What is a SIMPLE IRA?

It seems like we’re never going to run out of different IRAs to discuss, and today’s topic, the SIMPLE IRA, is yet another option that may be available to you. SIMPLE is capitalized because it’s an acronym that stands for Savings Incentive Match Plan for Employees. As its name suggests, these plans do tend to be less complicated than the other employee offered options, such as 401(k)s.

Who Sets It Up?

Employers offer SIMPLE IRAs to their employees, and these IRAs are a type of traditional IRA. This means that contributions to this account are tax deductible, and your money will grow “tax-deferred.” It’s similar to the idea of “buy now, pay later!” You don’t have to pay taxes on that portion of your income (your contributions) now, but you will have to pay taxes on the money you take from the account (your distributions).

Contributions

You can contribute to a SIMPLE IRA, and your employer must contribute to the account as well. If you contribute, these contributions are called elective-deferral contributions or salary reduction contributions because they come out of your paycheck prior to your income being taxed and prior to you receiving the paycheck.

These are the two main things that set these IRAs apart from SEP IRAs. Employers have two options when it comes to contributing to these accounts: matching contributions and non-elective contributions.

  • Matching Contributions

With matching contributions an employer has to match what his or her employee contributes to the account. There is a limit, however, and the employer will only match up to 3 percent of the employee’s salary. During a five year period, the employer may choose to reduce the percentage to 1 percent for up to two years. He or she can also switch from matching contributions to non-elective contributions. If he or she chooses to do this, then he or she still has two years, within the five year period, in which the matching contribution can be reduced.

  • Non-elective Contributions

With non-elective contributions, the employer simply contributes 2 percent of the employee’s salary. This occurs even if the employee decides not to add anything to his or her IRA.

Rules and Restrictions

To use this type of IRA, a company has to have 100 or fewer employees, and these employees must earn $5000 or more during the most recent full calendar year. The company cannot already be using any other type of retirement plan like 401(k)s.

There are restrictions when it comes to the employees as well. For example, the employee will need to have made at least $5000 a year during any two years prior to the plan being initiated, and they should expect to continue making at least that much during the current year. Employers have some leeway make these restrictions less restrictive.

You can only put a certain amount of money into a SIMPLE IRA as an employee. For 2013 and 2014 this limit is $12,000, but you are allowed to put as much of your compensation into this account as you want (up to the limit). If you’re over 50, you are allowed to put in slightly more money ($2500 for 2013) as a “catch-up contribution.”

If an employer is using the 2 percent non-elective contribution, there is a salary cap of $260,000 for 2014. This means when the employee is calculating his or her contribution, he or she will not consider compensation in excess of $260,000, which means that the most he or she will contribute to an account for an employee who earns $260,000 or more is $5200.

Getting Your Money

For the first two years that you have a SIMPLE IRA you cannot move the money into another type of retirement account. You can, however, move it to another SIMPLE IRA. Taking money out during this time if you are under 59 ½ years of age may mean a penalty in the form of a 25 percent fee, though there are exceptions. If you are older than 59 ½, there are no penalties.

Outside of this initial two-year period, the fee drops to 10 percent if you withdraw money before you reach 59 ½ years of age. Prior to reaching 59 ½ you can make penalty-free withdrawals under certain circumstances. Such exceptions include buying your first home, funding higher education for yourself or your dependents, paying out to a beneficiary in the event of your death, and more. Each of these exceptions has specific requirements, and it’s always a good idea to contact your plan custodian for more information.

Once you are 59 ½ your distributions will be subject to income tax, and when you reach 70 ½, you have to start taking your RMDs or required minimum distributions. If you don’t take your money, it will be subject to large fees.

The Pros and the Cons

These plans are easy and inexpensive (comparatively) to manage. As such, they are often a good choice for small businesses. The drawbacks to them are that their contributions limits are quite low. For example, you can contribute nearly four times as much money to a SEP IRA during a year.

What do you think? Do you work somewhere that uses a SIMPLE IRA?

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  • This is very interesting. SIMPLE IRA’s I suppose can help you reach your financial foals quicker as the employer will contribute a matching amount. I think the best way to use this feature is by maxing out on your contribution. Thanks for the excellent resources.

  • Thanks for the post! I honestly never heard of a SIMPLE IRA, so it was great to read this and learn this option is available for small business and their employees.

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