What is a SIMPLE IRA Plan and How Does it Work?

Is a SIMPLE IRA the same as a traditional IRA?

There are similarities between a SIMPLE IRA and a traditional IRA. For instance, a SIMPLE IRA follows the same investment, distribution, and rollover rules as traditional IRAs. However, key differences include contribution limits for each plan and who can open an account. See the table below to compare SIMPLE IRA vs. traditional IRAs.

How does a SIMPLE IRA work?

With a SIMPLE IRA, you and your employees can put a percentage of pay aside for retirement, up to the contribution limit. The money grows tax-deferred until it's withdrawn. Employees don't pay taxes on investment growth, but they will pay income taxes when making withdrawals.

SIMPLE IRA rules: Contributions and limits

Keep in mind the following rules around contribution limits for employees and employers in tax year 2024:

Employee contribution limits

For a SIMPLE IRA in 2024, an employee under age 50 can contribute up to $16,000. People age 50 and older can make an additional $3,500 catch-up contribution, for a total of $19,500.

Employer contribution limits

An employer is required to make a contribution to a SIMPLE IRA plan and can choose either of the following options:

• Make a non-elective contribution of at least 2 percent of compensation for all eligible employees earning at least $5,000. Maximum compensation is $345,000 for the 2024 tax year.
• Make a matching contribution of 100 percent up to the first 3 percent of compensation.

SIMPLE IRA rules: Withdrawals and transfers

Employees who make early withdrawals from their SIMPLE IRA will generally incur significant penalties. In general, SIMPLE IRA distribution rules mirror traditional IRA rules, except for non-qualified withdrawals within the first two years of participation. If an employee has had the SIMPLE IRA for less than two years and withdraws money before age 59½, they will be subject to both the standard 10 percent penalty from the IRS, as well as an extra 15 percent early withdrawal penalty — totaling 25 percent of the money taken out going toward penalties owed to the IRS, plus any applicable income taxes. For a $10,000 early withdrawal, that means a minimum $2,500 will go toward a tax bill.

There are also stringent rules around transfers and rollovers to another IRA or employer-sponsored retirement plan. Balances rolled over from the plan into anything other than another SIMPLE IRA during the two-year period after first participating in the plan are taxable.

Pros and cons of SIMPLE IRA plans

When considering a SIMPLE IRA, it's important to understand the advantages and drawbacks of this type of plan. Some notable benefits of establishing a SIMPLE IRA plan for employees include:

• Like other types of employer-sponsored retirement plans, SIMPLE IRAs allow employee participants to defer part of their salaries on a tax-deferred basis. Contributions can be made through payroll deductions.
• SIMPLE IRA plans are relatively straightforward to establish.
• Employees are immediately 100 percent vested in all SIMPLE IRA contributions. As opposed to the majority of qualified plans, matching employer contributions immediately belong to employees and travel with them if they leave employment.
• Businesses may be eligible to receive a tax credit of up to $5000 per year (for the first three years from the plan's inception) to help offset setup and administrative costs of establishing the plan.
• Employers do not have to file Form 5500 as part of the plan's requirements.

There are also some disadvantages of setting up a SIMPLE IRA, some of which include:

• Contribution limits for SIMPLE IRA plans are lower than other workplace retirement plans, such as a 401(k) plan. In 2024, employees, sole proprietors, and self-employed workers under age 50 can contribute $16,000 to a SIMPLE IRA versus $23,000 to a 401(k).
• Businesses are required to match employee contributions up to a certain percentage. Compare this to a retirement plan such as a 401(k), where employer contributions aren't required.
• Employers must follow strict rules set by the IRS, including rules around withdrawals and transfers (see SIMPLE IRA rules section above).

Setting up a SIMPLE IRA plan

SIMPLE IRAs are known for their ease of plan setup. You may be able to set up your plan in just a few steps, as outlined by the IRS:

• Execute a written agreement to provide benefits to all eligible employees using Form 5304-SIMPLE or Form 5305-SIMPLE, which are model SIMPLE plan documents.
• Give employees certain information about the agreement, including an annual notice to eligible employees.
• Set up an IRA account for each employee at an authorized financial institution.

After the SIMPLE IRA is set up, you and your employees can choose to make regular pre-tax contributions through payroll deduction. You can also choose how money gets invested.

Both candidates and current employees value workplaces that offer some type of retirement plan — and the more attractive, the better. That's why offering a SIMPLE IRA plan is an effective way to attract future employees, retain the workforce you currently have, and enjoy the benefits of an easy-to-manage plan.