If you’re a small business owner or are self-employed, a SIMPLE IRA can offer a cost-effective, easy way for you and any employees to save for retirement. This type of plan operates similarly to a Traditional IRA but, like a 401(k), can be an attractive benefit for existing and potential employees.

Understanding plan basics, including the pros and cons of a SIMPLE IRA, can help you determine if one is right for your business.

What Is a SIMPLE IRA?

A SIMPLE IRA, or Savings Incentive Match Plan for Employees Individual Retirement Account, is a retirement savings plan designed for self-employed individuals and solo small business owners and their employees.

A SIMPLE IRA operates similarly to a Traditional IRA: It is funded with pre-tax dollars and funds grow tax-deffered while in the account.

Both employers and employees can contribute to a SIMPLE IRA. This makes it an attractive option for employers who want to offer a retirement benefit but want to avoid the complexities and expenses associated with a 401(k).

Employers who offer a SIMPLE IRA must contribute to employee accounts in one of two ways: Matching up to 3% of employee contributions or making a 2% non-elective contribution.

Pros and Cons of a SIMPLE IRA

Like any other retirement plan, a SIMPLE IRA has drawbacks and benefits, the likes of which may determine whether this type of plan is best for your business.

Pros of a SIMPLE IRA

1. Low start-up and operational costs. Compared to 401(k)s, SIMPLE IRAs are less expensive to start and manage over time.
2. Easy to administer. SIMPLE IRAs are notably less complex to administer, require minimal paperwork, and are not subject to the compliance testing associated with 401(k)s.
3. Tax benefits to employers and employees. The funds in a SIMPLE IRA grow tax-deferred while in the account, and employers can deduct 100% of their contributions to employee accounts.
4. Contributions are immediately vested. Both employee and employer contributions are vested at 100%. This contrasts with other sponsored plans, which usually include a vesting schedule.
5. Participants can contribute to other plans at the same time. You can contribute to additional retirement plans, such as employer-sponsored 401(k) or a self-attained Roth IRA, as long as contributions stay within the IRS plan-specific limits.
6. Expanded investment options. Asset selection varies by plan provider, but SIMPLE IRAs generally offer a more diverse selection when compared to 401(k)s.

Cons of a SIMPLE IRA

1. Lower contribution limits compared to other employer-sponsored plans. The annual SIMPLE IRA contribution limit is $16,000 ($19,500 if you’re over 50). Under a 401(k), participants can contribute up to $23,000 annually ($30,500 if you’re over 50).
2. No Roth version available. SIMPLE IRAs follow a traditional IRA structure, which means contributions are made with pre-tax dollars, and withdrawals are taxed at the participant’s income tax rate. A Roth IRA structure, which allows for after-tax contributions and tax-free withdrawals, is not an option.
3. No plan loans. Some retirement plans, such as 401(k)s, allow for participant loans. As is the case for other IRAs, participants cannot take a loan against their SIMPLE IRA.
4. Extremely high penalties for early withdrawals. Early withdrawals from any IRA will result in a 10% penalty, but SIMPLE IRA participants who withdraw from their account within the first 2 years it was established are subject to a 25% penalty. This penalty also applies to rollovers to non-SIMPLE IRAs within the first 2-years.

Is a SIMPLE IRA Better than a 401(k)?

If you’re looking for a straightforward, inexpensive way to offer a retirement benefit that you and your employees can take advantage of, a SIMPLE IRA may be better than a 401(k).  SIMPLE IRAs have less paperwork and administrative requirements when compared to a 401(k), which is one of the driving reasons small business owners choose this type of plan.

However, a SIMPLE IRA may not be the best option if you’re a self-employed individual who doesn’t anticipate hiring employees. A SIMPLE IRA has a relatively low contribution level compared to other plans for which you may qualify.

For instance, a solo 401 (k), or self-directed 401(k), allows for up to $69,000 in annual contributions and an additional $7,500 if you’re 50 or older. Likewise, Simplified Employee Pension accounts, or SEPs allow participants to contribute up to $69,000 or up to 25% of their income, whichever is lesser.

Since both those plans have substantially larger contribution limits, they are worth considering.

How to Set Up a SIMPLE IRA

1. Find an Authorized Financial Institution

SIMPLE IRAs, like other retirement accounts, are set up with an authorized financial institution or trustee.  A trustee can be a bank, federally insured credit union, brokerage firm, saving and loan association, or insurance company.

The entity you choose will receive contributions and hold account assets. Look for a trustee with experience in executing and maintaining SIMPLE IRAs and a portfolio that matches your investment strategy.

Note that it’s common for the employer to choose a trustee, and you can pass that decision on to employees by filing Form 5304-SIMPLE instead of Form 5305-SIMPLE when starting your plan.

2. Create and execute a written agreement

First, you must complete and execute a written agreement for employees using one of the following forms:

• IRS Form 5304-SIMPLE. Use this form to allow employees to choose their own financial institute.
• IRS Form 5305-SIMPLE. Use this form if you intend to choose the financial institute.

The SIMPLE IRA written agreement includes important information, such as general eligibility requirements, excluded employees, elections, and contributions.

 3. Set Up IRAs for Employees

If implementing a SIMPLE IRA, you must establish an account for all eligible employees, and all contributions must go to that account. Initially, you can set up a SIMPLE IRA any time between January 1 and October 1 in that tax year. There is an exception if you’re setting up a SIMPLE IRA for the first time and your business was established after October 1.

If you had established a SIMPLE IRA in the past, you can only set up a plan on January 1.

4. Provide Annual Notice for Employees

You must establish annual communications that notify employees of your contribution intentions. You must give them 60 days to make or change their salary reduction contribution and choose a financial institution (if applicable, through Form 3504-SIMPLE).

Is a SIMPLE IRA Right for My Business?

If you’re a sole business owner with employees, then a SIMPLE IRA may be right for your business. SIMPLE IRAs allow you to set up a retirement plan for your employees and make regular contributions to their plans. Retirement plans are often an important employee benefit that can make it easier to attract and retain talent.

Further, with a SIMPLE IRA in place, you can contribute to employee plans and deduct those contributions during tax time.

When isn’t a SIMPLE IRA best for your business?

If you’re self-employed and don’t anticipate hiring employees, the lower contribution limits associated with a SIMPLE IRA can limit growth potential. Other accounts, like a SEP or Solo 401(k), may better suit your needs.

SIMPLE IRA FAQs

What are the contribution limits for SIMPLEIRAs?

The 2024 contribution limits for a SIMPLE IRA are as follows

• $16,000 annually.
• Additional $3,500 in catch-up contributions if you’re 50 or older ($19,500 total).
• If you have another employee-sponsored retirement account(s) and contribute to it via a salary reduction, your combined contribution limit is $23,000 in 2024.

Annual contributions for a SIMPLE IRA can change each year. Always check the latest IRA guidance to determine your contribution limit.

How does employer matching work in a SIMPLE IRA?

Employers making matching contributions to their employees’ SIMPLE IRAs typically must do so on a dollar-to-dollar basis, contributing up to 3% of each employee’s compensation.

Employers can choose to match contributions at less than 3% (but no less than 1%) but for no

longer than 2 years out of a 5-year period.

Employers can also make non-elective contributions at 2% of the employee’s compensation.

Can I contribute to a Simple IRA and another retirement plan simultaneously?

Yes, you can contribute to a SIMPLE IRA and another retirement plan at the same time. If you do so, make sure that your combined contributions do not exceed the IRS-determined limit. In 2024, the combined contribution limit for a SIMPLE IRA and another employer-sponsored account is $23,000.