SIMPLE IRA

A SIMPLE IRA is a type of tax-deferred retirement savings plan eligible to most small businesses with 100 or fewer employees. These plans require minimal paperwork for the employer and maintenance costs are low. Employee contribution limits are lower for SIMPLE IRAs than for 401(k) plans.

What Is a SIMPLE IRA?

A SIMPLE IRA stands for Savings Incentive Match Plan for Employees (SIMPLE) Individual Retirement Account (IRA). An employer must have 100 or fewer employees to establish a SIMPLE IRA.

Self-employed people can also set up a SIMPLE IRA.

Unlike some other retirement accounts, SIMPLE IRAs require mandatory contributions from employers.

Yearly employee SIMPLE IRA contribution limits are lower than 401(k) plans but higher than traditional IRA contribution limits.

Employees can contribute up to $13,500 a year to a SIMPLE IRA in 2021. Employees age 50 and older can make contributions up to $16,500 a year.

In comparison, employees can contribute up to $19,500 to a 401(k) plan in 2021.

There are few employee eligibility requirements for SIMPLE IRAs.

SIMPLE IRA Eligibility Rules for Employees
  • Earn at least $5,000 from the employer in any two previous calendar years.
  • Be expected to earn at least $5,000 in the current year.
  • Work for a company that offers a SIMPLE IRA.

How Does a SIMPLE IRA Work?

SIMPLE IRA rules share several similarities with traditional IRAs.

Contributions are tax deductible, which means the money you add to your account helps reduce your taxable income for the year.

Investment growth is also tax-deferred, which means you won’t owe taxes until you’re ready to make withdrawals during retirement.

Employers must contribute to each worker’s SIMPLE IRA.

Two Ways Employers Can Contribute to a SIMPLE IRA
  1. Provide a matching contribution up to 3 percent of the employee’s pay.
  2. Make nonelective contributions equal to 2 percent of the employee’s compensation if the employee earns $290,000 or less in 2021.

If your employer chooses the 3 percent matching option, you as an employee must put money into your SIMPLE IRA in order to receive the match.

For the 2 percent option, your company will add 2 percent of your salary to your SIMPLE IRA. As an employee, you don’t need to make any contributions to receive this money.

How to Set Up a SIMPLE IRA

As the name implies, a SIMPLE IRA is often easier for a small employer to set up and administer than a 401(k) plan.

These plans require minimal paperwork for the employer and maintenance costs are low.

A SIMPLE IRA is established through a financial institution, such as a bank, which then administers the plan.

The plan provider will offer various investment options to choose from, such as stocks, bonds and mutual funds.

Each employee can choose which investments to include in their own SIMPLE IRA.

Three Steps an Employer Must Follow to Establish a SIMPLE IRA

Select the type of SIMPLE IRA you want to provide. You must fill out IRS Form 5305-SIMPLE if you want to select the financial institution where employees will hold their IRAs. Or fill out IRS Form 5304-SIMPLE if you want workers to pick the financial institution that will hold their account.

  • Provide eligible employees with information about the SIMPLE IRA plan.
  • Create separate SIMPLE IRAs for each eligible employee using Form 5305-S or Form 5305-SA.

If you’re an employee and want to sign up for a SIMPLE IRA at work, your employer will have you fill out one of the forms above.

Advantages and Disadvantages of SIMPLE IRAs

SIMPLE IRAs come with different advantages and disadvantages for employers and employees.

Pros and Cons of SIMPLE IRAs for Employees
Advantages
  • You receive account contributions from your employer.
  • Few eligibility requirements.
  • You can contribute to other nonworkplace retirement savings plans at the same time.
  • More diverse investment options compared to 401(k) plans.
  • You can decide how much of each paycheck you want to contribute to your account.
Disadvantages
  • Employee contribution limits are lower than other workplace retirement plans.
  • There is no Roth version of a SIMPLE IRA.
  • Early withdrawals made within two years after opening a SIMPLE IRA result in a 25 percent tax penalty. In comparison, early withdrawals from traditional IRAs are taxed at 10 percent.
  • The 25 percent tax penalty also applies if you rollover your account into a different retirement plan less than two years after opening your SIMPLE IRA.

For business owners, SIMPLE IRAs offer lower start-up and operating costs than 401(k) plans. There are tax advantages as well.

Pros and Cons of SIMPLE IRAs for Employers
Advantages
  • Lower administrative costs to establish a SIMPLE IRA plan than a 401(k) plan.
  • Fewer regulations than other retirement plans.
  • Employers receive a tax deduction for any contributions made to employees’ accounts.
Disadvantages
  • Employer account contributions are required for each employee.
  • SIMPLE IRAs are typically only available to companies with less than 100 employees.
  • If you’re self-employed, other retirement accounts may better suit your needs, such as a SEP IRA or solo 401(k).
Last Modified: February 12, 2021

5 Cited Research Articles

  1. Internal Revenue Service. (2020, November 23). Choosing a Retirement Plan: SIMPLE IRA Plan. Retrieved from https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-simple-ira-plan
  2. Hogan, C. (2020, October 23). What Is a SIMPLE IRA? And How Does It Work? Retrieved from https://www.daveramsey.com/blog/what-is-a-simple-ira
  3. Internal Revenue Service. (2020, September 4). SIMPLE IRA Plan FAQs. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-simple-ira-plans
  4. Internal Revenue Service. (2020, January 18). SIMPLE IRA Plan. Retrieved from https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan
  5. Podell, D. (2019, January 29). Retirement Plans For Businesses Aren't Always Simple: SIMPLE IRAs Vs. 401(k)s. Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2019/01/29/retirement-plans-for-businesses-arent-always-simple-simple-iras-vs-401ks/?sh=f22d5b16eb52