- A SIMPLE IRA is a plan designed to encourage smaller employers to help their employees save for retirement.
- Employees own the accounts and have option of making contributions with pretax dollars.
- Employers are required to make contributions in one of two ways – matching contributions or non-elective contributions.
- Withdrawals are subject to income tax, and distributions taken before age 59 ½ may be subject to early-withdrawal penalty.
Small businesses with fewer than 100 eligible employees can offer SIMPLE IRAs to help workers save for retirement. An employee’s age determines their annual contribution limit and employers must match that contribution within certain limits.
What Is a SIMPLE IRA?
The acronym “SIMPLE” stands for Savings Incentive Match Plan for Employees. It was designed to encourage employers of smaller businesses to sponsor plans for their workers while avoiding the complex setup process of larger retirement plans. Small businesses prefer the SIMPLE IRA because they are less expensive to maintain than other qualified plans and require more limited record keeping.
For employees, SIMPLE IRAs offer three main benefits:
- Employers match their employees’ contributions up to 3% in most cases. Contributions are 100% vested immediately, so you can take the contributions with you when you leave the company.
- Employees pay no income tax on the money they defer into the plan, the money employers contribute to the plan, or earnings on the account. Distributions are taxed as regular income based on your tax bracket.
Who Is Eligible to Have a SIMPLE IRA?
Any employee who has earned at least $5,000 for any two preceding years with their current employer, and is expected to earn at least that much in the current calendar year, is eligible to participate in a company’s SIMPLE IRA. Employers may exclude non-resident alien employees and those whose benefits are administered according to a union agreement.
Understanding the SIMPLE IRA Rules
Employees can contribute up to $12,500 of pretax income per year. The contribution limits will likely ratchet up each year according to IRS estimates of inflation. Catch-up contributions of $3,000 can be made by employees age 50 and older.
One drawback is that the SIMPLE IRA contribution limits are lower than a standard 401(k). However, you can contribute to other IRA plans as long as your total contribution across all plans is less than $18,000.
Employers are required to make one of two types of contribution:
- Matching contributions are a dollar-for-dollar match up to 3% of the employee’s compensation. Matching contributions may be made on behalf of eligible employees who make deferred contributions into the plan.
- Non-elective contributions are contributions equal to 2% of the employee’s compensation (capped at $265,000) and paid to all eligible employees, irrespective of whether they make contributions to the plan.
The IRS will apply a 25% penalty if you attempt to roll your plan into a non-SIMPLE IRA within two years from the date of first contribution.
After the two-year waiting period, you are eligible to transfer funds from a SIMPLE IRA into another form of IRA by means of an IRA transfer, IRA rollover, or Roth IRA conversion.
A 10% early-distribution penalty applies for making cash withdrawals prior to retirement age of 59 ½. The IRS will waive the early-distribution penalty for certain hardship-related reasons. These include payment of medical or funeral expenses, payment of college tuition and purchase of a primary home. After retirement age, income tax is still applied on distributions but there aren’t additional penalties.
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