What Is a SIMPLE IRA? And How Does It Work?

If you run a small business, you want to make sure you’re taking care of your team members—and one of the best ways to do that is to help them save for retirement.

Now, if your business is just starting out, trying to figure out how to set up a workplace retirement plan for yourself and your employees can seem like a huge task. But it’s simple. No, really! I’m talking about a SIMPLE IRA.

And what if you’re one of the millions of Americans who work in a small business? You’re probably wondering what a SIMPLE IRA means for you! So let’s take a closer look at SIMPLE IRAs, how they work and some of the advantages (and some of the limitations) of having one.

What Is a SIMPLE IRA?

A SIMPLE IRA (which stands for Savings Incentive Match PLan for Employees) is a start-up retirement savings plan for small businesses, usually reserved for companies with no more than 100 employees.

This plan makes it easy for small-business owners to save for their own retirement and contribute to their employees’ retirement savings as well.  

How Does a SIMPLE IRA Work?

In many ways, SIMPLE IRAs aren’t that much different from a traditional 401(k) plan you might find at a larger company—there are just a few differences here and there you need to know about.

Here are some of the basics of a SIMPLE IRA plan:

• The plan allows employees and their employers to put money into a traditional IRA set up by the business.
• Your plan’s provider will offer a wide variety of investment options to choose from, and each employee is free to pick which ones to include in their own SIMPLE IRA. We recommend spreading out your investments between four different types of mutual funds: growth and income, growth, aggressive growth, and international.
• You also get to decide how much of each paycheck you want to contribute to your account and, since it’s a tax-deferred account, you won’t have to pay taxes on that money for now (but you will have to pay Uncle Sam when you take it out in retirement).

What Are the Contribution Limits for a SIMPLE IRA?

For 2024, employees can contribute up to $16,000 per year to a SIMPLE IRA (anyone age 50 and older can put in an extra $3,500 as a catch-up contribution).¹

Meanwhile, employer contributions are mandatory for SIMPLE IRAs, and they can be made one of two ways. Most employers choose to match employee contributions up to 3% of their salary. So if you’re in a plan with the “match” option, you have to put money into your SIMPLE IRA before your employer does. If you’re ready to invest, take advantage of that match—it’s free money!

The other option for employers is to make an automatic 2% contribution. That means your employer will contribute 2% of your salary into your SIMPLE IRA even if you don’t put in a dime!²

What Are the Pros and Cons of a SIMPLE IRA?

Before you decide whether or not a SIMPLE IRA is right for your business or whether or not you should invest in your company’s SIMPLE IRA, it’s important to keep in mind some of the advantages and limitations of these plans.

The Pros of Starting a SIMPLE IRA

1.  More flexibility and more options.

With some other employer-based retirement plans, like a 401(k) or 403(b), you might have to work at that company for a certain number of years before what the company puts in actually belongs to you. That’s not the case with a SIMPLE IRA!

How much will you need for retirement? Find out with this free tool!

Whatever money your employer contributes to a SIMPLE IRA is immediately vested. That simply means every dollar that’s put into your account immediately belongs to you and you can take it with you whenever you leave the company.

Not only that, but while a typical 401(k) plan might be limited to just a handful of options, SIMPLE IRAs usually have a much larger menu of investments for you to choose from!

2. Easier and less expensive to set up and operate.

One of the biggest benefits to opening a SIMPLE IRA is that they’re much easier to set up and less expensive to run than a typical 401(k) plan or other “qualified plans.” That’s because they have lower administrative costs and fewer regulations to worry about. That’s music to any business owner’s ears! 

 3. Plenty of tax advantages.

For all of you small-business owners out there, you get a tax deduction for any contributions you make to your employees’ accounts. That’ll help take some of the pressure out of tax season!

The Cons of Starting a SIMPLE IRA

1. There’s no Roth option for SIMPLE IRAs.

Unfortunately, there isn’t a Roth IRA option available for SIMPLE IRA plans that would allow employers and employees to enjoy tax-free growth and tax-free withdrawals in retirement. But as your company grows and expands beyond what a SIMPLE IRA plan can provide, you might want to look at introducing a Roth 401(k) option to your team!

2. Lower contribution limits.

Again, SIMPLE IRA contributions max out at $16,000 for most workers. That’s a few thousand dollars less than the contribution limit for a regular 401(k) plan, but it’s still a really good place to start!

Plus, you’re allowed to contribute to other retirement savings plans at the same time. So if you have another job that offers a workplace retirement plan or want to put money in a personal Roth IRA outside of work, go ahead and invest there too!

3. Beware of steep withdrawal penalties.

Taking money out of your SIMPLE IRA (or any retirement account) should always be a last resort to avoid either bankruptcy or foreclosure. If you withdraw from a SIMPLE IRA within two years of opening it, you’ll pay a whopping 25% penalty.

Yep, you read that right—a 25% penalty! That’s why you should only put money in your account if you can keep it there for a long, long time (which is what you want to do anyway!).

You’ll also get hit with that 25% penalty if you do a rollover into anything other than another SIMPLE IRA during those first two years.³  So, what’s the moral of the story here? Treat your SIMPLE IRA money like a hot potato and leave it alone!

How to Set Up a SIMPLE IRA

Believe it or not, setting up a SIMPLE IRA for your business isn’t very complicated. With the help of an investment professional, you can get your SIMPLE IRA program up and running in no time!

Here’s what you have to do . . .  

Step 1: Pick a financial institution.

To set up a SIMPLE IRA, first you need to pick a financial institution—like a brokerage firm or a bank—to serve as a provider for your SIMPLE IRA plan. This institution will receive and invest any contributions from you and your employees. They’ll also give your business updates each year on any new features and benefits available.

Small-business owners: Don’t rush through this process! You want to make sure you’re working with a financial institution that will provide the best mutual fund options for your employees and administrative support for your business.

As an alternative, you can decide to let your employees choose the financial institutions that will receive their contributions.

Step 2: Choose the type of SIMPLE IRA you want.

If you choose to go with a plan that allows your employees to pick the financial institutions that will receive their SIMPLE IRA plan contributions, you’ll fill out Form 5304-SIMPLE. But if you want to create a SIMPLE IRA through one specific financial institution, you’ll fill out Form 5305-SIMPLE instead. 

Whichever form you sign will also let you decide which of your employees are covered. You can choose to cover all employees without any restrictions, or you could limit the employees covered based on how much they’ve made over the past few years or are expected to make this year.

Once you fill out the form, don’t send it to the IRS! You’ll keep this form (signed by you and the financial institution that will be managing the SIMPLE IRA) for your records. That way, you and your team members can reference your rights and benefits under the plan. Oh, and don’t forget it’s up to you to make sure the plan is up to date each year!

Step 3: Set up individual SIMPLE IRAs for each employee.

An individual SIMPLE IRA must be set up for each employee, and that’s where all the contributions to the plan—from both the employee and employer—will go.

Generally, you can set up a SIMPLE IRA plan anytime between Jan. 1 and Oct. 1 of any given year. The only exception is if you start a business with employees after October 1 and don’t want to wait until after New Year’s to establish a SIMPLE IRA for your business.³

Are There Any Alternatives to a SIMPLE IRA?

Yup! There are two main alternatives to a SIMPLE IRA for small-business owners: SEP-IRAs and solo 401(k)s. Here’s a quick run-through on both of these retirement plans and who they’re for.

SEP-IRA

A simplified employee pension (SEP-IRA) is another retirement plan option for small-business owners. Like a SIMPLE IRA, they offer many of the same tax advantages of a traditional IRA.

But there are some key differences. In a SIMPLE IRA, both employers and employees contribute into the plan. With a SEP-IRA, only employers are allowed to contribute to the plan on behalf of their employees (like an old-school pension). For 2024, employers are able to contribute up to 25% of an employee’s salary to their account each year, up to a total contribution of $69,000.⁴

One-Participant 401(k)

Don't have any employees? A one-participant 401(k)—also known as a solo 401(k)—is just for you! In 2024, you can contribute up to $23,000 (or $30,500 if you’re age 50 or older). And all those contributions are tax-deductible.

Plus, you can add on an “employer match”—up to 25% of your income—as long as your total contributions are less than $69,000 per year.⁵

Work With an Investment Pro

Whether you’re a small-business owner trying to give your employees a chance to save for their retirement future or part of a company that offers a SIMPLE IRA, it helps to have an investment professional walk you through the ins and outs of SIMPLE IRAs.

Our SmartVestor Pros are qualified investment professionals and financial advisors who can answer all your questions about SIMPLE IRAs and help you create a plan to save for your retirement dreams.

Find your SmartVestor Pro today!