Personal Finance Insider writes about products, strategies, and tips to help you make smart decisions with your money. We may receive a small commission from our partners, like American Express, but our reporting and recommendations are always independent and objective.
Understanding the world of retirement savings accounts can be intimidating, but of all the options available, the SIMPLE IRA seems to be the one that most folks know the least about.
But if you’re eligible for its services and equipped with an understanding of its perks, the SIMPLE IRA can prove incredibly beneficial, so read on for all the information you need to make the most of this innovative account.
What is a SIMPLE IRA?
The SIMPLE IRA is a tax-deferred retirement savings plan established by the Small Business Job Protection Act of 1996. As you’ve probably gathered from the capitalization, the name is an acronym — it stands for Savings Incentive Match PLan for Employees. (And of course, IRA stands for “individual retirement account.”)
These accounts are designed expressly for small businesses with 100 or fewer employees that don’t offer a qualified retirement plan like a 401(k) or a 403(b), and are run through participating financial institutions.
For ease of use, the SIMPLE IRA requires less paperwork than its more elaborate cousins, and has aspects drawn from both traditional IRAs and employer-sponsored accounts.
How does it compare to other retirement accounts?
Just like with the traditional IRA, contributions to the SIMPLE IRA are tax-deferred, meaning you won’t be taxed on the funds until it comes time to withdraw them. Additionally, employees can contribute to the accounts themselves, and always maintain full ownership of the contents of their SIMPLE IRAs.
The SIMPLE IRA has a great deal in common with the 401(k), like the fact that employers can also add to the account in the form of matching contributions. But the small business-centric accounts actually take this facet one step further by making these contributions a requirement instead of an elective that varies from company to company.
Employers that offer a SIMPLE IRA are presented with two contribution options — they can either match contributions of up to 3% of an employee’s annual salary, or offer a 2% nonelective contribution. (The latter option meaning that your company will automatically contribute that 2% amount even if you, the employee, don’t make a contribution of your own.)
Your employer is obligated to contribute to your SIMPLE IRA every year until the account is terminated, but it’s worth noting that they can change their contribution decision at any time. They are required to notify you of any changes, however, so make sure you’re up to date on your office’s policies so you can make the most of your retirement savings.
Also, unlike a 401(k), a SIMPLE IRA can’t necessarily be rolled over into a traditional or Roth IRA immediately after your departure from the company. This transition can eventually take place, but it requires a two-year waiting period from the time the account was opened. So if you left your job within that two-year window, you’ll have to wait it out before rolling over your SIMPLE IRA.
Additionally, Simplified Employee Pension (SEP) IRAs and traditional IRAs cannot be rolled over into SIMPLE IRAs.
Do I have to choose one or the other?
Yes and no. You don’t have to choose between a SIMPLE IRA and an individual retirement account like a Roth or a traditional IRA.
But since these accounts are intended specifically for small businesses that don’t provide employee-sponsored retirement accounts, if your employer offers a 401(k) or similar plan, you cannot also take advantage of a SIMPLE IRA.
Who is eligible for a SIMPLE IRA?
There are just two requirements to determine SIMPLE IRA eligibility. The first is that you must work for a small business — typically defined as one that staffs 100 or fewer employees.
The second is that you must have earned at least $5,000 from your employer in each of the previous two years, and expect to earn at least $5,000 in the current year.
How much can I contribute to my SIMPLE IRA?
Like many other retirement accounts, the IRS places annual limits on employee contributions to SIMPLE IRAs.
For 2020, that limit is $13,500, which is significantly higher than the maximums placed on individual retirement accounts, but lower than the cap on 401(k) contributions. Also, those aged 50 and over are granted an additional catch-up contribution of $3,000, bringing their yearly maximum up to $16,500.
When can I withdraw my money?
While you can theoretically withdraw funds from your account at any time, you should do your best to wait until age 59 1/2 to take the first disbursement from your SIMPLE IRA. That’s because unless you qualify for an exception, disbursements taken before that point are subject to an additional 10% tax. (Which comes on top of the funds being taxed as income.)
Even more crucially, that fine increases to an additional 25% tax if you dip into the funds within the first two years of enrollment in your SIMPLE IRA. (A time frame that begins with your employer’s first contribution to your account.)
Because these early withdrawal penalties are so steep, it’s important that you’re only setting aside those funds that you’re comfortable parting with long-term.
How can I invest?
For employers, establishing a SIMPLE IRA for your workers is as simple as filling out a form — Form 5304-SIMPLE if you want employees to be able to choose the financial institution where their accounts will live, or 5305-SIMPLE if you wish to make that choice yourself.
And for employees, participation is as simple as filling out a SIMPLE IRA adoption agreement at your place of work. Once you’re enrolled, you should be able to choose one of the investment options on offer through the selected financial establishment, where your money can grow steadily until it’s time for retirement.