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Discover the simple IRA, a straightforward retirement plan. This post explains how to easily start and benefit from it.

SIMPLE IRA: Definition and How to Get Started

Disclaimer: This website and its content are for informational purposes only and is not financial advice.

What is a SIMPLE IRA?

A SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees Individual Retirement Account, is a retirement plan designed specifically for small employers. This includes businesses, self-employed individuals, and even non-profit organizations.

The fundamental idea behind a SIMPLE IRA is to provide a cost-effective and easy-to-administer retirement savings option that benefits both the employer and the employee.

It combines elements of a traditional IRA with employer contributions, creating a robust savings mechanism without the complexities often associated with larger retirement plans like 401(k)s.

Contributions made to a SIMPLE IRA grow tax-deferred, meaning you don't pay taxes on the earnings until you withdraw the money in retirement.

Eligibility for Employers and Employees

For an employer to establish a SIMPLE IRA plan, there are a few key requirements. The business must have 100 or fewer employees who earned at least $5,000 in compensation during the preceding calendar year.

Additionally, the employer cannot currently sponsor another retirement plan. This makes the SIMPLE IRA an ideal solution for small businesses looking to offer their first retirement plan.

For employees, generally, you are eligible to participate in a SIMPLE IRA if you earned at least $5,000 during any two years before the current calendar year from the employer sponsoring the plan, and you expect to earn at least $5,000 from them in the current year.

There are some exceptions, such as employees covered by collective bargaining agreements or non-resident aliens with no U.S.-sourced earned income. If you meet the criteria, a SIMPLE IRA can be a valuable tool for your long-term savings goals.

How Contributions Work with a SIMPLE IRA

One of the defining features of a SIMPLE IRA is the shared contribution responsibility between the employer and employee. Employees can contribute a portion of their salary to their SIMPLE IRA, which is known as a salary reduction contribution.

For 2025, employees under age 50 can contribute up to $16,500. If you are age 50 or older, you can make additional "catch-up" contributions. For those aged 50-59 or 64 and older, this catch-up contribution is an additional $3,500. For employees aged 60-63, a higher catch-up contribution of $5,250 is possible.

Employers, on the other hand, have two main options for making contributions to a SIMPLE IRA:

• Matching Contributions: The employer can choose to match employee contributions dollar-for-dollar, up to a maximum of 3% of the employee's compensation. While typically 3%, employers have the flexibility to reduce this match to as low as 1% in no more than two out of every five years.

• Non-elective Contributions: Alternatively, the employer can make a non-elective contribution of 2% of each eligible employee's compensation, regardless of whether the employee contributes to their SIMPLE IRA. This contribution is made for all eligible employees, up to a certain compensation limit ($350,000 for 2025).

It's important to remember that employer contributions are immediately 100% vested, meaning employees own the money as soon as it's contributed, a significant benefit. Employers can also deduct their contributions as a business expense, providing a tax advantage for the business.

Updated May 25th, 2025

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Setting Up a SIMPLE IRA Plan

Establishing a SIMPLE IRA plan is relatively straightforward, designed to be less burdensome than other retirement plans. The process generally involves:

1. Choosing a Financial Institution: The employer selects a financial institution (like a bank, mutual fund company, or brokerage firm) to hold the SIMPLE IRA accounts. Many institutions offer pre-approved plan documents.

2. Completing the Plan Document: The employer completes and signs an IRS-approved plan document, such as Form 5304-SIMPLE or Form 5305-SIMPLE. These documents outline the plan's terms and do not need to be sent to the IRS.

3. Informing Employees: The employer must notify eligible employees about the SIMPLE IRA plan, their right to participate, the contribution choices, and provide a summary description of the plan. This notification usually happens during a 60-day election period.

4. Employee Enrollment: Employees then decide whether to participate and how much to contribute from their salary.

5. Funding the Accounts: The employer deposits employee salary deferrals and their own contributions into each employee's SIMPLE IRA account.

Investment Options and Withdrawals

Within a SIMPLE IRA, employees typically have a range of investment options, including individual stocks, mutual funds, exchange-traded funds (ETFs), and bonds. Each employee generally makes their own investment decisions for their individual account.

Withdrawals from a SIMPLE IRA are generally taxed as ordinary income in retirement. However, there are specific rules for withdrawals before age 59½. An early withdrawal penalty of 10% usually applies, similar to other IRAs.

What makes a SIMPLE IRA distinct is a higher penalty of 25% if you withdraw funds within the first two years of your initial participation in the plan, unless an exception applies.

Once the two-year period has passed, the penalty reverts to 10% for early withdrawals. Required Minimum Distributions (RMDs) also apply to SIMPLE IRAs once you reach age 73.

Benefits of a SIMPLE IRA

The advantages of a SIMPLE IRA are numerous for small businesses and their employees:

• Simplicity and Low Cost: As its name suggests, a SIMPLE IRA is known for its ease of setup and administration, making it a less complex and often more affordable option compared to 401(k)s. There are generally fewer administrative requirements and no annual Form 5500 filing with the IRS.

• Tax Benefits: Both employer contributions and employee salary deferrals can offer tax advantages. Employer contributions are tax-deductible for the business, and employee contributions reduce taxable income in the current year. Earnings within the SIMPLE IRA grow tax-deferred.

• Immediate Vesting: All contributions, both employee and employer, are immediately 100% vested. This means the money belongs to the employee from day one, providing a strong incentive and benefit.

• Employee Participation: The employer matching contribution or non-elective contribution can encourage employees to save for retirement, enhancing financial security for the workforce.

Key Takeaways

For small businesses seeking to offer a retirement plan to their employees without the heavy administrative burden and costs of a 401(k), the SIMPLE IRA presents an excellent solution.

It provides a valuable benefit to employees, helping them save for retirement with the added incentive of employer contributions. For individuals, a SIMPLE IRA offers a straightforward way to save for retirement with tax advantages and immediate ownership of all contributions.

If you are a small business owner considering a retirement plan, or an employee looking to understand your savings options, exploring the SIMPLE IRA is a wise step towards building a more secure financial future.

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By Jordan McCaleb, Investment Researcher