- SIMPLE IRA stands for Savings Incentive Match Plan for Employees. A SIMPLE IRA is a type of employer-sponsored retirement plan — kind of like a 401(k), but with different rules.
- Only small businesses with 100 or fewer employees are eligible to establish a SIMPLE IRA.
- SIMPLE IRAs have a required employer match – usually 3% of employee contributions, but the employer can also choose to contribute 2% regardless of whether the employee contributes anything. SIMPLE IRAs also carry slightly lower contribution limits than 401(k)s do.
- SIMPLE IRAs have another important (and potentially expensive) quirk: If you make a withdrawal within two years of opening the account, the regular 10% early withdrawal penalty shoots up to 25%.
- After two years, a SIMPLE IRA can be rolled over into traditional (pre-tax) retirement accounts, like an IRA.
What is a SIMPLE IRA?SIMPLE IRA stands for Savings Incentive Match Plan for Employees — which makes sense, since it’s a type of employer-sponsored retirement savings plan. This can be a source of confusion, since most other IRAs are not employer-sponsored, and can be opened by people who don’t necessarily have a regular, W2 job. A lot of people ask, “Is a SIMPLE IRA a traditional IRA?” Not quite! A SIMPLE IRA is a lot more similar to a 401(k) from the saver’s side than other IRAs, though there are some important differences for the employers who sponsor them. Let’s dive into the details of this unique retirement account.
How Does a SIMPLE IRA Work?A SIMPLE IRA looks a lot more like a 401(k) than an IRA: it’s offered to workers through their jobs, and comes with significantly higher contribution limits than a traditional or Roth IRA does – more on that in just a moment. Like a 401(k), contributions are made pre-tax and directly from an employee’s paycheck. As with many 401(k) plans, the employer offers a match. One big difference with SIMPLE IRAs is how employer contributions are made. An employer generally has two options:
- Option 1: The employer must match employees’ contributions up to 3% of the employee’s salary. This requires employees to contribute to benefit from the match. There are some IRS exceptions that allow employers to reduce the match to 1%, but not for more than two out of five years in any given period. Employers can also go above 3% if they would like to.
- Option 2: The employer can make a flat contribution of 2% of the employees’ salary for all employees, regardless of whether or not the employee is contributing at all.
What Are the SIMPLE IRA Rules for Contributions?Like other retirement vehicles, SIMPLE IRAs come with limits on how much money can be contributed to them in a given year. (“Contributed” is IRS-speak for “money you put into to your retirement account.”) For a SIMPLE IRA, the employee contribution limit in 2021 is $13,500. Those aged 50 and over have the opportunity to make an additional “catch-up contribution” of up to $3,000, for a total limit of $16,500. With a 401(k), on the other hand, employees can contribute up to $19,500 in a given tax year. The 401(k) contribution limits also allow for a catch-up contribution of $6,500, bringing the total limit to $26,000 for savers aged 50 and over. Traditional and Roth IRAs also have limits – up to $6,000, or $7,000 if you’re 50 or older.
|Annual Employee Contribution Limits (2021)||SIMPLE IRA||Traditional and Roth IRA*||401(k)|
|Those aged 50 and under||$13,500||$6,000||$19,500|
|Those aged 50 and over||$16,500||$7,000||$26,000|
What Are the Withdrawal Rules for a SIMPLE IRA?The SIMPLE IRA rules for withdrawals are very similar to those for 401(k)s and other types of retirement accounts. Long story short, these accounts are designed to help you save for retirement, which means the IRS places limits on when you can withdraw the money. If you make a withdrawal before age 59 ½, you’ll be subject to a 10% early withdrawal penalty, just as you would with a 401(k). And with SIMPLE IRAs specifically, that penalty shoots up to 25% if you take the money out within two years. To state the obvious, that’s a steep penalty. So, try to avoid withdrawing within two years if you can! There are a few exceptions that allow you to withdraw early, but make sure to check with an advisor if you aren’t sure you qualify.
How Do Taxes Work with a SIMPLE IRA?Even if you avoid the early withdrawal penalties mentioned above, you’ll still be on the hook for some taxes when it comes time to make your SIMPLE IRA withdrawals. That’s because a SIMPLE IRA is a pre-tax investment vehicle, like a traditional IRA or 401(k). Because the contributions are made pre-tax — and tax deductible in the year they’re made — regular income taxes must be paid at the time withdrawals are taken. This kind of account might also be called “tax-deferred,” which basically just means you’re paying your taxes later. One way or another, you’ll definitely pay taxes at some point. Unfortunately, there’s no such thing as a SIMPLE Roth IRA.In fact, the IRS specifically states that “A SIMPLE IRA cannot be a Roth IRA.” But you could still open a separate Roth IRA if you wanted to!
How Do Rollovers Work for a SIMPLE IRA?When it comes to rollovers, the SIMPLE IRA rules are, again, fairly similar to the rules for other retirement accounts: after the first two years, they can be rolled over into most other traditional (pre-tax) retirement plans, such as a traditional IRA or 401(k). However, within the first two years, a SIMPLE IRA can only be rolled over into another SIMPLE IRA. Otherwise, the rollover will be treated as a withdrawal and you’ll face that elevated 25% penalty tax, along with regular income taxes.
Bottom LineYou may be eligible for a SIMPLE IRA if you work at a small business — and in many ways, the account works very similarly to a 401(k). However, a SIMPLE IRA means your employer is required to match your contributions. Be sure to keep in mind the two-year rule, which means your early withdrawal penalty will skyrocket from 10% to 25% if you take out the funds too early!
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