Many retirement plans that work well for large companies are not practical for small businesses, which often require plans with lower costs and fewer administrative responsibilities. If you are a small-business owner, you may want to consider a retirement savings plan known as a SIMPLE IRA.
What is a SIMPLE IRA?
SIMPLE stands for Savings Incentive Match Plan for Employees, reflecting the fact that both employers and employees make contributions to the plan. An employee can choose to defer a portion of their salary into their retirement account, and then their employer has the option to either match that contribution up to a limit of 3% (4% in some cases) of employee compensation or contribute a fixed percentage based on the employee's compensation.
SIMPLE IRAs were designed for small businesses that don't have the resources to handle the administrative duties involved with larger retirement plans. They also do not require the business to file annual plan reports with the IRS.
SIMPLE IRAs are limited to businesses with 100 employees or fewer. In addition to providing employees with many of the tax benefits of traditional retirement accounts—such as pre-tax contributions and tax-deferred growth—they also can provide tax benefits for employers. For example, employer contributions to SIMPLE IRAs can be considered a tax-deductible business expense and may qualify for tax credits.
Employees can choose a variety of investment options for their SIMPLE IRAs, including stocks, bonds, exchange-traded funds, mutual funds, and CDs. Employees do not need to meet a minimum investment in order to open a SIMPLE IRA. However, some investment options may require minimum investments and may not be available for investment under the SIMPLE plan.
How does a SIMPLE IRA work?
SIMPLE IRAs offer employees the tax benefits of a 401(K) with the convenience of a personal IRA. Each year, employees can choose how much of their salary they would like to contribute to their accounts. Their contributions are automatically deducted from their paychecks before federal income tax, reducing taxable income while creating the opportunity for future tax-deferred growth on that money.
Once employers have set up a SIMPLE IRA plan, they must give employees 60 days to decide if they would like to participate in the SIMPLE plan, and if so, at what rate. For an ongoing plan, that 60 days begins November 2nd and ends December 31st for the upcoming year. For new plans, that 60 days needs to include the effective date of the plan. Prior to this election period, the employer is required to send a notice to employees informing them of the contribution the employer has chosen and the dates of the election period. During the election period, employees also choose the amount of their salary they wish to contribute in the coming year. Typically, any employee who has earned more than $5,000 in 2 preceding years is eligible to join the plan, but employers can also design a plan that's open to all employees. Keep in mind that if, as an employer, you offer a SIMPLE IRA, you cannot offer additional separate retirement plans.
SIMPLE IRA contribution limits
The employer match component adds another incentive for employees to contribute. SIMPLE IRA plans require employers to contribute to their employees' accounts in 1 of 2 ways. The employer can choose to match their employees' contributions dollar for dollar up to a certain amount or make a nonelective contribution.
If you choose to match your employees' contributions, you would contribute 3% (in some cases 4%) of the employee's compensation up to either the annual contribution limit or what the employee contributed, whichever is less. In 2024, the employee contribution limits to a SIMPLE IRA are $16,000 for employees under 50 years old and $19,500 for employees 50 and older by the end of the calendar year. In 2025, these amounts increase to $16,500 and $20,000, respectively. Additionally, from 2025 onwards, per the SECURE Act 2.0, employees ages 60 through 63 can contribute $5,250 as a catch-up contribution, in place of their regular catch-up contribution limit. The nonelective contribution is typically 2% of the employee's compensation (3% in some cases) and is based on a maximum salary of $345,000 for 2024 and $350,000 in 2025.
The ability to choose between employer match or nonelective contribution means SIMPLE IRAs can work well for businesses that need to adapt to changing financial circumstances. As a business owner, you can choose to match employee contributions in one year, then opt to make a nonelective contribution in the following year, depending on how much you want to commit.
You also have the option of reducing the percentage of the matching contribution to as low as 1% of annual compensation. However, the percentage can only be reduced for 2 years within any given 5-year period. If the employer chooses the nonelective contribution, the percentage cannot be changed or reduced unless switching back to a matching option.
The SECURE Act 2.0 also introduced changes to contribution limits for SIMPLE IRA plans. As of 2024, for employers with 25 or fewer employees, employees are able to contribute up to $17,600 and, if applicable, the catch-up limit for that year ($3,850 for 2024 and 2025). Employers with 26-100 employees may permit this higher contribution limit, but only if they increase their employer contributions to either a 4% match or 3% nonelective contribution. Further, the employer can make an additional uniform nonelective contribution of the lessor of 10% of each employee's compensation or $5,000 in 2024 and $5,100 in 2025.
SIMPLE IRA rules to encourage long-term savings
Employer contributions to SIMPLE IRAs are immediately vested to the employee. But like personal IRAs, SIMPLE IRAs are designed to discourage account holders from taking money out before retirement. The basic rules governing withdrawals and rollovers for SIMPLE IRAs are as follows:
- Withdrawals from a SIMPLE IRA before age 59½1 are generally subject to a 10% penalty.
- The penalty for withdrawals before age 59½ increases to 25% if the withdrawal occurs within the first 2 years of establishing the account.
- Account holders can transfer SIMPLE IRA assets into another SIMPLE IRA within the 2-year aging period.
- After the 2-year aging period for SIMPLE IRAs has been met, account holders also can roll or transfer a SIMPLE IRA into another IRA or employer plan, subject to some restrictions depending on the receiving account or plan.
- Starting at age 73, participants must begin taking required minimum distributions.
If you are a small-business owner and do not currently offer your employees a retirement savings plan, the SIMPLE IRA's flexibility can help you achieve several important goals. These plans offer tax advantages for employers and employees, are easy to maintain, and encourage employees to save for retirement through the option for matching contributions. And because plan rules allow business owners and employees to adjust their contribution levels each year, they enable all parties to manage changing financial circumstances and still save for retirement.
Potential Drawbacks of SIMPLE IRAs
SIMPLE IRAs are not ERISA plans and do not offer the same level of creditor protection. IRAs are protected in the event of bankruptcy under federal law, but additional coverage varies by state. Consult your tax advisor for details regarding the laws within your state.
Unlike some plan types, SIMPLE IRAs do not offer loans and, compared to other plans, may have lower contribution limits. Depending on your situation, keep other retirement plan types in mind such as SEP IRAs, Self-Employed 401(k)s, and pooled employer plans (PEPs) like the Fidelity Advantage 401(k)℠ plan that may address these concerns.