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simple ira vs traditional ira

Investing for retirement is critical for your long-term financial stability. But which of the several available tax-advantaged investment accounts should you choose? SIMPLE IRAs and traditional IRAs are two options. Let’s explore the details of a SIMPLE IRA and traditional IRA. If you need help sorting out the best option for your unique situation, a financial advisor can help.

What Is A SIMPLE IRA?

A SIMPLE IRA stands for ‘savings incentive match plan for employees individual retirement account.’ It’s a type of IRA that small business owners can open if they have 100 employers or less.

As a small business owner, you can set up a SIMPLE IRA for yourself and your employees. Like a 401(k), the employee can choose to make ‘elective deferrals.’ Essentially, that means that an employee can choose to tuck a part of their paycheck into this vehicle pre-tax.

Employees are unable to opt out of a SIMPLE IRA. But they can choose to skip the elective deferrals.

As an employer, you can match up to 3% of your employee’s contributions. Or the employer can choose a non-elective contribution, which is not tied to how much an employee contributes in a given year.

Employers can deduct their contributions made to employees’ SIMPLE IRAs as a business expense. With that, employers can use this retirement savings vehicle to lower their tax obligations.

As of 2022, the SIMPLE IRA contribution limit is a combined total of $14,000. That includes contributions from both the employee and the employer. If you’re over 50, you also get $3,000 in catchup contributions for a total of $17,000.

What Is A Traditional IRA?

simple ira vs traditional ira

A traditional IRA is another type of individual retirement account. You can open a traditional IRA without the involvement of your employer. In fact, this individual retirement account is specifically for you to open outside of your employment relationship. Although that eliminates an employer-match option, you’ll still find a tax-advantaged retirement saving option.

Like a SIMPLE IRA, the contributions are tax-deferred. With that, you can lower your tax burden now in favor of enjoying tax-free growth and investment gains until you withdraw the funds in retirement.

The contribution limits for a traditional IRA are a bit lower than the SIMPLE IRA limits. You’ll be able to contribute up to $6,000 to a traditional IRA in 2022. Plus, you can contribute an extra $1,000 per year if you are 50 or older.

SIMPLE IRA vs Traditional IRA

There are a few key differences to note when deciding between a SIMPLE IRA vs traditional IRA. Here’s what to consider.

Contribution Limits

The SIMPLE IRA contribution limit is much higher. You can contribute up to $14,000 to a SIMPLE IRA in 2022. That’s compared to the relatively low limit of $6,000 for a traditional IRA.

As a small business owner, the higher contribution limits of a SIMPLE IRA are attractive. Plus, you’ll have the option to contribute as an employee and an employer if you are self-employed.

Required Employer Matches

As a business owner, the SIMPLE IRA match requirements are something to keep in mind. Specifically,

An employer must match part of their employee’s contribution. If your employees invest through a traditional IRA, there is no employer contribution requirement.

Depending on your business, a SIMPLE IRA may or may not work well for your situation.

Early Withdrawal Penalties

The early withdrawal penalties associated with SIMPLE IRAs and traditional IRAs also come with slightly different rules.

If you withdraw funds from a SIMPLE IRA within the first two years of participation, you’ll encounter a 25% early withdrawal penalty. That’s incredibly steep!

However, the early withdrawal penalty for a SIMPLE IRA matches that of a traditional IRA after the two-year mark. So, if you are under the age of 59.5, you’ll incur a 10% tax on the amount you withdraw.

There are a few exceptions to the early withdrawal rule. You can skate by the penalty if you are making a withdrawal to buy, build or rebuild your first home, qualified education expenses or certain medical expenses.

The Bottom Line

simple ira vs traditional ira

Investing in an IRA is a smart move for your retirement savings. But choosing between a SIMPLE IRA and a traditional IRA will vary based on your unique situation. If you want guidance on the best choice for your individual situation, consider working with a financial advisor. A qualified financial advisor can help you choose the best option.

Tips On Investing For Retirement

  • Once you decide which IRA is right for you, start tucking away funds as soon as possible. If you aren’t sure what the best investment strategy is, then find a financial advisor for guidance. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Take a look at SmartAsset’s free retirement calculator to determine how much income you’ll need in your golden years. The tool can help you find out if you are on track for your dream retirement.

Photo credit: ©iStock.com/metamorworks, ©iStock.com/jeffbergen, ©iStock.com/smshoot

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