Is your employer offering you a SIMPLE IRA but you have no idea what it is or how you will benefit from it? A SIMPLE IRA is a tax-deferred employer-sponsored retirement plan that allows you to save a before-tax portion of your wages for retirement savings. Both employees and employers can make contributions to the plan.
A SIMPLE IRA is usually offered by small businesses and your employer will contribute to the plan. With a SIMPLE IRA, you will grow your account on a tax-deferred basis and pay taxes during retirement. For 2024, the contribution limits to SIMPLE IRA are $16,000. If you are 50 or older, you get an extra $3,500 catch-up contribution.
Here is everything you need to know about a SIMPLE IRA plan.
What is a SIMPLE IRA?
A SIMPLE IRA is a retirement plan offered by employers with no more than 100 employees. This plan allows small businesses and their employees to set aside a percentage of before-tax money for retirement savings.
The SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account. Contributions made to the account can be invested and grown on a tax-deferred basis. However, you pay income tax on distributions you make from the account during retirement.
SIMPLE IRA works in similar ways to the traditional IRA. The plan allows you to make before-tax contributions, grow your money on a tax-deferred basis, and pay income tax when you are withdrawing money.
Why is SIMPLE IRA for small businesses?
Small businesses cannot afford highly complicated and expensive retirement plans such as 401(k) plans. This is because small businesses have fewer employees and pre-tax 401(k) plans are complex to set up and finance. In addition, 401(k) plan fees go higher when the number of participants decreases. This means that an alternative is needed for businesses to offer their employees some kind of retirement benefits. And the SIMPLE IRA can do the trick.
Unlike the traditional IRA, the SIMPLE IRA is offered through the employer and both employees and employers can contribute to the plan. With a SIMPLE IRA, employers are required to match the contributions of each eligible employee up to a certain percentage.
SIMPLE IRA contribution limit in 2024
Just like any other retirement plan, there is a limit to how much you can contribute to the SIMPLE IRA. Both employees and employers will have limited contributions. These contributions can change from one year to another. According to the Internal Revenue Service(IRS), the following are SIMPLE IRA contribution limits for both employers and employees for 2024.
- SIMPLE IRA employer contribution limits in 2024. Employers are required to contribute to the plan and they have two choices.
- Choose Matching contributions of 100% up to 3% of each eligible employee’s compensation
- Choose a non-elective contribution of 2% of wages for every eligible employee. The employees must earn between $5,000 and $305,000.
- SIMPLE IRA employee’s contribution limits. The maximum contribution to a SIMPLE IRA an employee can make in 2024 is $16,000. If you are 50 or older you get a catch-up contribution of $3,500. In order words, if you are 50 or older, you can contribute up to $19,500 to a SIMPLE IRA in 2024.
Pros of SIMPLE IRA
If you are skeptical about making contributions to a SIMPLE IRA, here are the pros of this plan to help you decide.
- Reduces your taxable income. Contributions to SIMPLE IRA come from before-tax through payroll deduction.
- No IRS filing of Form 5500. All reporting requirements are done by the plan provider. So, the business and employees don’t have to.
- Low maintenance cost. Unlike pre-tax 401(k) plans that require a lot of maintenance, SIMPLE IRAs are cheaper to maintain.
- Easy to set up. The account does not come with a lot of paperwork, and most of the time, you can open and set up the account online.
- Employer contributions are 100% vested. Your employer match to the plan is yours from the moment it is contributed to the account. If you are to leave your job, the money will be yours.
- The business could qualify for a tax credit of up to $5,000/year
Cons of SIMPLE IRA
Just like other retirement plans, the SIMPLE IRA also comes with disadvantages.
Here are the pros of SIMPLE IRA you should know before opening the account.
- Lower contribution limit. The account comes with a lower contribution compared to other Pre-tax 401(k) plans.
- Early withdrawal penalty. If you withdraw money from SIMPLE IRA early, you will pay a 25% penalty
- No Roth contributions. You cannot fund your retirement account with after-tax money
- Employer-matching requirement. The employer must match employees’ contributions up to a certain percentage.
SIMPLE IRA vs. traditional IRA
| Features | Traditional IRA | SIMPLE IRA |
| Eligibility | Anyone with earned income from a year before | Small businesses/employers with no more than 100 employees that earned $5,000 a year before. |
| Tax-deductible? | It can be tax-deductible | Yes |
| Employer contribution | No contribution | Employer chooses either a 100% matching contribution up to the first 3% of compensation or a non-elective contribution of 2% of all eligible employees earning at least $5,000. |
| The contribution limit in 2024 | $7,000 or $8,000 if you are 50 or older | $16,000 or $19,500 if you are 50 or older |
| Who makes contributions? | The person who owns the account | Employers and employees make contributions to the account |
| Who can open the account? | An individual who wants to save for retirement and earned income | Employers with 100 employees on behalf of their employees or self-employed |
| Where to open an account | At a brokerage firm, bank, or investment company | Through your employer |
| Early withdrawal penalty | 10% penalty plus applicable tax | 25% penalty (10% regular penalty and additions 15% penalty) plus applicable tax |
| Required Minimum Distributions(RMDs) | Requires RMDs when you turn 73 | Requires RMDs when you turn 73 |
Early withdrawal penalty on SIMPLE IRA
Most retirement plans come with an early withdrawal penalty. This penalty applies to the SIMPLE IRA as well. The money contributed to your account is designed specifically for retirement. Taking the money out before you have reached the proper age allowed by the IRS violates this rule.
According to the IRS, if you withdraw money from a SIMPLE IRA before you turn 59½ and your account is less than 2 years old, you will pay a 10% penalty plus an extra 15% penalty. That is the SIMPLE IRA early withdrawal penalty is 25%. On top of this penalty, you will also pay income tax on the money withdrawn.
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