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.
SIMPLE stands for Savings Investment Match Plan for Employees, reflecting the fact that both employers and employees make contributions to the plan. Employees choose to defer a portion of their salaries into their retirement account, and then employers have the option of matching a percentage of their employees' contributions, or contributing a fixed percentage of employees' salaries to their accounts.
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.
Flexibility and choice in contribution levels
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.
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 of up to 3% of annual pay, or make a nonelective contribution of 2% of employees' salaries.
If you choose to match your employees' contributions of up to 3% of annual pay, you would contribute no more than the contribution limits to an employee's account. In 2022, the contribution limits to a SIMPLE IRA are $14,000 for employees under 50 years old and $17,000 for employees 50 and older by the end of the calendar year. The 2% nonelective contribution is based on a maximum salary of $305,000 for 2022, meaning that you would contribute no more than $6,100 to an employee's account.
The ability to choose between matching options 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 2% nonelective contribution in the following year, depending on how much you want to commit to employee accounts.
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 2% nonelective contribution, the percentage cannot be changed or reduced unless switching back to a matching option.
Easy setup and maintenance
SIMPLE IRAs were designed for small businesses that don't have the resources to handle the administrative duties involved with larger retirement plans.
Many administrative details are shouldered by the financial institution that manages the accounts and you don't have to file annual plan reports with the IRS.
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 start a SIMPLE IRA. However, not all fund families offer mutual funds that are approved for SIMPLE IRAs with no minimum investment requirement.
Once employers have set up a SIMPLE IRA plan, they must announce which contribution method they have chosen during an election period of at least 60 days from November 2 to December 31. During that 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 employees who have earned less than $5,000.
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 roll SIMPLE IRA assets into another SIMPLE IRA.
- Account holders also can roll a SIMPLE IRA into a traditional IRA (tax-free) or Roth IRA (income tax due) after 2 years.
- Starting at age 72,2 participants must take 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.
Next steps to consider
Take advantage of potential tax-deferred or tax-free growth.
Determine which type of IRA is the best fit for you.
See how small increases in contributions can add up over time.