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Simple IRA vs. Roth IRA: What’s the Difference?

A woman looking up the differences between a Simple IRA and a Roth IRA

A Simple IRA (Savings Incentive Match Plan for Employees) is primarily designed for small businesses, allowing both employees and their employers to contribute towards retirement savings. In contrast, a Roth IRA is a type of retirement savings account into which individuals deposit income after taxes, expecting tax-free earnings over time and during withdrawal at retirement. Here is how each compares to each other. To find the right retirement plan for you, consider working with an experienced financial advisor

How Does a Simple IRA Work?

A Simple IRA operates under the tax-deferred principle, with taxes applicable at the withdrawal stage during retirement. To clarify, the pre-tax money an employer puts into the plan and the returns it earns over the years will be taxed only when withdrawn. This arrangement offers an up-front tax advantage as it lowers the taxable income for the time contributions are made. 

However, as of tax year 2023, SECURE 2.0 allows Simple IRAs to accept Roth contributions. This means that you can now take advantage of the after-tax benefits of a Roth IRA. So, the money that you put into the account can now grow tax-free after paying taxes on those initial contributions.

For an employer with a workforce of 100 employees or less, setting up a Simple IRA involves tasks from administrative (filling an IRS form) to strategic (selecting a trustee financial institution). Informing employees about the plan, and its details, and empowering them to decide their contribution amounts is a crucial step.

How Does a Roth IRA Work?

Roth IRA contributions are made up of the income you have already paid taxes on. Therefore, while this plan doesn’t provide immediate tax benefits, it does promise tax-free earnings and withdrawals during retirement. This feature can hold appeal for those expecting to climb into higher tax brackets during their retirement years.

To set up a Roth IRA, one needs qualifying earned income falling within specific limits. It can be opened through various financial platforms like a bank, brokerage firm or other financial institutions. Post setup, the Roth holder gets to choose how to diversify their investments within the account.

Differences Between a Simple and Roth IRA

Simple IRA vs. Roth IRA: What's the Difference?

When comparing these two IRA options, remember: Simple IRAs that don’t include Roth contributions provide immediate tax relief and suit individuals destined for a lower tax bracket at retirement, while Roth IRAs offer tax benefits upon withdrawal, catering to those who anticipate a higher tax bracket at retirement. Here is how they compare with some of the most important aspects of each:

  • Eligibility: A Simple IRA is for employers with 100 or fewer employees earning at least $5,000 in any previous calendar year, and is expected to in the current year. In contrast, Roth IRAs have income thresholds for eligible individuals, whether their filing status is single or married filing jointly.
  • Contribution limits: The contribution limits for 2023 go as follows: the Simple IRA permits up to $15,500 (plus an additional $3,500 for those aged 50 or older), while the Roth IRA allows up to $6,500 (or $7,500 for those aged 50 or older). Contribution limits for 2022 were: Up to $14,000 for Simple IRA (plus an additional $3,000 for those 50 or older), and up to $6,000 for Roth IRA (or $7,000 for those 50 or older).
  • Withdrawal rules: While both IRAs allow withdrawal from age 59 ½ without penalties, Roth IRA holders can also withdraw their original contributions tax-free anytime. Furthermore, earnings within the account become tax-free after five years if the owner is at least 59 ½ years old. 
  • Investment options: Both types of IRAs offer a variety of investment choices like stocks, bonds, mutual funds and ETFs. However, the range in Simple IRAs depends on the selected financial institution managing these accounts.

Can You Use Both a Simple and Roth IRA?

As long as you meet eligibility requirements for each, you can contribute to both a Simple and a Roth IRA in the same year, allowing for diverse tax advantages. While the mix of immediate tax reduction (Simple IRA) and tax-free withdrawal at retirement (Roth IRA) stands out as the chief benefit, the complexity of managing two different accounts, each with its rules and contribution limits, could potentially pose a challenge. That’s the one thing to keep in mind if you plan on having each account.

Bottom Line

Simple IRA vs. Roth IRA: What's the Difference?

Knowing the differences between a Simple IRA and a Roth IRA will position you for smart retirement planning. Bear in mind that each IRA option has unique benefits and potential drawbacks pegged to individual financial situations and retirement objectives. As you deliberate about your ideal retirement plan, consider factors like income level, tax situation, retirement ambitions and the flexibility to access funds. Remember, the right choice can catalyze your savings growth, optimize tax liabilities and result in a secure retirement.

Tips for Retirement Investing

  • If you’re not sure what to invest in for you to meet your retirement goals, consider working with a financial advisor. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now
  • A retirement calculator can help you figure out how much you need to save for retirement. This is the perfect starting point to start your retirement savings journey.

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