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All You Want to Learn About the SIMPLE IRA

As the old adage goes, it’s never too early to start saving for retirement. However, for small business owners, retirement planning isn’t always so straightforward given the rising costs of running a successful enterprise. That’s where the SIMPLE IRA, or Savings Incentive Match Plan for Employees, can help.

As the name implies, a SIMPLE IRA is a traditional IRA for small businesses and self-employed Americans looking to streamline their retirement savings. Just like other traditional IRAs, the SIMPLE IRA helps you maximize contributions by allowing you to grow your investments in a tax-deferred account. All contributions are tax deductible and there are no capital gains penalties as long as you hold your investments until retirement.

Most small businesses employing 100 people or fewer can utilize the SIMPLE IRA. Under the plan, employers can choose to contribute a mandatory 2% to their workers’ retirement account or an optional matching contribution of up to 3%. In 2018, the maximum contribution space for employees is $12,500 per year. The contribution ceiling can change based on the annual inflation rate. It’s important to note that only employees earning $5,000 or more are eligible for the plan.

Employees above age 50 are permitted to contribute an extra $3,000 annually to their SIMPLE IRA. This so-called “catch-up contribution” helps retirement savers maximize their savings before their golden years.

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SIMPLE IRAs vs 401(k)s

SIMPLE IRAs are designed for small business owners looking for a less expensive and less complicated retirement savings plan for their employees. Although the SIMPLE IRA behaves very much like a 401(k), the latter has a higher contribution limit of $18,000 as of 2017 or up to $24,000 with a catch-up contribution. Matching employee contributions dollar-for-dollar may be more difficult for small business owners under the 401(k) plan. What’s more, employers under a SIMPLE IRA can lower the matching contribution to 1% to 2% of total compensation in no more than two out of five years the plan is in effect.

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That being said, one of the challenges associated with the SIMPLE IRA is the rollover process – that is, if you decide to participate in another plan. Retirement savers contributing to a SIMPLE IRA can easily move money into a rollover IRA or new employer 401(k) after two years; the process isn’t so straightforward if you decide to make the switch less than two years into the SIMPLE IRA plan.

It’s also worth mentioning that a SIMPLE IRA cannot be rolled over into a traditional IRA without a two-year waiting period from the time the employee first joined the plan. Such restrictions do not apply to the 401(k).

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Another obvious drawback for employees and their workers is that a SIMPLE IRA does not maximize savings to the same extent as a 401(k) or a simplified employee pension (SEP). As we touched upon earlier, these plans also have higher catch-up contributions.

A SIMPLE IRA has the same early redemption penalties as a 401(k) – that is, if an employee takes money out of the fund before age 59½, they will pay a 10% penalty.

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The Bottom Line

The SIMPLE IRA provides small business owners with a tax-efficient vehicle for growing their retirement savings. Although they sacrifice contribution space relative to other retirement accounts, they gain more flexibility and incur potentially lower costs as a result.

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Nov 29, 2018