SIMPLE IRA: Understanding the benefits & basics
SIMPLE IRA: Understanding the benefits & basics
SIMPLE IRA: Understanding the benefits & basics
When you’re self-employed, saving for retirement becomes a bit more challenging. No longer do you have access to the employer sponsored 401(k) plans that come standard with most large companies. Instead, you’re left to figure out your own retirement plan.
As of 2023, there are roughly 16.5 million self-employed individuals in the United States, which make up more than 10% of the population.1 Luckily, the federal government has created retirement savings tools specifically designed for self-employed individuals, including the SIMPLE IRA.
The SIMPLE IRA works similarly to other retirement accounts in its tax-advantaged nature but differs in terms of contribution limits, eligibility, and more.
What is a SIMPLE IRA plan?
A SIMPLE IRA — short for Savings Incentive Match Plan for Employees IRA — is a retirement plan designed for small business owners and their employees to save for retirement. It’s available to any small business with 100 or fewer employees who have no other retirement plan in place.
SIMPLE IRAs share some key characteristics with other retirement plans, including their tax advantages, employee and employer contributions, investment options, and more.
How does a SIMPLE IRA work?
SIMPLE IRAs work similarly to other employer-sponsored retirement plans where employees can make pre-tax contributions to their accounts. In other words, contributions help reduce a worker’s taxable income and tax burden that year. Their retirement contributions offer tax-free growth potential in their account and won’t be subject to taxes until they’re withdrawn in retirement.
Note: Currently, SIMPLE IRAs can only accept pre-tax contributions — Simple Roth IRAs were created by the 2022 Secure Act 2.0 but are not yet available.
As with other retirement plans, the IRS sets restrictions on when the money can be accessed without penalty. Generally speaking, the money in a SIMPLE IRA is designed to remain there until the participant turns 59 ½. If you withdraw money earlier, you’ll be subject to a 10% early withdrawal penalty — and that’s on top of the regular income taxes you’ll owe.
Additionally, if you withdraw money within the first two years of participation, the 10% early withdrawal penalty will be increased to 25%.
When you leave your job where you had a SIMPLE IRA, you can roll the funds over into another SIMPLE IRA with no restrictions. You can also roll the funds over into a retirement account other than a SIMPLE IRA, but only after two years of plan participation.
The SIMPLE IRA differs from other workplace retirement plans in an important way: employers are required to contribute to their employees’ retirement accounts, either in the form of a matching or nonelective contribution. Here’s what those options look like:
- Matching contribution of up to 3% of an employee’s compensation
- Non-elective contribution of 2% of an employee’s compensation
These employer contributions can be a key attraction and retention tool for small business owners. Often, small businesses struggle to attract skilled employees because they can’t offer the benefits programs that larger companies can. The employer contributions offered under a SIMPLE IRA can help small business owners overcome that hurdle.
Of course, you don’t have to have employees to set up a SIMPLE IRA for your small business. Even if your business is just you, a SIMPLE IRA can help you save for retirement through both your employer and employee contributions. However, as we’ll discuss in later sections, a SIMPLE IRA may not be the best option for one-person businesses.
Benefits of a SIMPLE IRA
SIMPLE IRAs come with several key benefits, which makes them a popular option for self-employed individuals and small businesses. Let’s talk about some of the benefits a SIMPLE IRA can offer both employers and employees.
Benefits for employers
- Lower start-up and operating costs: SIMPLE IRAs have lower startup and ongoing costs than 401(k) plans, which can reduce the financial burden for small businesses.
- Tax deduction for employer contributions: As an employer, your business will get a tax deduction for the money you contribute to your employees’ SIMPLE IRA accounts.
- Easy implementation: SIMPLE IRAs have a streamlined administrative process that makes them more accessible to small businesses with limited resources.
Benefits for employees
- Employer contributions: Employees enjoy an employer contribution of either 2% or 3%, which is essentially free money for retirement.
- Elective salary reduction: As with other workplace retirement plans, employees can have money taken from their paychecks to go into their retirement accounts.
- Tax-deferred contributions and growth: SIMPLE IRA contributions are pre-tax, and any growth is tax-deferred until the money is withdrawn from the account.
- Inclusive eligibility requirements: SIMPLE IRAs have basic eligibility criteria, meaning most employees will qualify, and employers can even loosen the requirements.
- Immediate vesting of employer contributions: All employer contributions are 100% vested for employees, which isn’t the case with all workplace retirement plans.
- Concurrent contributions to other retirement plans: Employees can contribute to a SIMPLE IRA at the same time as other retirement accounts.
- Diverse investment choices: A SIMPLE IRA can be invested in a wide variety of securities, and each employee can direct their own investments.
Drawbacks of a SIMPLE IRA
Despite their advantages, SIMPLE IRAs also have some important downsides. Whether you’re a small business owner or simply an employee, consider these downsides before using a SIMPLE IRA as your primary retirement savings tool.
Lower contribution limits: SIMPLE IRAs have considerably lower contribution limits than other options for self-employed people, such as 401(k)s or SEP IRAs.
- Participant loan restrictions: Participant loans aren’t permitted with SIMPLE IRAs, which means there are fewer options to access your money prior to retirement.
- Tax penalties for early withdrawals: There’s an early withdrawal penalty of 10% for distributions before 59 ½, and it increases to 25% in the first two years of participation.
- Rollover restrictions: SIMPLE IRAs are eligible for rollovers to other non-SIMPLE IRA accounts, but only after two years of participation in the plan.
Key rules and eligibility criteria
To participate in a SIMPLE IRA as an employee of a small business, you generally must meet the following requirements:
- You earned at least $5,000 during any two years before the current one
- You expect to earn at least $5,000 during the current year
Employers can establish less restrictive eligibility requirements, but not more restrictive ones. For example, an employer could eliminate all compensation requirements but couldn’t limit the plan to only those employees who will earn $10,000 in the current year.
Maximizing contributions: Understanding limits
As with other retirement plans, SIMPLE IRAs have a limit on how much employees and business owners can contribute. Employees can contribute up to $16,000 to their SIMPLE IRA in 2024, up from $15,500 in 2023.2 There’s also a catch-up contribution allowed of $3,500 for employees 50 and older.
Employees are limited to contributing either 2% of an employee’s compensation as a non-elective contribution or 3% of their compensation as a matching contribution.
The contribution limits for SIMPLE IRAs are considerably lower than for other retirement plans. Though this type of plan can be a good option if you have employees and you want to contribute a small amount to their retirement, it’s not necessarily the best plan for business owners to save for their own retirement.
SIMPLE IRA vs. the alternatives: Choosing the right retirement plan
A SIMPLE IRA is one of a handful of retirement accounts available to self-employed individuals.
SIMPLE IRA vs. Solo 401(k)
A solo 401(k) — also called the one-participant 401(k)3 — is a retirement plan available to self-employed individuals with no employees other than themselves and a spouse. A solo 401(k) is nearly identical to a regular 401(k) in terms of contribution limits and other rules.
The solo 401(k) is a great option for business owners who want to maximize their retirement contributions. First, someone may contribute $23,000 as an employee (up from $22,500 in 2023). The business can also contribute to the plan, with a total maximum contribution of $69,000 in 2024 (up from $66,000 in 2023) or 100% of the person’s income.
SIMPLE IRA vs. SEP IRA
A Simplified Employee Pension (SEP) IRA4 is a retirement plan designed for self-employed individuals with or without employees. This plan allows someone to contribute up to 25% of their compensation, with a maximum contribution of $69,000 in 2024.
A SEP IRA is unique in that employees can’t contribute on their own behalf — only the business can contribute. And though the employer can decide for themselves how much to contribute each year, they must contribute the same percentage of compensation for each person. For example, if a business owner wants to contribute 25% for themselves, they must also contribute 25% for any employees they have.
SIMPLE IRA vs. Traditional IRA
A traditional IRA5 isn’t an employer-sponsored retirement plan or one specifically designed for self-employed individuals, but it can still be used by them.
A traditional IRA allows anyone with earned income to contribute up to $7,000 per year in 2024 (up from $6,500 in 2023). Depending on the individual’s income and whether they have a retirement plan through an employer, the contributions may or may not be tax-deductible.
It’s worth noting that a traditional IRA can be used alongside another workplace retirement plan, and the contributions limits are entirely separate. So if you have a SIMPLE IRA and max out your contributions, you may still max out the contributions on a traditional or Roth (which we’ll talk about in the next section) IRA.
SIMPLE IRA vs. Roth IRA
A Roth IRA is similar to a traditional IRA but with a different tax advantage. Rather than having tax-deductible contributions, all Roth contributions are after-tax, meaning there’s no upfront tax benefit. However, your contributions offer tax-free growth potential in your account and can be withdrawn tax-free during retirement. Since your contributions were made with after-tax dollars, they can be withdrawn at any time.
Roth IRAs have the same contribution limits as traditional IRAs. It’s a combined contribution limit, meaning if you contribute $7,000 to a traditional IRA, you can’t also contribute to a Roth IRA, and vice versa. However, you may split your contributions between the two.
Roth IRAs have restrictions on who can contribute to one. If your income is too high, you may not be able to use a Roth IRA.
A Roth IRA could be a useful tool to use alongside a SIMPLE IRA.
Read more: Roth 401(k) vs. Roth IRA
Is a SIMPLE IRA the right choice for you?
A SIMPLE IRA could be a good option for small business owners who want to save for their retirement while helping their employees do the same. It has advantages that include simple administration and low costs.
However, the SIMPLE IRA isn’t right for everyone. Compared to other self-employed retirement accounts, SIMPLE IRAs have relatively low contribution limits. If you are a business owner with no employees, you might find a solo 401(k) or SEP IRA preferable to help to contribute large amounts to your retirement account.
If you’re an employee who has been offered a SIMPLE IRA through your employer, it may be worth taking advantage of it. If your employer offers a matching contribution, it’s wise to contribute at least enough to take advantage of the full match. And remember — you can use a SIMPLE IRA alongside other retirement accounts, either individual ones or those offered by other employers. It doesn’t have to be an either-or decision.
Read more: Retirement savings: The saver’s credit
FAQs about SIMPLE IRA plans
What is the difference between a 401(k) and a SIMPLE IRA?
There are several differences between a 401(k) and a SIMPLE IRA. 401(k)s have considerably higher contribution limits. They also allow employers to contribute far more than a SIMPLE IRA does. However, 401(k)s may be more expensive and difficult to administer, especially if you have employees.
What are the disadvantages of a SIMPLE IRA?
Disadvantages of a SIMPLE IRA include their low contribution limits — they are lower than the other two types of self-employed retirement plans. Other downsides include the strict requirements around plan loans, early withdrawals, and rollovers.
What percentage should I put in my SIMPLE IRA
If you’re an employee, it’s worth contributing at least enough to your SIMPLE IRA to get your full employer match. However, if the SIMPLE IRA is your only retirement account, it’s wise to contribute as much as your budget will allow to help you secure a comfortable retirement.
The bottom line
A SIMPLE IRA is one of several options that self-employed individuals can use to save for retirement. Whether it’s the right choice for you depends on your income, the number of employees you have, and more.
If you’re a business owner and are considering setting up a SIMPLE IRA for your business, consider consulting a financial or tax professional to help you determine whether a SIMPLE IRA is your best option or whether it’s worth considering something else, such as a solo 401(k) or a SEP IRA.
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- Bureau of Labor Statistics, “Data Retrieval: Labor Force Statistics (CPS),” February 2020.
- IRS, “401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000,” November 2023.
- IRS, “One-Participant 401(k) Plans,” August 2023.
- IRS. “Simplified Employee Pension Plan (SEP),” December 2022.
- IRS. “Traditional IRAs,” July 2023.
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