SIMPLE IRA

SIMPLE IRA stands for Savings Incentive Match Plan for Employees It is a type of retirement plan designed for small businesses and self-employed individuals. Under this, both employer and employee contribute to the scheme. SIMPLE IRA is an attractive option for small businesses offering retirement benefits to their employees. This article will help you to learn about the SIMPLE type of IRA plan in detail.

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What is a SIMPLE IRA Plan?

SIMPLE IRA or Savings Incentive Match Plan for Employees is the best workplace pension plan for small-scale business owners and sole proprietors with less than or equal to 100 employees. 

It allows employers and employees to contribute to individual retirement accounts (IRAs) set up for each eligible employee.

Key Features of a SIMPLE IRA Plan:

  • In a SIMPLE IRA plan, employees can contribute a certain percentage of their salary to their IRA account

  • Employers can either match with equal contributions or make a non-elective contribution to each employee's IRA account

  • The contribution limits, administrative costs, and requirements of reporting and paperwork are far lesser than other pension plans, like 401(k)

These features make a SIMPLE IRA Plan a more attractive option for small businesses.

Eligibility Criteria

Let us learn the major eligibility criteria for a SIMPLE IRA plan from the list mentioned below:

Eligibility Criteria for Employers Eligibility Criteria for Employee
  • Have 100 or fewer employees in the company
  • Employees must be employed by the employer in the current calendar year
  • Employers may set additional eligibility criteria, such as a waiting period before employees can participate
  • Received a compensation of $5,000 or more in any two previous years
  • Must be expecting to earn the same compensation in the current calendar year
  • Must not be participating in any other employer-contributing retirement plan (except SEP IRA)

Note: Employers must understand and comply with the eligibility criteria to ensure their SIMPLE IRA plan complies with IRS regulations.

How Does a SIMPLE IRA Plan Works?

The working of a SIMPLE IRA plan is as follows:

  • The employer establishes a SIMPLE IRA plan and notifies eligible employees

  • Employees decide how much they want to contribute from their pre-tax salary up to the contribution limit set by the IRS

  • Employers are required to make either a matching contribution to each employee's account or a non-elective contribution to all eligible employees, as specified by the plan

  • Overall contributions are deposited into each employee's SIMPLE IRA account, which is held at a financial institution chosen by the employer

  • The contributions grow tax-deferred until they are withdrawn during the retirement period

  • Employees can choose how to invest their SIMPLE IRA funds, typically through a selection of best investment plans

  • Employers must also file Form 5500 annually to report on the plan's activities and ensure compliance with IRS regulations

Contribution Limits of a SIMPLE IRA Plan in 2023

IRS sets the contribution limits for a SIMPLE IRA plan and can update them periodically. As of 2023, the contribution limits are:

Particulars SIMPLE IRA Contribution Limits
Contribution by Employee and 
  • Age less than 50 years: $ 15,500 annually
  • Age more than 50 years: $ 19,000 annually 
Contribution by Self-Employed Individuals
  • Age of 50 years or less: $ 15,500 per year
  • Age of 50 years or more: $ 19,000 per year
Employer’s Contribution
  • Contribute equally to the employee’s contributions
  • Up to 3% of the employee’s yearly compensation is allowed
  • Or else, 2% of the employee’s annual compensation as a non-elective contribution

How to Establish a SIMPLE IRA Plan?

To establish a SIMPLE IRA plan, the employer must follow these essential steps as mentioned below:

Step 1: Determine the eligibility of your business 

Step 2: Choose a financial institution to serve as the SIMPLE IRA plan trustee and hold employee contributions

Step 3: Create a written document outlining the plan rules, procedures, eligibility requirements, contribution limits, and distribution rules.

Step 4: Notify eligible employees of all the required information about the plan

Step 5: Set up employee accounts with the selected financial institution

Step 6: Make contributions in the SIMPLE IRA account through salary deferral

Step 7: Ensure compliance with all the IRS rules and regulations, including annual filings of Form 5500

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Rules to Withdraw a SIMPLE IRA Plan

The employee or self-employed individual must follow the below-mentioned rules to withdraw money from their SIMPLE IRA account:

  1. Early Withdrawal Penalty 

    If an account holder withdraws funds from their SIMPLE IRA before 59.5 years of age, they may have to pay a 10% early withdrawal penalty. This penalty is in addition to the ordinary income tax payable on the amount withdrawn.

  2. Distribution Rules 

    Required Minimum Distribution (RMD) rules are applicable on the SIMPLE IRAs. As per these rules, the account holder must take pension payouts from their account by 01 April of the following year, wherein they turn 72 years of age. This limit is 70.5 years if they attain this age before 01 January 2020.

  3. Taxation 

    Withdrawals from a SIMPLE IRA are generally subject to ordinary income tax laws, regardless of the account holder's age.

  4. Exceptions 

    There are some exceptions to the early withdrawal penalty of a SIMPLE IRA account. For example, no penalty is levied for certain medical expenses or if the account holder becomes disabled.

  5. Transfer or Roll Over 

    SIMPLE IRA funds are transferrable or can roll over to another retirement account. However, following IRS rules and regulations is essential to avoid tax penalties.

Benefits of a SIMPLE IRA Plan

Some of the benefits of a SIMPLE IRA plan for employers and employees are listed below:

  1. Low Cost 

    SIMPLE IRA plans are generally less expensive to set up and maintain than other retirement plans. This makes them a good option for small businesses than 401(k) plans.

  2. Easy to Administer

    SIMPLE IRA plans are easy to administer and require minimal paperwork, saving employers time and money.

  3. Tax Advantages 

    Contributions to a SIMPLE IRA are available for tax benefits to the employer. For employees, the SIMPLE IRA contributions are made on a pre-tax basis. This helps them to reduce taxable income and save money on taxes.

  4. Employer Contributions 

    Employers are required to make either a matching contribution or a non-elective contribution to their employees' SIMPLE IRA accounts. This helps attract and retain talented employees.

  5. Flexibility 

    Employees can choose how much to contribute to their SIMPLE IRA accounts up to the contribution limits set by the IRS. They can also choose how to invest their funds from a selection of investment options the financial institution offers.

  6. Portable 

    Employees can take their SIMPLE IRA accounts if they leave their job. This facility allows them to stay invested in their retirement savings.

Wrapping It Up

A SIMPLE IRA is among the best pension plans offering tax benefits, low cost, and ease of administration advantages. This makes it an attractive option for both employers and employees. With contribution limits and withdrawal rules set by the IRS, a SIMPLE IRA provides a simple and flexible way to save for retirement.

FAQ's

  • What is a SIMPLE IRA?

    A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement savings plan offered to small business owners and self-employed individuals. It provides benefits like tax advantages, low cost, and ease of administration. Both employees and employers can make contributions in a SIMPLE IRA plan. 
  • What is a SIMPLE IRA vs 401k?

    SIMPLE IRA and 401(k) are retirement savings plans employers offer their employees. However, there are some critical differences between these two plans.

    Let us learn them from the table mentioned below:

    Terms SIMPLE IRA Plan 401(k) Plan
    Eligibility Designed for small businesses with 100 or fewer employees Can be offered by any employer, regardless of the size of the business
    Contributions Both employees and employers can make contributions up to a certain limit Both employees and employers can make contributions which are higher than a SIMPLE IRA
    Employer Contributions Employers can make either a matching contribution or a non-elective contribution to their employees' SIMPLE IRA accounts Employer contributions are optional
    Maturity Employer contributions are immediately 100% owned by the employees Employer contributions are subjected to a vesting schedule, i.e. the employees may have to wait a certain amount of time before owning the full amount
    Cost and Administration Less expensive and easier to administer More complex and costly due to the larger contribution limits and administrative requirements
  • What is a SIMPLE IRA vs IRA?

    A SIMPLE IRA and a traditional IRA (Individual Retirement Account) are both retirement savings plans, but they have some key differences; they are:
    Terms SIMPLE IRA Plan Traditional IRA Plan
    Eligibility Offered to small businesses with 100 or fewer employees Anyone can open traditional IRAs with earned income
    Contributions Both employees and employers can make contributions up to certain limits set by the IRS Individuals can make contributions up to certain limits set by the IRS, but there is no employer contribution
    Contribution Limits Contribution limits for SIMPLE IRAs are generally higher Lower contribution limits
    Premature Withdrawals Withdrawals before age 59 ½ are generally subject to a 25% penalty in addition to income tax Withdrawals before age 59 ½ are generally subject to a 10% penalty in addition to income tax
    Required Minimum Distributions Required minimum distributions (RMDs) must be taken starting at age of 72 years (age 70 ½ years if the account was opened before 2020) RMDs must be taken starting at age of 72 years
    Cost and Administration Generally less expensive and easier to administer More expensive as it may require more paperwork and have more investment options to choose from
  • What is the IRA limit for a SIMPLE IRA?

    The IRS sets the contribution limits for a SIMPLE IRA regularly. For 2023, the contribution limit for a SIMPLE IRA is $15,500. If you are age 50 or older, you are eligible to make contributions of up to $19,000. It is important to note that employer contributions, which are required in a SIMPLE IRA plan, are not included in these limits.

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^^The information relating to mutual funds presented in this article is for educational purpose only and is not meant for sale. Investment is subject to market risks and the risk is borne by the investor. Please consult your financial advisor before planning your investments.

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