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Simple IRA – A Retirement Plan for Small Businesses

SIMPLE IRA – An Individual Retirement Account (IRA) is a method through which employers make contributions towards the retirement account of employees. As a small business owner, you would probably like to increase job satisfaction and help your employees build a more secure future for retirement, but setting up an Investment Retirement Account (IRA) can be intimidating.

Fortunately, for there is something designed specifically for those of you who employ less than 100 employees. A Savings Incentive Match Plan for Employees (SIMPLE) IRA does everything that an IRA does, without the complications, and lets you enjoy some tax-benefits too. Don’t let the lengthy name fool you, setting up a SIMPLE IRA is pretty straightforward – as SIMPLE as the acronym!

Simple IRA

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What is a Simple IRA?

A simple IRA allows the employees to make small contributions to this account through salary reductions, while the employer is able to make similar, if not equal contributions to this account. As in the case of most IRAs, the contributions made to the simple IRA are tax deductible and the investments grow tax-free until the time withdrawals are made at the time of retirement.

The unique thing about the simple IRA is the fact that the employer makes the contribution on behalf of the employee. This contribution may be of an equal amount of up to 3% of the salary or “non-elective”, at a flat rate of 2% of the salary of the employee, regardless of whether the employee makes a contribution or not.

Simple IRA Eligibility – Who Can Contribute to a SIMPLE IRA?

Like most other workplace offered plans, both employers and employees can contribute towards a SIMPLE IRA. Employees can make tax-deductible contributions to this type of IRA through directly salary deductions and employers can make similar, if not equal contributions.

In case of “non-elective” contributions, it is required that the employer be non-discriminatory. Simply put, all employees that are making $5,000 or more annually are eligible for this contribution of 2%. As an added benefit, since the employer makes the contribution on behalf of the employee, they are eligible to deduct all contributions made to the SIMPLE IRA of the employee on their own income tax returns.

There are just two qualifiers for employers, and one for employees-

  • As the employer, you must have less than 100 employees who have worked for you at any point during the calendar year, who have each received a compensation of $5,000 or more.
  • You cannot maintain any other qualified plans, like 401(k) or 403(b) plans, unless they are targeted toward a bargaining unit workforce
  • Employees can qualify if they have been earning at least $5,000 a year for any two prior to the plan being set up, and expect to in the current year, though employers can choose to be less restrictive.

Simple IRA Contribution Limits – How Much Can I Contribute to a SIMPLE IRA?

The rules and limits for contributing to a SIMPLE IRA are different for employees and employers:

Employee Contribution

As an employee you can contribute a percentage of your salary, but there are limits

  1. For 2017 and 2018, the employee contribution limit for SIMPLE IRAs is $12,500
  2. If you are 50 years or older, you can contribute and additional $3,000 each for both years, as ‘catch-up’ contributions, taking the maximum up to $15,500
Employer Contribution

As an employer, you must make a contribution for each employee for every year you maintain a SIMPLE IRA plan, even if the employees are not contributing.

  1. Contribution may be an ‘elective’ dollar-for-dollar, up to a maximum of 3% of the employee’s salary, or a ‘non-elective’ flat 2% of the compensation
  2. The matching contribution for two out of every five years can be lowered to 1% of the salary
  3. Each employee must receive the same type of contribution

Is a SIMPLE IRA the Right Choice for Me?

There are a lot of plans and incentives you can offer your employees, so deciding on the best option can get a little frustrating. A SIMPLE IRA is an excellent solution for small business owners and professionals who are self-employed, but there are a few key aspects, you should be focusing on.

Here’s how it compares to other plans like 401(k)s, Simplified Employee Pension (SEP) IRAs, or even profit-sharing plans:

  • Compared to 401(k) plans and profit-sharing, SIMPLE IRAs are much easier to set up, monitor and administer
  • Adding new employees and removing those that you no longer employ can be a hassle, especially for smaller businesses maintaining a SEP IRA or 401(k)
  • A SIMPLE IRA is only available for as long as you employ fewer than 100 people, so your expected growth in the near future will be a major deciding factor
  • The contribution limits for SIMPLE IRAs is lower than a SEP IRA’s, so it will affect your (and your employees’) ability to save enough for retirement

SIMPLE IRA Withdrawals

As in the case of most IRAs, the contributions made to the SIMPLE IRA are tax deductible and the investments grow tax-free until the time withdrawals are made at the time of retirement. Making withdrawals from a SIMPLE IRA is fairly straightforward too:

  • An employee is eligible to make withdrawals from their SIMPLE IRAs from the age of 59 ½ onwards
  • There is a 10% additional tax penalty for employees making early withdrawals before the age of 59 ½, unless an exception applies
  • The employer does not control the withdrawals and cannot require employees to maintain any portion of the contributions accumulated in their account
  • Additionally, employers are not allowed to make any plan-specific rules for withdrawal
  • While a SIMPLE IRA shares most of the rules that govern traditional IRAs, the exception is a “2 year period,” starting from the date of the employee’s first participation in this plan. In case the employee decides to take an early distribution within this 2-year period, the additional tax penalty imposed is raised from 10% to 25%. This penalty can be forgone in certain exceptional cases.As in the case of IRA rollovers, most transfers of SIMPLE IRA plans do not count as taxable distributions. However, a similar “2 year period” rule is applicable, as with withdrawals:
  • Employees must wait two years from the first day a deposit is made into a SIMPLE IRA, to make a tax-free rollover into other qualified plans like an IRA, 401(k), etc.
  • In case the employee wants to make a tax-free rollover within this period, it can only be made to another SIMPLE IRA
  • Early distributions that are of a different nature are subject to an additional 10% tax on the distribution
  • In cases where the “2 year period” rule is not satisfied, this penalty increases to 25%