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What Is a SIMPLE IRA Plan?
A SIMPLE IRA Plan (Savings Incentive Match Plan for Employees Individual Retirement Account) is a retirement plan designed for small businesses in the United States. It allows both employees and employers to contribute to individual retirement accounts with simplified rules and contribution options. This plan provides a convenient and accessible method for small employers to help their employees save for retirement while enjoying potential tax advantages
A SIMPLE IRA has an employer matching incentive built-in. The employer can either match the employee contributions, up to 3% of the employee’s salary, or the employer can make contributions of a flat 2% of the employee salary, whether or not the employee chooses to participate in the plan.
A SIMPLE IRA is similar to a 401(k) plan. The contributions made to this plan are with pre-tax dollars, and the money grows tax-deferred in the plan until the money is withdrawn at retirement.
How Much Can I Contribute to a SIMPLE IRA Plan?
Employees can contribute up to 100% of compensation, up to a maximum of $16,000 for 2024, $15,500 for 2023 or $14,000 for 2022. The maximum contribution increases periodically to account for inflation. If the employee is 50 years or over, the maximum contribution is up to $19,500 in 2024, $19,000 in 2023 and $17,000 in 2022.
Who Can Open a SIMPLE IRA and who is eligible for a SIMPLE IRA Plan?
- We need to have 100 or fewer employees who have earned at least $5,000 in the preceding year.
- Any other employer-sponsored retirement plan cannot be maintained.
- Need to have earned at least $5,000 from the employer in any two preceding years.
- Must be expected to earn at least $5,000 in the current year.
How Does a SIMPLE IRA Work?
The SIMPLE IRA plan offers small employers a straightforward approach to contribute to both their employees’ and their own retirement savings. Workers have the option to contribute a portion of their salary, while the employer is obligated to make either matching or nonelective contributions.
A SIMPLE IRA is fundamentally different from a traditional IRA or Roth IRA.
While the latter IRAs are established by employees for themselves, with different plan rules, annual contribution limits, and purposes, a SIMPLE IRA is more like a 401(k), but it’s easier for the company to open and manage it.
Employers are free from complex federal reporting requirements, and they can set up a SIMPLE IRA through a financial institution, which operates it.
The IRS allows employers/self-employed with fewer than 100 employees earning at least $5,000 in the preceding year to open up a SIMPLE IRA.
Like a traditional retirement plan, the employees are allowed to get their wages deducted from their paycheck to contribute to a SIMPLE IRA.
Employers have to contribute to their employees’ SIMPLE IRA accounts, but they have two options:
- Match employees’ contributions, up to 3% of employees’ earnings.
- Make nonelective contributions of up to 2% of employees’ compensation up to the annual compensation limit of $345,000 for 2024 & $330,000 for 2023.
What Are the Advantages and Drawbacks of a SIMPLE IRA?
Advantages of SIMPLE IRA from the perspective of employers:
Drawbacks of SIMPLE IRA from the perspective of employees:
Don’t fall in love with the idea of opening a SIMPLE IRA. Not yet.
Consider some of its disadvantages:
How to Establish a SIMPLE IRA?
Opening a SIMPLE IRA
Most IRA providers offer SIMPLE IRAs that you can establish online. The process of opening a SIMPLE IRA is similar to opening a traditional IRA. But, if you are a business owner, you need to meet additional reporting requirements and submit relevant documents to set up the plan.
For employers or solo business owners, the IRS outline these steps for setting up a SIMPLE IRA plan:
Other points to consider:
What are the SIMPLE IRA Rules?
Just like other employer-sponsored retirement plans, SIMPLE IRAs are covered under ERISA (Employee Retirement Income Security Act).
These ERISA rules are applied to SIMPLE IRAs:
Enacted in 1974, ERISA outlines the requirements for establishing and managing employer-sponsored retirement plans. For SIMPLE IRAs, ERISA dictates the eligibility of the employees and how employee contributions are handled by the company
Employers are given the flexibility to customize the eligibility requirements, but usually, employees who have put in at least one year of service and are 21 years or above are eligible for the plan. However, some employers may decide to make their employees eligible sooner or, in some cases, even immediately.
ERISA defines key issues while handling employee contributions. For example, with a SIMPLE IRA, the salary deferral contributions have to be deposited in the account by the end of the month following the month in which the funds were withheld from the employee’s paycheck. SIMPLE IRAs are subject to contribution limits. You can find the details here.
When it comes to investment choices, a SIMPLE IRA functions like any other IRAs. It means the employee has full control of the investment choices for their accounts, unlike a 401(k) plan where the employer offers a limited option from which the employees have to choose.
The two-year time frame begins the day you and your employer make the first contribution to the SIMPLE IRA.
If you take any distributions from your SIMPLE IRA during this two-year period, and you are less than age 59½ at the time of the withdrawal, then the distributions are subject to an early-distribution penalty of 25%.
Since you can roll over money from your SIMPLE IRA to another SIMPLE IRA, you can consider this option when you are no longer employed with the company that sponsored the plan. You can either leave the assets with your ex-employer until the two-year period is over, or rollover the money to another SIMPLE IRA at another financial institution.
To get the transfer done, you need to submit a SIMPLE IRA adoption agreement and a copy of the Form 5304-SIMPLE or Form 5305-SIMPLE that your employer had filled out initially to open the SIMPLE IRA. The transfer takes place once the new account is established.