A SIMPLE (Savings Incentive Match Plan for Employees) IRA is a retirement plan that was established by the IRS a number of years ago to provide a low cost, relatively simple option for small businesses. The goal was to make it easier for these smaller companies to offer a retirement plan option for their employees.
These plans are easy to establish, and they are easy to administer.
Who can establish a SIMPLE IRA plan?
A SIMPLE IRA plan is available to any employer with 100 or fewer employees. This includes solo and self-employed individuals as well. The employer cannot offer any other type of retirement plan. For example, a company could not offer a SIMPLE IRA in addition to a 401(k) plan.
How does a Simple IRA work?
For eligible companies and self-employed individuals, all employees who earned at least $5,000 in either of the previous two years or who expect to earn at least that amount in the current year are eligible to participate in the plan.
Employers can use less restrictive requirements than these if they so choose. Employees who are covered by a union collective bargaining agreement can be excluded from participation, as can nonresident alien employees who do not receive U.S. based wages or benefits from the employer.
The elective deferral contribution limits for 2021 are $13,500, which is unchanged from 2020. Employees who are 50 or over in 2021 can contribute another $3,000 as a catch-up contribution. Employers are required to match employee contributions:
- Up to 3% of your employee’s compensation
- The match must be at least 1% of your employee’s compensation in no more than two out of five years.
Alternatively the employer can make a 2% non-elective contribution to every employee’s account regardless of whether or not they choose to contribute to the plan.
What are the benefits of a SIMPLE IRA?
A SIMPLE IRA offers a number of benefits for small businesses.
- A SIMPLE IRA plan is easy to establish and set up. There is minimal paperwork involved when compared to other types of small business retirement plans such as a 401(k). In some cases you may be able to set up your company’s SIMPLE IRA plan online.
- SIMPLE IRAs are usually low cost to open and to maintain. The ongoing paperwork and regulatory requirements are minimal compared with other types of retirement plans.
- Both employer and employee contributions are made on a pre-tax basis offering an annual tax benefit.
- Your plan provider generally handles any IRS filing requirements.
- There is no required non-discrimination or top heavy testing, vesting schedules or tax reporting to worry about as with a 401(k). Employer matching contributions immediately belong to the employee, unlike with a 401(k) where there is a vesting period before the employee can take the employer contributions with them when leaving the company.
SIMPLE IRA drawbacks
Along with its many advantages, the SIMPLE IRA does have some drawbacks.
- There is a two-year period from the date of your first contribution to the SIMPLE IRA in which you are unable to transfer funds via a rollover from a SIMPLE IRA to an IRA, 401(k), 403(b) or other qualified retirement plan upon leaving the employer. The exception to this two-year prohibition is a transfer to another SIMPLE IRA account.
- Low contribution rates. The maximum employee contribution of $13,500, with a $3,000 catch-up contribution for those who are 50 or over, is lower than the $19,500 with a $6,500 catch-up contribution available with an employer 401(k) or a solo 401(k) for those who are self-employed. The contribution levels are also lower than those potentially available with a SEP-IRA, though all contributions to a SEP-IRA are employer contributions and depend upon the level of compensation from the business.
- Employer matching contributions are required every year, regardless of the earnings of the business.
- There is no Roth option available with a SIMPLE IRA plan.
How to set up a SIMPLE IRA
There are several steps involved with setting up a SIMPLE IRA plan.
Execute a written agreement
There are two types of SIMPLE IRA agreements:
- Form 5304 – SIMPLE should be used if the employer is going to allow each plan participant to select the financial institution they will be directing their contributions to.
- Form 5305 – SIMPLE should be used if the employer will be using only an institution designed by them for employee contributions.
It’s important for both the employer and the financial institution to fully complete and sign all appropriate areas for the form. The form should be kept on file but does not need to be submitted to the IRS.
As an alternative to an individually designed plan, many mutual fund companies, insurance companies, banks or other qualified custodians will have prototype SIMPLE IRA plans that can be used.
Annual notice to eligible employees
Employers must provide eligible employees with notification of the following prior to their election period for the plan:
- The employee’s ability to make a new salary reduction election or change an existing election.
- The employee’s ability to select a financial institution to serve as trustee and custodian of their SIMPLE IRA account if the plan allows for this choice.
- The employer’s decision regarding whether they will make matching contributions or non-elective contributions for their employees.
- A summary plan description, this may often be provided by the financial institution used for the plan.
- Written notice that employees can transfer their balances without cost or penalty to a designated plan financial institution if the plan uses one.
The notification period is generally 60 days prior to the end of the calendar year, or a 60 day period that falls prior to the first date the employee becomes eligible for the plan if the plan is established mid-year.
If the employer has used either Form 5304 – SIMPLE of 5305 – SIMPLE they can give each employee a signed copy of the form to fulfill their notification requirements.
Set up a SIMPLE IRA for each employee
A SIMPLE IRA account must be established for each eligible employee and all employee and employer contributions must be directed to that account.
Permitted financial institutions include banks, brokerage firms including online brokers, savings, loans and most mutual fund companies. SIMPLE IRA contributions can be directed to mutual funds, ETFs, individual stocks and bonds and most other types of investments allowed in an IRA account.
Employers can establish a SIMPLE IRA plan on any date from January 1 through October 1 provided they did not previously maintain a SIMPLE IRA. If the employer is new and started their business on or after October 1, they can establish a SIMPLE IRA as soon as is feasible for them after establishing their business.
Is a SIMPLE IRA the same as a 401k?
These two retirement plans are different. Some of these differences include:
- SIMPLE IRAs are designed for employers with 100 or fewer employees. There are no such limits on an employer offering a 401(k) plan.
- SIMPLE IRA plans require the employer to make a contribution to the plan, there is no such requirement for a 401(k) plan.
- Employees are always 100% vested in the employer contributions to their account, a 401(k) plan may require a vesting period for employer matching contributions.
- The employee contribution limits are higher for a 401(k) limit than for a SIMPLE IRA plan.
What Is a SIMPLE IRA vs Traditional IRA?
- A SIMPLE IRA is connected with an employer or a self-employed individual. A traditional IRA is opened or funded by an individual investor and not connected with an employer.
- The annual contribution limits for a SIMPLE IRA are higher than those for a traditional IRA account.
Can you roll a 401(k) into a SIMPLE IRA?
A new rule enacted in 2015 allows employees to transfer balances from employer sponsored retirement plans such as a 401(k), 403(b) or 457(b). Transfers are not allowed from a Roth option within these types of plans into a SIMPLE IRA. There is a two-year waiting period from the time of the employee’s first contribution to the plan before these qualified plan balances can be transferred into their SIMPLE IRA account.
How much can an employer contribute to a SIMPLE IRA?
Employers are required to contribute to employee accounts with a SIMPLE IRA. There are several options for employer contributions:
- A 2% non-elective contribution to all employees regardless of whether or not they are contributing to the plan.
- A matching contribution of the employee’s contributions up to 3% of the employee’s contributions. They may reduce their contribution below the 3% level, but never lower than 1%, for two years out of a five year period.
- Other than these types of contributions, the employer cannot make any other contributions to the employee’s account.
Do SIMPLE IRA contribution limits include the employer match?
The employee contribution limits are $13,500 plus a $3,000 catch-up contribution for those who are 50 or over for 2021. These contribution limits are separate from and do not include any employer matching contributions.
A SIMPLE IRA is a solid alternative for small businesses who want to offer a retirement plan for their employees. SIMPLE IRAs have minimal paperwork and administrative requirements compared to other types of retirement plans such as a 401(k). SIMPLE IRAs are limited to businesses with 100 or fewer employees. There are some rules and restrictions with a SIMPLE IRA that both employers and employees need to be aware of, however.