 23,000 to their 401(k) and an additional $7,500 if they’re 50 or older. In comparison, in 2023, individuals can contribute $15,500 to a SIMPLE IRA, plus $3,500 extra for those 50 and up. For 2024, they can contribute $16,000, plus an additional $3,500 if they are 50 or older.
SIMPLE IRA Contribution Rules
Employer Contribution and Matching Rules
When an employer sets up a SIMPLE IRA plan, they are required to contribute to it each year. They have two options: They can either make matching contributions of up to 3% of an employee’s compensation, or they can make a nonelective contribution of 2% for each eligible employee, up to an annual limit of $330,000 in 2023 and $345,000 in 2024.
If the employer chooses the latter option, they must make a contribution to their employees’ accounts, even if those employees don’t contribute themselves. Contributions to employee accounts are tax deductible.
Employee Contributions
Eligible employees can choose to contribute to the plan, as well. In 2023, SIMPLE IRA contribution limits are up to $15,500 in deferrals. Those 50 and older can contribute an extra $3,500 in catch-up contributions, which brings their annual maximum contributions up to $19,000. In 2024, eligible employees can contribute up to $16,000, while those 50 and older can contribute an additional $3,500. Those contribution levels may change over time, as the government adjusts them to account for inflation.
Contributions reduce employees’ taxable income, which gives them an immediate tax benefit, lowering their income taxes in the year they contribute. Contributions can be invested inside the account and may grow tax-deferred until the employee makes withdrawals when they retire.
IRA withdrawal rules are particularly important to pay attention to as they can be a bit complicated. Withdrawals made after age 59 ½ are subject to income tax. If you make withdrawals before then, you may be subject to an additional 10% or 25% penalty. Account holders must make required minimum distributions from their accounts when they reach age 73.
Establishing and Operating a SIMPLE IRA Plan
SIMPLE IRAs are relatively easy to put in place, since they have no filing requirements for employers. Employers cannot offer another retirement plan in addition to offering a SIMPLE IRA.
If you’re interested in opening a SIMPLE IRA, banks and brokerages may have a plan, known as a prototype plan, that’s already been approved by the IRS.
Otherwise you’ll need to fill out one of two forms to set up your plan:
• Form 5304-SIMPLE allows employees to choose the financial institutions that will receive their SIMPLE IRA contributions.
• You can also fill out Form 5305-SIMPLE, which means employees will deposit SIMPLE IRA contributions at a single financial institution chosen by the employer.
Once you have established the SIMPLE IRA, an account must be set up by or for each employee, and employers and employees can start to make contributions.
Notice Requirements for Employees
There are minimal paperwork requirements for a SIMPLE IRA. Once the employer opens and establishes the plan through a financial institution, they need to notify employees about it. This should be done by October 1 of the year the plan is intended to begin. Employees have 60 days to make their elections.
Eligible employees need to be notified about the plan annually. Any changes or new terms to the plan must be disclosed. At the beginning of each annual election period, employers must notify their employees of the following:
• Opportunities to make or change salary reductions.
• The ability to choose a financial institution to receive SIMPLE IRA contribution, if applicable.
• Employer’s decisions to make nonelective or matching contributions.
• A summary description provided by the financial institution that acts as trustee of SIMPLE IRA fund, and notice that employees can transfer their balance without cost of penalty if the employer is using a designated financial institution.
Participant Loans and Withdrawals
No loans are allowed to participants in a SIMPLE IRA. Withdrawals made before age 59 ½ are subject to a possible 10% or 25% penalty.
Rollovers and Transfers to Other Retirement Accounts
For the first two years of participating in a SIMPLE IRA, participants can only do a tax-free rollover to another SIMPLE IRA. After two years, they may be able to roll over their SIMPLE IRA to other non-Roth IRAs or an employer-sponsored plan such as 401(k).
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
The Advantages and Drawbacks of a SIMPLE IRA Plan
While SIMPLE IRAs may offer a lot of benefits, including immediate tax benefits, tax-deferred growth, and employer contributions, there are some drawbacks. For example, SIMPLE IRAs don’t allow employees to save as much as other retirement plans such as 401(k)s and Simplified Employee Pension (SEP) IRAs.
In 2023, employees can contribute up to $22,500 to a 401(k) account, with an extra $7,500 in catch-up contributions for those 50 and older. In 2024, they can contribute up to $23,000 to a 401(k), plus an additional $7,500 for those 50 and over. Individuals with a SEP IRA account can contribute up to 25% of their employee compensation, or $66,000, whichever is less, in 2023. They can contribute up to $69,000 or up to 25% of their compensation, whichever is less in 2024.
The good news is, employees with SIMPLE IRAs can make up some of that lost ground. Employers may be wondering about the merits of choosing between a SIMPLE and traditional IRA, but they can actually have both.
Employers and employees can open a traditional or Roth IRA and fund it simultaneously. For 2023, total contributions to IRAs can be up to $6,500, or $7,500 for those ages 50 and older. For 2024, total IRA contributions can be up to $7,000, or $8,000 for those 50 and over.
Here some pros and cons of starting and funding a SIMPLE IRA at a glance:
| Pros of a SIMPLE IRA | Cons of a SIMPLE IRA |
|---|---|
| Easy to set up, with less paperwork than other retirement accounts, such as 401(k)s. | Lower contribution limits than other plans, such as 401(k)s and SEP IRAs. |
| Employers have lower upfront and management costs to run the plan. | Withdrawals made before age 59 ½ are subject to a possible 10% or 25% penalty. |
| Contributions are tax deductible for employers and employees. | There is no Roth option that would allow employees to fund the retirement account with after-tax dollars that would translate to tax-free withdrawals in retirement. |
| There are no filing requirements with the IRS. |
Eligibility and Participation in a SIMPLE IRA
As mentioned previously, there are some rules about who can participate in a SIMPLE IRA. Here’s a quick recap.
Who Can Establish and Participate in a SIMPLE IRA?
Small business owners with fewer than 100 employees and self-employed individuals can set up and participate in a SIMPLE IRA, along with any eligible employees.
Employers can’t offer any other type of employer-sponsored plan if they set up a SIMPLE IRA.
Employees’ Eligibility and Participation Criteria
In order for an employee to be eligible to participate, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, and they must expect to make $5,000 in the current calendar year.
Employees can choose less restrictive requirements if they choose. They may also exclude certain individuals from a SIMPLE IRA, such as those in unions who receive benefits through the union.
Investment Choices and Account Maintenance
The employer chooses investment options for the SIMPLE IRA and maintains the plan. Employees then select the investment options they want.
Investment Choices Under a SIMPLE IRA
Typically, there are more investment choices with a SIMPLE IRA than there with a 401(k). Investment options can include stocks, mutual funds, exchange-traded funds (ETFs), and bonds.
Understanding SIMPLE IRA Distributions
There are particular rules for SIMPLE IRA distributions, and it’s important to be aware of them. This is what you need to know.
Withdrawal Rules and Tax Consequences
As discussed previously, withdrawals made before age 59 ½ are subject to income tax plus a potential 10% or 25% penalty. Withdrawals made after age 59 ½ are subject to income tax only and no penalty. Account holders must make required minimum distributions from their accounts when they reach age 73.
The 2-Year Rule and Early Withdrawal Penalties
There is a two-year rule for withdrawals from a SIMPLE IRA. If you make a withdrawal within the first two years of participating in the plan, the penalty may be increased from 10% to 25%.
The Takeaway
SIMPLE IRAs are one of the easiest ways that self-employed individuals and small business owners can help themselves and their employees save for retirement, whether they’re experienced retirement investors or they’re opening their first IRA.
These accounts can even be used in conjunction with certain other retirement accounts and investment accounts to help individuals save even more.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
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