The majority of people haven’t heard about a SIMPLE IRA, and they are curious as to what the rules and limits are and how this differs from a 401 (k).
Is it easy to set up a SIMPLE IRA? How does it compare with 401ks and other retirement plans? As we dive deep into the Simple IRA limits and rules, we’ll be able to answer this question and many others.
What is a Simple IRA (Simple Individual Retirement Account)?
A Simple IRA or Savings Incentive Plan for Employees is a type employer-sponsored retirement saving plan designed to be simple to set up and maintain by small business owners.
The plan allows employees to save on a tax deferred basis for retirement, and also requires employers to contribute on behalf of employees.
Simple IRA vs 401k: What are the benefits?
Simple IRAs are easy to maintain and set up for small businesses.
| A Simple IRA is available to any employer who has less than 100 employees. |
The plan also requires little paperwork and is relatively inexpensive to administer.
Simple IRA: Benefits
A Simple IRA also offers employees the opportunity to contribute to the plan before taxes are due. The money that employees contribute to the Simple IRA is not taxed until they withdraw it in retirement.
It can save employees money in the short term on taxes, and allow them to save more for retirement over the long run.
Employers must also contribute to a Simple IRA for their employees.
Employers must match employee contributions up to 3% or provide a non-elective 2% contribution for all employees.
It can be an excellent way to encourage employees to save money for retirement, and for small business owners a way to retain and attract talented employees.
| Simple IRA Rules | Details |
|---|---|
| Employer Eligibility | Simple IRAs can be established by any employer who has 100 employees or less and earned $5,000 in the prior year. |
| Employee Eligibility | Simple IRA plans are available to employees who have received compensation of at least $5,000 from their employer in any two calendar years preceding the current one, and are expected to make at least $5,000 this year. |
| Contribution Limits | Employees can contribute up $15,500 in 2023 to a Simple IRA. Employees who are 50 years old or older can contribute an additional $3,500 catch-up amount. Employers can either make a matching contribution up to 3% or a non elective contribution of 2%. |
| Vesting | Employee contributions are 100% vested. Employer contributions are subject to vesting schedules, meaning that the employee may need to work for some time before receiving the full amount. |
| Withdrawals | Simple IRA withdrawals are subject to income taxes and a 10% tax penalty if made before the age of 59 1/2. There are some exceptions, including for the first time home purchase or certain medical costs. |
| Rollovers | Simple IRAs can be rolled into another Simple IRA or a Traditional IRA. They can also be rolled into a Qualified Employer Plan. Rolling over funds is subject to certain restrictions and taxes. |
Here are some of the most common reasons you may see an employer offer a SIMPLE IRA instead of a 401(k).
What you should know about the SIMPLE IRA
1. The Employer Contributions you receive are 100% vested.
Most 401(ks) require you to work for your employer for a specific number of years before they will vest. If you leave the employer, you can take their matching contribution.
SIMPLE IRA vesting schedule is different from the 401(k).
The SIMPLE IRA gives you 100% ownership of the money that your employer deposits into your account.
It is a big difference from the 401(k). You and your employees will both benefit from immediate vesting of not only your contributions, but also the matching contributions of the employer.
2. Employers Must Match SIMPLE IRA Contributions
Every year, your employer must make a contribution into your SIMPLE IRA. This can be in the form a matching contribution or a so-called non-elected contribution. The employer must match your contribution.
If you match 3%, your employer must also match 3%. is the maximum that an employer can match. This could be different from a 401k.
The employer must match your 3%. is the maximum that an employer can match. This could be different from a 401k.
Employers can reduce the amount of matching to 1% in two years out of five. If the employer chooses to do so, then they will have to match 3% of the total amount for the other three years.
Calculation can be tricky, but your employer will match regardless.
The employer may choose to make a “non elect contribution” if they do not want to match. This means that they will contribute 2% to your salary. They will not contribute 2% of your salary if you pay 3%.
3. Employees control the investments
You are restricted to the options provided by your employer with most 401(k). SIMPLE IRA is a very different investment vehicle. The SIMPLE IRA is a self employed retirement plan that allows you to choose where you want your money invested.You can buy CDs, mutual funds, individual stocks or ETFs. This is the exact same feature as a SEP IRA offers.
Two factors influence the investment control factor:
- Employee selection of investment trustee You may designate the plan to allow the employee to choose the financial institution that will hold the plan. This gives employees more choice and relieves the employer of the responsibility of managing everyone’s plan.
- Self directed investing Participants are free to choose their financial institution and also do their own investing. They can decide how and where to invest their money, as well the risk level they want to take.
4. Employees are allowed to contribute up to 100% of their annual income into a SIMPLE IRA.
In a SIMPLE-IRA, you can contribute up to $14,000 per year, which is up from $14,000 for 2022. You can make a catch-up payment if you are over 50. This has increased to $3500. Note that $15,500 or $19,000 is less than what you can contribute to your 401(k).
It is not as high as (up to $66,000) that you can contribute to a SEP IRA, or a Solo 401k.
The SIMPLE IRA contribution cap is over two times higher than the traditional or Roth IRA contribution limits. The contribution limit for those 50 and older is nearly 2 1/2 times the limit of $7,500 for Roth IRAs or traditional IRAs.
SIMPLE IRAs have a 100% contribution feature, which means employees can contribute up to their maximum amount. If an employee earns $30k, they can contribute up to $15,500 (or $19,000 for those over 50). The contribution is not limited by a percentage, but only by the dollar amount.
It’s true, you can contribute to other plans like the SEP-IRA and Solo 401(k). Since both plans are based on percentages, your business must have a high income in order to achieve these levels.
If your annual self-employment income falls below $100,000, the SIMPLE IRA may be a better option for you.
SIMPLE IRAs, for example, do not require special IRS reports. Also, they are not subject to discrimination or top-heavy tests. It’s more like a group IRA. Simple is an advantage for small businesses.
5. SIMPLE IRAs do not allow loans
Many plans have loan provisions which allow employees to borrow money from their 401(k). SIMPLE IRAs do not have this limitation. Remember this if you think that this is a place where money can be taken out as a last option.
This is because a SIMPLE IRA, first and foremost, is an IRA. You can’t borrow money from a SIMPLE IRA either, just like you cannot from a Roth IRA or a traditional IRA. This is probably not a negative thing. Any retirement plan should give you the option to create an investment portfolio that is tax-sheltered for your retirement.
You will be forced to use the SIMPLE IRA for its original purpose, since you can’t borrow from it.
6. The SIMPLE IRA Two Year Rule
The SIMPLE IRA should have this information. Most retirement plans — 401(k)s, regular IRAs, or Roth IRAs, etc. If you are under age 59.5, there is a 10% penalty for early withdrawal. The SIMPLE IRA takes this one step further.The 10% penalty is waived if you haven’t cashed out your SIMPLE IRA for more than two years. You will be charged a 25 % penalty In addition to the ordinary income tax
Don’t forget this. Remember that this does not apply to cashing out your IRA. The 25% penalty also applies if you try to convert your Simple IRA in a rollover IRA. You should wait two years to convert it into a regular IRA, or cash it out.
7. Contributions for 2023 have increased
The contribution limit has increased to $16,500 for 2023. The catch-up limit has also been increased to $3,000. This means that someone who turns 50 in 2022 or 2023and is able to contribute $19,000 can do so.
How to Set Up a SIMPLE IRA & Maintain Filing Requirements
SIMPLE IRAs are only a bit more complex to set up than traditional or Roth IRAs. The first step is to choose a financial institution.
- Sign a written contract to offer benefits to eligible employees
- Employees should be informed about the contract
- Create an IRA for every employee
The written agreement may be completed with IRS form 5304-SIMPLE, or tax form 5305-SIMPLE. The 5304 form is used when each participant chooses their own financial institution. If you want to designate a financial institution that will be responsible for the entire plan, then a 5305 should be used.
You do not need to file either form with the IRS. However, you should retain a copy of it, complete with all signatures. You can also use the proforma provided by the financial institute that will hold your plan. This will achieve the same goal.
At the start of the election period, you’ll have to send an annual notice to all eligible employees (or give them a copy each of the 5304 or the 5305 form completed). This will inform each employee:
- The SIMPLE IRA plan gives employees the opportunity to reduce their salary or make changes.
- Employees can choose a financial institution to act as trustee for their SIMPLE IRA if applicable.
- You can choose to match or not elect contributions.
- The financial institution should provide a summary description;
- If you use a designated financial institution, give the employee written notice that they can transfer their balances without any cost or penalty.
All contributions must be made to the plan by each employee. The plan must be set up between January 1 and October 1 each year. Unfortunately SIMPLE IRAs cannot include a Roth provision. This is not possible for a 401k plan.
