What Is a SIMPLE IRA Plan and How Does It Work?

A Savings Investment Match Plan for Employees plan (SIMPLE IRA) is an easy and low-cost way for small employers to set up a retirement program for their employees. These plans offer lower costs, reduce taxes, and help employers attract top talent.

What Is a SIMPLE IRA?

A SIMPLE IRA plan is an easy-to-manage savings plan that lets participants save for retirement with tax-deferred dollars. Contributions in this plan get invested in a similar manner to traditional individual retirement arrangements (IRAs), where individuals contribute to their plan with pre-tax dollars, and investments can grow tax-deferred until they are withdrawn.

A SIMPLE IRA is built for smaller employers. This plan allows them to avoid the more complex structure and regulations found with traditional retirement plans while offering their employees a sought-after benefit.

Key Attributes of a SIMPLE IRA

• Available to employers with 100 employees or less
• Employers must contribute to individual accounts set up for each eligible employee
• Employees may defer a part of their salaries into the plan for retirement
• Employers and employees can both make contributions
• Employer and employee contributions are always 100 percent vested

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 IRAs vs. traditional IRAs.

How Does a SIMPLE IRA Work?

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 The money grows tax-deferred until it's withdrawn.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

Maximizing Benefits for Your Business

SIMPLE IRAs don't just benefit your employees; they help you as a business owner. These plans are much less complicated to set up and administer, have fewer rules, and cost less than other more traditional retirement plans, like a 401(k) plan. Further, by offering a tax-favorable retirement plan, you can attract and retain top talent while boosting employee engagement and loyalty.

You also get to deduct each contribution you make to your employees' SIMPLE IRAs on your taxes. Additionally, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, businesses may be eligible to receive a tax credit of up to $5,000 per year (for the first 3 years from the plan's inception) to help offset setup and administrative costs of establishing the plan.

If you enroll your employees into the SIMPLE IRA plan automatically, you will be eligible for an additional tax credit of $500. This tax credit is available for 3 years, beginning with the first taxable year you include an auto-enrollment feature, adding to your potential tax savings.

SIMPLE IRA Rules: Contributions and Limits for 2024

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

Employee Contribution Limits

Like other retirement plans, there are also SIMPLE IRA contribution limits. For a SIMPLE IRA max contribution in 2024, an employee under age 50 can contribute up to $16,000. People aged 50 and older can make an additional $3,500 catch-up contribution, for a total of $19,500.

However, for employers with 25 or fewer employees, the Securing a Strong Retirement Act of 2022 (SECURE Act 2.0) allows employees to increase the deferral limit up to $17,600 for those under 50. For those over 50, the catch-up contribution is increased to $3,850, for a total of $21,450 for these employees.

Employer Contribution Limits

An employer must contribute to a plan and can choose either of the following SIMPLE IRA employer match rules:

• Make a non-elective contribution of at least 2 percent of compensation for all eligible employees. You may limit these non-elective contributions to eligible employees earning at least $5,000, although you do not have to do so. Maximum compensation is $345,000 for the 2024 tax year. You must make these non-elective contributions for each eligible employee regardless of whether the employee elects salary deferrals for that calendar year.
• Make a matching contribution of 100 percent up to the first 3 percent of compensation. Employees only get this matching contribution if they contribute to the plan.
• Allow additional nonelective contributions to SIMPLE IRA plans. Section 116 of the SECURE Act 2.0 allows employers to make additional contributions to their employees “in a uniform manner,” as long as the contribution does not exceed either up to 10 percent of compensation or $5,000, whichever is less.

No matter which matching contribution you choose, you may deduct your SIMPLE IRA contributions on your business's tax returns for the year.

Choosing the Right Contribution Strategy for Your Business

When setting up your SIMPLE IRA plan, it's essential to choose the right contribution strategy for your business.

Since employer contributions are mandatory to a SIMPLE IRA plan, you'll choose between making non-elective or matching contributions.

For non-elective contributions, you must set aside the equivalent of 2 percent of your employees' compensation, regardless of whether your employees contribute to the SIMPLE IRA plan or not. However, you only need to set aside 2 percent of the first $345,000 the employee earns in 2024. Any employees earning over $345,000 in 2024 may receive a smaller match.

For matching contributions, if you cannot provide the 3 percent match, you may reduce your match contribution rate to a minimum of 1 percent for up to 2 out of every 5 years. You may not drop it below 1 percent, nor can you drop it below 3 percent for more than 2 out of 5 years.

You have until your tax filing deadline to make your contributions. This can help you plan cash flow throughout the year while providing a tax-favorable retirement benefit to your employees.

SIMPLE IRA Rules: Withdrawals and Transfers

Employees who withdraw early 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 2 years of participation. If an employee has had the SIMPLE IRA for less than 2 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. A $10,000 early withdrawal means a minimum of $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 2-year period after first participating in the plan are taxable.

Pros and Cons of SIMPLE IRA Plans

When considering a SIMPLE IRA, it's essential 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 most qualified plans, matching employer contributions belong to employees and travel with them if they leave employment.
• Businesses may be eligible to receive a tax credit of up to $5,000 per year (for the first 3 years from the plan's inception) to help offset the 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 to 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 must match employee contributions up to a certain percentage. This is in contrast 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).

Step-by-Step Guide for Setting Up a SIMPLE IRA Plan

SIMPLE IRAs are known for their ease of plan setup. Most banks and financial institutions provide standardized plans that you can use when setting up your retirement plan, often allowing you only to use one simple form.

If you don't use a standardized plan from your bank or financial institution, you'll follow these steps when setting up a SIMPLE IRA:

1. Complete Form 5304-SIMPLE, which permits employees to choose their own bank or financial institution to receive their SIMPLE IRA plan contributions. This is often more convenient for employees.
2. Or, if you prefer, complete Form 5305-SIMPLE, which designates one bank or financial institution for all SIMPLE IRA plan contributions. This is often more convenient for employers.
3. Once completed, keep the original forms with your signature. Do not file these with the IRS.
4. Notify each employee before the beginning of the election period for the SIMPLE IRA (typically the 60-day period before your SIMPLE IRA plan year, which is often January 1st). This notice gives your employees information on the plan before they make their salary reduction choice for the plan year. This notice will also communicate your decision about offering matching or non-elective contributions. If you use Form 5304-SIMPLE or Form 5305-SIMPLE, you can provide copies of these forms to your employees to satisfy this annual notice obligation.
5. Set up an IRA account for each employee at the designated bank or 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 decide 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 your current workforce, and enjoy the benefits of an easy-to-manage plan.

For small-business employers contemplating offering a retirement plan, it is prudent to consider the benefits of establishing a SIMPLE IRA plan. In particular, there are many perks to employers and their workers as compared to more complex and rules-heavy retirement plans.

How To Evaluate SIMPLE IRA Providers

When evaluating SIMPLE IRA plan providers, here are some things to consider when deciding which retirement services work best for you and your employees:

• Is the setup simple?
• What are the startup and ongoing administrative fees?
• Is the investment lineup limited in any way? Or can employees have complete discretion in choosing their investments?
• If an investment lineup is provided, does it include reasonably priced investments, or are they higher-cost funds?
• Does the plan provider's SIMPLE IRA integrate with your payroll system?
• What is the process for depositing contributions?

It's critical that your SIMPLE IRA plan provider works with you to help you set up and manage your SIMPLE IRA easily.

Common Mistakes To Avoid When Managing SIMPLE IRAs

As easy as SIMPLE IRAs can be, the IRS provides common mistakes you should still be on the lookout for to avoid when managing your plan.

• If you own more than one business, you may need to include the employees of all businesses in your SIMPLE IRA.
• You may be ineligible to sponsor a SIMPLE IRA plan if your combined number of employees (who earned at least $5,000 in the preceding calendar year) in all your related businesses exceeds 100. You may be able to take advantage of a 2-year grace period if this occurs.
• You may have inadvertently excluded employees who are eligible for the SIMPLE IRA plan. You may need to contribute additional amounts for these excluded employees in this case.
• On the other hand, you may have included employees who weren't eligible for the SIMPLE IRA plan. In this case, you'll need to remove these contributions from the plan and inform the employees of the mistake.
• You may also find that you've contributed too much to the plan. You can work with your SIMPLE IRA plan provider or your employee benefits attorney to correct this.

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