Imagine if your employer provided a retirement savings plan in which they’re required to help seed your account, either by matching a portion of what you contribute or depositing a sum equal to a percentage of your salary, even if you don’t save a penny on your own. On top of that, the money vests immediately.
That, in a nutshell, is the best part about the retirement savings plan for small businesses known as the SIMPLE IRA, an abbreviation for Savings Incentive Match Plan for Employees Individual Retirement Account.
While some of the perks are appealing, when compared with other types of retirement plans, there are definite drawbacks to SIMPLE IRAs, including lower contribution limits, the lack of a Roth version of the plan, inflexible account portability and harsher early withdrawal penalties.
Read on to find out whether a SIMPLE IRA is the right investment account for you and/or your employees.
What is a SIMPLE IRA?
A SIMPLE IRA is the small-company version of a 401(k) plan that is subject to many of the same rules as traditional IRAs. This workplace retirement savings account allows eligible employees to invest a portion of their pretax salary into an individual account and receive mandatory employer contributions.
Small businesses — generally those with 100 or fewer employees — sometimes offer workers a SIMPLE IRA plan in lieu of a 401(k) because (as the acronym implies) it’s easier to set up and administer. If you work for yourself, you’re also allowed to contribute to a SIMPLE IRA, although there may be better retirement plan options for the self-employed.
What are the SIMPLE IRA rules?
SIMPLE IRAs have many of the same investment, distribution and rollover rules as a traditional IRA. Contributions are tax-deferred, meaning the amount you save up to your contribution limit reduces your taxable income for the year, and investment growth is tax-deferred until you start taking distributions in retirement.
In other ways, SIMPLE IRAs are like 401(k) plans: Eligible employees indicate how much (if anything) of each paycheck they want to contribute to the account, and the money is automatically diverted into the worker’s individual investment account.
The mandatory employer contribution is what makes SIMPLE IRAs different from some other employer-sponsored retirement plans.
What are SIMPLE IRA contribution limits?
Employee contribution limits for a SIMPLE IRA in 2019 are $13,000 for those under age 50 and $16,000 if you’re age 50 and over.
Employer contributions are mandatory and can be made using one of two methods:
- Provide matching contributions up to 3% of the employee’s pay, not limited by any annual compensation limit.
- Make non-elective contributions equal to 2% of the employee’s compensation based on a maximum salary of $280,000 in 2019. If you earn more than that, your employer can contribute no more than $8,400 annually to your SIMPLE IRA.
What are the pros and cons of a SIMPLE IRA?
Some of the advantages of SIMPLE IRAs are:
- Employers must contribute to employee accounts, as detailed in the section above.
- Employees don’t have to sign up for salary deferrals to get the employer contribution if your employer chooses the nonelective 2% contribution option. If your plan uses the elective salary reduction/matching method, you must contribute to earn the match.
- Eligibility requirements are low. In general, you’re eligible to participate in a SIMPLE IRA if you’ve received at least $5,000 in compensation during any two preceding calendar years and expect to earn at least that much during the calendar year of participation. But the IRS also allows employers to offer these accounts to employees who don’t meet these standards.
- Employer contributions vest immediately. With no vesting period, you have 100% ownership of all the money in your SIMPLE IRA.
- The IRS lets individuals contribute to other retirement savings plans at the same time. That’s handy if, for example, you have more than one job that offers an employer-sponsored retirement plan, or if you also want to contribute to a traditional or Roth IRA.
- Investment choices tend to outnumber what’s offered in 401(k)s. Instead of being limited to whatever mutual funds a 401(k) plan administrator chooses, you can invest in stocks, bonds, mutual funds and any other investments offered by the IRA provider.
- Start-up and operating costs for employers are generally lower than setting up a 401(k) plan.
- Employers get a tax deduction for their contributions to employees’ accounts.
Before you fall in love with the idea of opening a SIMPLE IRA, consider some of its shortcomings:
- Contribution limits are lower than other workplace retirement plans. In 2019, employees and solo business owners under age 50 are allowed to contribute $13,000 in a SIMPLE IRA versus $19,000 in a 401(k), and $16,000 versus $25,000 for those age 50 and up.
- There is no Roth version of the SIMPLE IRA. This is a big drawback given the benefits Roth IRAs and Roth 401(k)s offer. (See “What Is a Roth IRA?” for more on why we like these accounts.)
- Participant loans are not allowed. Although we discourage dipping into retirement savings early, if you need to, SIMPLE IRA doesn’t allow them.
- You’ll pay a steep tax penalty for some early withdrawals. In general, SIMPLE IRA distribution rules mirror traditional IRA rules, except for non-qualified withdrawals within the first two years of your participation. For those, you’ll pay an extra 15% early withdrawal penalty on top of the standard 10% penalty. That means if you tap into the money before age 59 ½ and before you’ve had the plan for two years, you’ll likely owe the IRS 25% of the money you take out in penalties, plus whatever income taxes you owe on it.
- Rollovers to another IRA or employer-sponsored retirement plan are also subject to strict rules. The 25% penalty mentioned above also applies if you do a rollover into anything other than another SIMPLE IRA during the two-year period after you first participate in the plan.
» Looking to open an IRA? Here are the best IRA providers.
Is a SIMPLE IRA right for me?
The answer depends on whether you are an employee or the employer.
For employees: Anyone who has access to the plan at work and wants to maximize their savings should contribute to the account. Otherwise, you’re leaving free money on the table.
If your plan provides the automatic 2% employer contribution, you’ll get that money even if you elect not to divert any of your salary. If the employer contribution is offered by matching funds, you must sign up to contribute a portion of your own salary to earn the match. (Remember: You can still save in other types of tax-favored retirement savings accounts in addition to a SIMPLE IRA.)
For business owners: If you are a solo business owner or self-employed and your goal is to maximize your own retirement savings, there are other retirement savings plans that have higher contribution limits:
- A solo 401(k) allows a business owner with no employees to contribute up to $56,000 in 2019, with an additional $6,000 catch-up contribution if you’re age 50 or older. The exception to the no-employees rule is if your spouse earns income from your business.
- A SEP IRA (Simplified Employee Pension Individual Retirement Account) is a lot like a SIMPLE IRA. But like a solo 401(k), the contribution limits are much higher: You’re allowed to contribute either 25% of compensation or up to $56,000 in 2019, whichever is less.
If you own a small business with employees, a SIMPLE IRA might be attractive if you want to offer your employees a retirement plan but would like to avoid the extra administrative costs that can come with a 401(k). Just keep in mind that some employees may still wish for a 401(k) because of its higher contribution limits.
How do I open a SIMPLE IRA?
Opening a SIMPLE IRA is similar to opening a traditional IRA. However, if you are a business owner, there are additional reporting requirements and documents you must fill out to establish the plan. Most IRA providers also offer SIMPLE IRAs that you can open online.
The IRS outlines three steps for employers or solo business owners setting up a SIMPLE IRA plan:
- Pick the type of SIMPLE IRA plan you want to use by filing either IRS Form 5305-SIMPLE (if you’re depositing contributions at a designated financial institution) or IRS Form 5304-SIMPLE (if employees are permitted to choose a financial institution for the account).
- Provide eligible employees information about the SIMPLE IRA plan.
- Set up separate SIMPLE IRAs for each eligible employee using Form 5305-S or Form 5305-SA.
If you work at a company that offers a SIMPLE IRA, your employer will have you fill out one of the forms above to establish an individual account.
» Ready to set up a SIMPLE, SEP, Roth or traditional IRA? These are some of NerdWallet’s top picks for best IRA providers: