A SIMPLE IRA is a retirement savings option for the owners and employees of small business. True to its name, the SIMPLE IRA is easy to set up and administer. If you’re a business owner, a SIMPLE IRA lets you save for yourself and your employees. People who work with their spouses can double their retirement savings by using a SIMPLE IRA. Let us explain the SIMPLE IRA and how it works.
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SIMPLE IRA Definition and Rules
SIMPLE IRA (also sometimes written as Simple IRA) stands for Savings Incentive Match Plan for Employees Individual Retirement Account. A SIMPLE IRA is similar to a traditional IRA, but has higher contribution limits.
Here’s how it works: A small business owner, along with the sole proprietor or partner in a business, can set up a SIMPLE IRA for herself and her employees. Per IRS rules, all employees who, in the previous two calendar years, received at least $5,000 in compensation from the employer setting up the SIMPLE IRA and who are expected to receive at least as much during the present calendar year, are eligible.
Eligible employees can decide to make “elective deferrals,” just like with a 401(k). That means that employees can choose to save a certain percentage of their pre-tax income. The employer then contributes to the SIMPLE IRA on behalf of each eligible employee.
Employer contributions can be either matching (up to 3% of the employee’s contributions) or non-elective. Non-elective means that the employer makes a unilateral decision to contribute to an employee’s savings plan, regardless of whether the employee contributes in a given year.
IRS rules prohibit employees from opting out of a SIMPLE IRA. They can choose not to make elective deferrals (in which case they wouldn’t receive an employer match), but they cannot opt out of receiving non-elective contributions from their employers. But why would they want to?
Related Article: Getting Started with Retirement Planning
SIMPLE IRA Contribution Limits
In 2015 SIMPLE IRA contributions can reach $12,500, with a catch-up contribution limit of $3,000. Plus, the owner of a business can give herself an employer match of up to 3% of net self-employment income. If two spouses work together, they can both make maximum contributions (and deduct them at tax time), making the SIMPLE IRA a great option for married people who work together and file jointly.
SIMPLE IRA Rollover
Things get a little tricky when it comes to SIMPLE IRA rollovers. That’s because the rules are different for the two-year period beginning when an employee enrolls in a SIMPLE IRA plan. During this two-year period, a tax penalty-free rollover is only possible as a trustee-to-trustee transfer from one SIMPLE IRA to another. After the two-year period, an employee can make a penalty-free trustee-to-trustee rollover from a SIMPLE IRA to a regular IRA.
What is this trustee-to-trustee business, you ask? It comes up any time retirement account rollovers are in the mix. If you move money from the trustee of one retirement account (Fidelity, for example) to another trustee (say, Vanguard), you can avoid a tax penalty. But if you ask Fidelity to write you a check for the amount you have in your retirement account and then you wait a while before sending that money over to a new account at Vanguard, you’ll pay tax penalties as if you took an early withdrawal. If you’re considering a rollover, ask your new retirement account provider to help you enact a tax-free rollover.
SIMPLE IRA vs. 401(k)
Business owners and sole proprietors don’t have to opt for the SIMPLE IRA. They can also open an Individual 401(k). But with an Individual (also known as a Solo) 401(k), you can’t contribute for your employees, unless those employees are your spouse, your business partner, your business partner’s spouse, a shareholder or a shareholder’s spouse. So, no contributions for regular old employees. If you’re concerned about attracting and retaining talent, a SIMPLE IRA can be a good option. Plus, SIMPLE IRAs are easier to administer than Individual 401(k)s. On the other hand, the contribution limits are higher on an Individual 401(k) than they are for a SIMPLE IRA ($18,000 vs. $12,500).
SIMPLE IRA vs. SEP-IRA
SEP-IRA stands for Simplified Employee Pension Individual Retirement Account. With a SEP-IRA, a business owner can contribute money for her own retirement plan and make contributions on behalf of employees. Employee contributions are not an option with SEP-IRAs, however. If you want to encourage your employees to be active participants in their own retirement planning while they’re in your employ, a SIMPLE IRA will likely be a better bet.
The SIMPLE IRA also lets you save more for yourself and less for your employees. You can save more of your income in a SIMPLE IRA than in a SEP-IRA, so if you’ve put off saving for retirement and you want to make up for lost time, you may want to go with a SIMPLE IRA. Plus, with a SEP-IRA, you must pay the same percentage of salary into an account for each employee. Meanwhile with a SIMPLE IRA, if an employee doesn’t sign up for matching contributions, you’re not obligated to give them.
Related Article: What Is a SEP-IRA?
SIMPLE IRA Tax Advantages
Employers can deduct as business expenses all contributions made to employees’ SIMPLE IRAs. For employees, the money contributed to a SIMPLE IRA is pre-tax. This means it can lower your tax liability now.
If you want to boost your retirement savings, do right by your employees and get a tax break all at the same time, a SIMPLE IRA may be the way to go. Happy saving!
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