For small-business owners, it can be expensive and time-consuming to establish a 401(k) plan for their employees. But a Savings Incentive Match Plan for Employees (SIMPLE) individual retirement account (IRA) may be a less costly option. SIMPLE IRAs work similarly to traditional IRAs and can help your employees maximize their retirement savings.
A SIMPLE IRA is a workplace retirement plan generally designed for small businesses with 100 or fewer employees. As with a traditional IRA, the money in a SIMPLE IRA grows tax-deferred until account holders make qualified withdrawals at age 59.5 or later. Within a SIMPLE IRA, employees can choose from various investing options, including stocks, bonds, exchange-traded funds (ETFs) and more.
Employer contributions are mandatory, and employees can elect to contribute as well. Contributions are always 100% owned by the employee.
| Type of employer | Typically small businesses with 100 or fewer employees |
|---|---|
| Who can contribute | Employers and employees |
| Contribution limits | In 2024, employees can contribute up to $16,000 and an extra $3,500 if they are age 50 or older.(1) If the employee participates in another employer-sponsored retirement plan, such as a 401(k) in which they make elective deferral contributions, the total they can save across all those plans in 2024 is $23,000. Employers must match up to 3% of the employee’s pay or a nonelective contribution for each eligible employee equal to 2% of the employee’s salary up to the annual limit of $345,000. |
| Employee eligibility | Employees who received at least $5,000 in compensation during any two prior years and who are expected to make at least $5,000 in compensation during the current calendar year.(3) |
| Tax status | Pre-tax |
| Deductible contributions | Employers can deduct all contributions on their tax returns. Employees can’t deduct contributions, but their contributions reduce their taxable income. |
| Access to funds before age 59.5 | Withdrawals before age 59.5 are taxable and subject to a 10% early withdrawal penalty; withdrawals within the first two years of participation in the plan incur a 25% penalty instead of 10%. |
A SIMPLE IRA functions like a traditional IRA in terms of investment options and distribution and rollover rules. Here are the highlights of a SIMPLE IRA:
Employers are required to contribute each year to their employees’ SIMPLE IRAs. Employers can choose either a matching contribution of up to 3% of compensation or a nonelective contribution for each eligible employee equal to 2% of their compensation up to the annual limit of $345,000. In other words, if an employee makes $350,000 a year, the 2% contribution would be $6,900 (2% x $345,000 = $6,900) instead of $7,000 (2% x $350,000).
Employees can choose to contribute to their accounts as well. Employee contributions are made through elective deferrals, and they can contribute up to $16,000 in 2024 and another $3,500 if they’re age 50 or older. If the employee participates in another employer-sponsored retirement plan in which they make elective deferrals, the most they can contribute across all these accounts is $23,000.
Money in a SIMPLE IRA grows tax-deferred. This means you won’t need to pay taxes on your savings until you withdrawn them. But if you make a withdrawal before age 59.5, you’ll likely face an early withdrawal penalty. The usual penalty is 10%, but it’s bumped to 25% if you withdraw money within the first two years of participation in the plan.
The employer can deduct its contributions each year. Employees can’t deduct contributions, but their contributions reduce their taxable income.
SIMPLE IRA funds in bank deposit products like a certificate of deposit (CD) are insured up to the $250,000 limit set by the Federal Deposit Insurance Corporation (FDIC). If your IRA investments are in stocks and exchange-traded funds (ETFs), FDIC insurance will not apply.(4)
However, an IRA held at a brokerage firm that’s a member of the Securities Investor Protection Corporation (SIPC) is protected up to $500,000 for securities and cash.
If you want to start a SIMPLE IRA for your small business, you have two options:
Weigh the pros and cons of a SIMPLE IRA to decide if it’s right for you.
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SIMPLE IRAs, SEP IRAs and Solo 401(k)s are all retirement plans available to business owners, but these plans differ in how they operate.
| SIMPLE IRA | SEP IRA | Solo 401(k) | |
|---|---|---|---|
| Who it’s for | Small businesses with 100 or fewer employees | Any size business | Business owner with no employees |
| Who can contribute | Employers and employees | Employers | Business owner contributes as employer and solo employee |
| Employee contribution limits | $16,000 | None | $23,000 |
| Employer contribution limits | Employers must match up to 3% of the employee’s pay or a nonelective contribution for each eligible employee equal to 2% of the employee’s salary up to the annual limit of $345,000 | Up to 25% of employee’s compensation | Up to 25% of employee’s compensation |
| Tax status | Pre-tax | Pre-tax | Pre-tax or after-tax |
If you’re a small business with 100 or fewer employees looking for a simple, cost-friendly retirement plan for your employees, a SIMPLE IRA may be worth considering. Employers are required to make contributions on behalf of each eligible employee, but their contributions are tax-deductible. Employees also get tax benefits for contributing — contributions reduce their taxable income, and their money grows tax-deferred until they begin taking withdrawals.
What are the disadvantages of a SIMPLE IRA?
SIMPLE IRAs have stricter early-withdrawal penalties than other retirement plans. With many retirement plans, you’ll incur a 10% early withdrawal penalty if you pull your money out before reaching age 59.5. If you make an early withdrawal from a SIMPLE IRA within the first two years of participation in the plan, you’ll pay a 25% penalty. SIMPLE IRAs also don’t have a Roth option, which would allow you to make tax-free withdrawals at retirement.
What is the 2-year rule for a SIMPLE IRA?
If you withdraw money from a SIMPLE IRA before turning age 59.5 within the first two years of participation in the plan, you owe a 25% early withdrawal penalty.
Is a SIMPLE IRA better than 401(k)?
The better option depends on your needs and plans. A 401(k) has a higher contribution limit of $23,000, but 401(k)s are typically more difficult and costly to set up.
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