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SIMPLE IRA Plans: An Employers Guide To This Retirement Option

by Kevin Schuler on Nov 1, 2022 9:25:03 AM

Even as a smaller business, you know how important employee benefits are to attracting and retaining talent today. And since retirement plans remain a sought-after benefit, you may be wondering what options are available. A good choice for companies who want a plan but not the greater cost and administration that come with it is a SIMPLE IRA (Savings Incentive Match Plan for Employees). What do you need to know about these plans? Let’s find out.

In this article, we’ll cover what a SIMPLE IRA is, how they work, compliance responsibilities, contributions, and more. After reading this, you’ll be able to decide if this type of plan is a good fit for your business.

What is a SIMPLE IRA?

A SIMPLE IRA is a tax-advantaged plan that allows employees and employers to contribute to IRAs set up for employees. Your employees can elect to defer part of their salary pre-tax and you as an employer make either a matching contribution or non-elective contribution, which we’ll explain later. The money is only taxed when it’s withdrawn.

It’s important to note that SIMPLE IRAs are designed for smaller companies and are only available to businesses with 100 or fewer employees.

How does a SIMPLE IRA work?

To start a SIMPLE IRA, all you have to do is adopt Form 5304-SIMPLE, Form 5305-SIMPLE, a SIMPLE IRA prototype, or your own plan document. Then you’ll need to distribute plan information to employees – a summary description usually provided by the financial institution – and set up an IRA account for each one. You’ll do this by logging into your provider’s platform and creating the accounts.

Once your accounts are set up, you’ll need to contribute each year to your employees’ accounts either a:

  • Matching contribution up to 3% of compensation or
  • 2% nonelective contribution for each eligible employee (if you choose this option, your contributions can’t be based on more than $330,000 of the employee’s salary in 2023) 

Employees may also choose to contribute to their plans up to a maximum set by the IRS; for 2023, the limit is $15,500 plus $3,500 in catch-up contributions for those over 50. Either way, there are no vesting schedules with SIMPLE IRAs so the employee is 100% vested in all funds in the account immediately.

When it comes to withdrawal of the funds, SIMPLE IRA contributions and earnings can be withdrawn at any time. The withdrawal is taxable in the year the employee receives it and, if they are not age 59 ½, they may have to pay an additional 10% tax – or 25% if the withdrawal occurs within the first 2 years of participation. 

Who can participate?

For employees to participate, they must generally have:

  • Earned at least $5,000 in compensation during any 2 years before the current calendar year and
  • Expect to earn at least $5,000 in the current calendar year

Keep in mind that you can decide to use less restrictive criteria for participation. For example, you may lower or eliminate the compensation amounts.

Is there a contribution limit?

While employer contributions to a SIMPLE IRA are mandatory, employee contributions are elective. And there are annual limits employees must adhere to. As we mentioned earlier, the maximum amount an employee can contribute to their SIMPLE IRA for 2023 is $15,500. Workers aged 50 or older can make additional catch-up contributions of $3,500. These contributions are pre-tax, which lowers employees’ taxable income in the year they’re made. And the investment growth is tax-deferred until the employee starts taking distributions.

Are there any SIMPLE IRA rules I need to follow?

While SIMPLE IRAs are not as heavily regulated as other retirement plan options like a 401k, there are still some rules you’ll need to be aware of.

  • You can only set up a plan from January 1 to October 1 of a year. The exception to this rule is if you’re a new employer that starts after October 1.
  • You can’t have any other retirement plan.
  • You must contribute as the employer.
  • Loans are not allowed.
  • You can’t make profit sharing contributions. 
  • Employee rollovers to another IRA or employer-sponsored plan are subject to a penalty if done during the first 2 years they participate.

What are my employer responsibilities?

As an employer, there aren’t many steps you need to take to stay in compliance. Once you’re up and running, the only thing that’s required from you in terms of administration is that you’ll need to issue an annual notice 60 days before the start of the plan year.  

This notice must disclose:

  • The employee’s opportunity to make or change their salary contributions
  • Their choice to select a financial institution as the trustee of their IRA, if applicable
  • Your decision on which type of contributions you’ll make
  • That the employee can transfer their balance without cost if you’re using a designated financial institution

Unlike a 401k, there’s no annual non-discrimination compliance testing or filing requirements so the plans are easy to maintain.

How to Best Decide if a SIMPLE IRA is a Good Fit for Your Company

SIMPLE IRAs are easy to run and less costly than other retirement plan options. If you’re a small company, these benefits could make a SIMPLE IRA an ideal choice for you.

However, you’ll also have to consider the potential downsides of these plans. For example,  contributions are mandatory, and that may be challenging if you’re a new company or have fluctuating income from year to year. In addition, if you’re growing, you’ll need to be aware of your employee count since the plans are only available to those with 100 or fewer workers. Lastly, the annual contribution limits are lower than with other retirement plan types , so employees won’t be able to save as much for retirement. For these reasons, you may be thinking a SIMPLE IRA isn’t a good fit and may wonder if a 401k plan is a better option for your organization.

For more on the pros and cons of a SIMPLE IRA versus a 401k for your company, read our next article that compares these two plan types.

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