What Is a SIMPLE IRA? Retirement Plan Rules, FAQs

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.

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How to Set Up a SIMPLE IRA

As the name implies, a SIMPLE IRA is often easier for a small employer to set up and administer than a 401(k) plan.

These plans require minimal paperwork for the employer and maintenance costs are low.

A SIMPLE IRA is established through a financial institution, such as a bank, which then administers the plan.

The plan provider will offer various investment options to choose from, such as stocks, bonds and mutual funds.

Each employee can choose which investments to include in their own SIMPLE IRA.

Three Steps an Employer Must Follow to Establish a SIMPLE IRA

Select the type of SIMPLE IRA you want to provide. You must fill out IRS Form 5305-SIMPLE if you want to select the financial institution where employees will hold their IRAs, or fill out IRS Form 5304-SIMPLE if you want workers to pick the financial institution that will hold their account. Provide eligible employees with information about the SIMPLE IRA plan. Create separate SIMPLE IRAs for each eligible employee using Form 5305-S or Form 5305-SA.

If you’re an employee and want to sign up for a SIMPLE IRA at your job, your employer will have you fill out one of the forms above.

Employee Rules Requirements for a SIMPLE IRA Plan

Employees must fill out a SIMPLE IRA adoption agreement in order to open their accounts. Employees are not required to make regular IRA contributions to their SIMPLE IRA account.

1. SIMPLE IRA Eligibility

All employees, sole proprietors, or the self-employed who received at least $5,000 in compensation during any of the two preceding calendar years and who are expected to receive at least $5,000 during the current calendar year are eligible to participate in a SIMPLE IRA plan.

2. SIMPLE IRA Contribution Limits

In 2022, an employee can contribute an annual maximum of $14,000 into a SIMPLE IRA. However, employees over the age of 50 can make an additional catch-up contribution of up to $3,000, bringing their total contribution to $17,000 per year. Compare that with the 401k plan catch-up contribution in 2022 of $6,500.

Setting Up a SIMPLE IRA Plan

Otherwise, you may have to complete: The 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.
After your SIMPLE IRAs are set up, you and your employees can choose to make regular pre-tax contributions through payroll deductions. You can also pick how your money gets invested. For example, you can set up your account to invest in mutual funds. Your SEP IRA grows tax-deferred until you make withdrawals.1, 2 IRS, “Retirement Topics – SIMPLE IRA Contribution Limits”3 IRS, “401(k) contribution limit increases to $19,500 for 2020; catch-up limit rises to $6,500”The Hartford shall not be liable for any damages in connection with the use of any information provided on this page. Please consult with your insurance agent/broker or insurance company to determine specific coverage needs as this information is intended to be educational in nature.The information contained on this page should not be construed as specific legal, HR, financial, or insurance advice and is not a guarantee of coverage. In the event of a loss or claim, coverage determinations will be subject to the policy language, and any potential claim payment will be determined following a claim investigation.

The Rules Guiding SIMPLE IRAs

Like every other retirement plan, SIMPLE IRAs have their own rules set by the IRS. Below are some of the most important SIMPLE IRA rules to be familiar with:

Early Withdrawal Penalties

The withdrawal age for a SIMPLE IRA is the standard 59 ½ years. Any withdrawals before that will incur a 10% withdrawal penalty. However, the penalty grows to 25% if the withdrawal occurs within the first two years of first participation in the plan.

Required minimum distributions (RMD) also set in by age 72.

Contribution Deadlines

For employees who choose to contribute to the plan, contributions must be made within 30 days after the end of the month in which the amounts would have become payable to them.

On the other hand, the employer must make contributions before the due date for filing business income tax returns (including any applicable extensions).

Contribution Limits

In 2022, employees can contribute a maximum of $14,000 to a SIMPLE IRA. For employees 50 years old and above, there is a catch-up contribution of $3,000 that increases their limit to $17,000.

These contribution limits are adjusted every year to cater to cost-of-living adjustments (inflation).

Who Can Open a SIMPLE IRA?

To open a SIMPLE IRA, you and your employer must meet certain criteria:

  • Employer Eligibility for a SIMPLE IRA. An employer must have 100 employees or fewer to open a SIMPLE IRA, and it must make contributions each year. It can switch between matching contributions and non-elective contributions as long as it provides notice.
  • Employee Eligibility for a SIMPLE IRA. Employees may participate in a SIMPLE IRA if they have received at least $5,000 in compensation during any two of the previous calendar years and expect to be paid that much in the current year. Employers may use less stringent requirements, though whatever rules they set must be applied identically to all employees. Employers don’t have to let an employee participate in a SIMPLE IRA plan if they receive union benefits.

SIMPLE IRA vs. 401(k)

While SIMPLE IRAs and 401(k) plans are both useful for saving for retirement, there are some key differences between the two plans. SIMPLE IRAs are unique to small businesses and can only be used by employers with 100 or fewer workers, while 401(k) plans can be opened at any workplace with one or more employees.

Employer contributions are optional in 401(k) plans, but mandatory for SIMPLE IRAs. You’ll also have higher contribution limits in 401(k) plans than in a SIMPLE IRA.

The fees and administrative tasks involved are higher in 401(k) plans, whereas a SIMPLE IRA has no required annual tax filing and relatively low fees. Also, investment options are more limited in a 401(k) plan and are chosen by the employer and a plan administrator.

One major bonus of 401(k) plans is that they can come with a Roth option that allows you to make pre-tax contributions and tax-free withdrawals during retirement.

SIMPLE IRA vs. Other Employer-Sponsored Retirement Plans

Besides SIMPLE IRAs, other types of employer-sponsored retirement savings plans include:

  • 401k
  • SEP IRAs
  • 457
  • 403b
  • Profit-sharing plans (PSPs)
  • Employee stock ownership plans (ESOPs)

SIMPLE IRA vs. 401k

The biggest difference between a SIMPLE IRA and a 401k is that for the latter, employer contributions are optional (unless the 401k plan has a “safe harbor” provision) while for the former, they are mandatory. Businesses having over 100 employees cannot offer SIMPLE IRA plans, while any size of employer can offer a 401k plan. Employer contributions to a SIMPLE IRA vest immediately, while with a 401k plan, the employer can set a vesting schedule for their contributions.

The contribution limit for 401k plans in 2022 is $20,500 compared to a limit of $14,000 for a SIMPLE IRA plan. The catch-up contribution for a 401k plan is currently $6,500 for those over age 50.

SIMPLE IRA vs. SEP IRA

A SEP IRA, where “SEP” stands for Simplified Employee Pension, is used by both employers and the self-employed. It differs from a SIMPLE IRA in that a SIMPLE IRA allows both the employer and the employees to make contributions while a SEP IRA allows only the employer to make contributions, both for themselves and for their employees.

A SEP IRA allows up to 25% of income to be contributed tax-deferred. In 2022, a maximum of $61,000 can be placed into each participant’s SEP IRA account. Compare that with the $14,000 maximum for a SIMPLE IRA. SEP IRA account holders are immediately vested, and they can transfer the money in their SEP IRA account to other qualified retirement savings plans or convert it to a Roth IRA, subject to transfer rules between plans.

What Are the Pros and Cons of a SIMPLE IRA?

Before you decide whether or not a SIMPLE IRA is right for your business or whether or not you should invest in your company’s SIMPLE IRA, it’s important to keep in mind some of the advantages and limitations of these plans.

1.  More flexibility and more options

With some other employer-based retirement plans, like a 401(k) or 403(b), you might have to work at that company for a certain number of years before what the company puts in actually belongs to you. That’s not the case with a SIMPLE IRA!

Whatever money your employer contributes to a SIMPLE IRA is immediately vested. That simply means every dollar that’s put into your account immediately belongs to you and you can take it with you whenever you leave the company.

Not only that, but while a typical 401(k) plan might be limited to just a handful of options, SIMPLE IRAs usually have a much larger menu of investments for you to choose from!

2. Easier and less expensive to set up and operate

One of the biggest benefits to opening a SIMPLE IRA is that they’re much easier to set up and less expensive to run than a typical 401(k) plan or other “qualified plans.” That’s because they have lower administrative costs and fewer regulations to worry about. That’s music to any business owner’s ears! 

 3. Plenty of tax advantages

For all of you small-business owners out there, you get a tax deduction for any contributions you make to your employees’ accounts. That’ll help take some of the pressure out of tax season!

1. There’s no Roth option for SIMPLE IRAs

Unfortunately, there isn’t a Roth IRA option available for SIMPLE IRA plans that would allow employers and employees to enjoy tax-free growth and tax-free withdrawals in retirement. But as your company grows and expands beyond what a SIMPLE IRA plan can provide, you might want to look at introducing a Roth 401(k) option to your team!

2. Lower contribution limits

Again, SIMPLE IRA contributions max out at $13,500 for most workers. That’s a few thousand dollars less than the contribution limit for a regular 401(k) plan, but it’s still a really good place to start!

Plus, you’re allowed to contribute to other retirement savings plans at the same time. So if you have another job that offers a workplace retirement plan or want to put money in a personal Roth IRA outside of work, go ahead and invest there too!

3. Beware of steep withdrawal penalties

Taking money out of your SIMPLE IRA (or any retirement account) should always be a last resort to avoid either bankruptcy or foreclosure. If you withdraw from a SIMPLE IRA within two years of opening it, you’ll pay a whopping 25% penalty. You should only put money in your account if you can keep it there for a long, long time (which is what you want to do anyway!).

You’ll also get hit with that 25% penalty if you do a rollover into anything other than another SIMPLE IRA during those first two years. So what’s the moral of the story here? Leave that money alone, people!

How a SIMPLE IRA works

While the plan is called an IRA, a SIMPLE IRA is fundamentally different from a traditional IRA or Roth IRA. These latter IRAs are established by workers for themselves, with different annual contribution limits, plan rules, and purposes. Instead, a SIMPLE IRA looks more like a 401(k) program, but it tends to be easier for the company to set up and manage.

It’s called SIMPLE – short for Savings Incentive Match Plan for Employees – for a reason.  Employers don’t have to worry about complex federal reporting requirements like they do with 401(k) plans. And they can set up the plan through a financial institution, which operates it.

Contribution limits

Like a traditional retirement plan, the SIMPLE IRA allows employees to have wages deducted from their paycheck. Employees can defer up to $14,000 in 2022. Those over age 50 can defer an additional catch-up contribution of $3,000. These contributions are “elective deferrals” that count toward the total annual limit on elective deferrals to this and other retirement plans.

Employers are required to chip in to their employees’ SIMPLE IRA accounts, and they have two options to contribute funds:

  • Match workers’ contributions on a dollar-for-dollar basis, up to 3 percent of individual earnings.
  • Make non-elective contributions up to 2 percent of wage earners’ compensation up to the annual compensation limit of $305,000 for 2022.

Example of a SIMPLE IRA

Imagine you earn $60,000 a year, and your employer matches the contributions you make for up to 3 percent of your salary. You would like to save a total of 10 percent of your salary, including the match. So you decide to defer 7 percent of your own pay in each paycheck.

Over the course of the year, you would save $4,200 in pre-tax dollars, while your employer would contribute $1,800, for a total contribution of $6,000. Since you contributed more than 3 percent of your salary, you will have received the full employer match of 3 percent.

In this scenario, you had to contribute money in order to receive the employer match. But employers may instead offer a 2 percent non-elective contribution to employees.

In this second scenario, all eligible employees would receive a contribution regardless of whether they contributed from their own salary. Based on your salary of $60,000, you would receive a total contribution of $1,200 for the year from your employer. Then you could contribute any additional amount up to the annual contribution limit.

Withdrawal rules

In terms of distributions, a SIMPLE IRA functions like a traditional IRA. Money in the account is subject to tax only when it is withdrawn. While you can withdraw money at any time, a 10 percent tax may apply (as well as a special 25 percent tax in certain circumstances), unless you withdraw the funds after age 59½ or some other exception.

Funds in a SIMPLE IRA must eventually be withdrawn under the IRS’s required minimum distribution (RMD) rules. The SECURE Act has raised the age for RMDs to 72.

Terminate a SIMPLE IRA Plan

Other than the first year you set up your plan, SIMPLE IRA plans must be maintained for a whole calendar year. Once started, you must continue your SIMPLE IRA plan for the entire calendar year, funding all contributions promised in the employee notice.

If you decide your SIMPLE IRA plan no longer suits your business, consult with your financial institution to determine if another type of retirement plan might be a better match.

How do I terminate my SIMPLE IRA plan?

Step 1: Notify your employees within a reasonable time before November 2 that you’ll discontinue the SIMPLE IRA plan effective the following January 1.

Step 2: Notify your SIMPLE IRA plan’s financial institution and payroll provider that you won’t be making SIMPLE IRA contributions for the next calendar year and that you want to terminate your contributions.

Step 3: You should keep records of your actions, but you don’t need to notify the IRS that you have terminated the SIMPLE IRA plan.

Example: Acme Company decided on November 18, 2014, to terminate its SIMPLE IRA plan as soon as possible. The earliest effective date for the termination is January 1, 2016. Acme must notify its employees before November 2, 2015, that it won’t sponsor a SIMPLE IRA plan for 2016.

Can I terminate or amend my SIMPLE IRA plan in the middle of the year?

No, you cannot end your plan in the middle of the calendar year. Once started, you must continue your SIMPLE IRA plan for the entire calendar year, funding all contributions promised in the employee notice.

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