Investment options and taxation
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A SIMPLE IRA is an individual retirement account that allows employees and employers to contribute to a retirement plan. The full name is Savings Incentive Match Plan for Employees and it is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.
SIMPLE IRAs are primarily intended for small businesses with about 100 employees and self-employed individuals. Generally, you may participate in a SIMPLE IRA if you’ve received at least $5,000 in compensation during any two preceding calendar years and expect to earn at least that much during the calendar year of participation. Employers may also offer these accounts to employees who don’t meet these standards.
What is a Simple IRA?
How does a SIMPLE IRA work?
SIMPLE IRA Explained: A Flexible Retirement Plan for Small Businesses
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed to provide a straightforward and flexible way for small businesses and their employees to save for retirement. Contributions made to a SIMPLE IRA are generally tax-deductible, which may help reduce the taxable income of both the employer and the employee.
This retirement plan is employer-sponsored, meaning the employer plays a central role in funding the account. However, employees also have the option to contribute a portion of their salary. The Internal Revenue Service (IRS) sets annual contribution limits that apply to both employers and employees.
Employee Contribution Limits
Employees can contribute up to $13,500 in 2021, or $16,500 if they are age 50 or older thanks to catch-up contributions. These limits are lower than those of a 401(k) plan, where employees can contribute up to $19,500 (or $26,000 for individuals aged 50 or older). However, employees participating in a SIMPLE IRA may still contribute to another employer-sponsored retirement plan, with a combined contribution limit of $19,500.
Employer Contribution Options
Employers must contribute to employees’ SIMPLE IRA accounts and can choose between two methods:
Option 1: Matching Contributions
The employer matches employee contributions dollar-for-dollar up to 3% of the employee’s compensation. In certain circumstances, this matching percentage can be temporarily reduced to as low as 1% in two out of every five years.
Option 2: Non-Elective Contributions
The employer contributes 2% of each eligible employee’s compensation, regardless of whether the employee makes their own contribution. For the 2021 tax year, this calculation applies to compensation up to $290,000.
Key Feature
In a SIMPLE IRA plan, employer contributions are mandatory, while employee contributions are optional. This structure ensures that employees receive retirement contributions even if they choose not to contribute their own funds.
What is a Simple IRA?
Investment options and taxation
The investment choices in SIMPLE IRAs tend to be more numerous than those available in 401(k) plans. You can access a full range of investment choices, including stocks, bonds, options, ETFs, mutual funds and any other investments offered by the IRA provider.
In terms of taxation, you can take advantage of the following benefits. Your contributions reduce your taxable income for the year, so the more you put away in the account, the lower your annual tax bill will be. The invested money will grow tax-deferred until it’s withdrawn at retirement but you will have to pay income taxes when you take out money.
Be careful with early withdrawal, as SIMPLE IRA rules tend to be punitive. As with many tax-advantaged savings accounts, if you make a withdrawal before the age of 59½ without a qualifying reason, such as the need to pay a large medical bill, you must pay a 10% early-withdrawal penalty. Note that SIMPLE IRAs charge a 25% early-withdrawal penalty for non-qualified withdrawals within the first two years of owning the account. This comes on top of whatever income taxes you owe on the withdrawn money.