DEFINITION of 'SIMPLE IRA'

A retirement plan that can be used by most small businesses with 100 or fewer employees. SIMPLE stands for “Savings Investment Match Plan for Employees”; IRA stands for “individual retirement account.” Employers can choose to make a mandatory 2% retirement account contribution to all employees or an optional matching contribution of up to 3%. Employees can contribute a maximum of $12,000 annually in 2013; the maximum is increased periodically to account for inflation.

BREAKING DOWN 'SIMPLE IRA'

SIMPLE IRAs have minimal paperwork requirements--just an initial plan document and annual disclosures to employees. The employer establishes the plan through a financial institution that administers it. Startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees. To be eligible to establish a SIMPLE IRA, the employer must have 100 or fewer employees. To participate in the plan, employees must have earned at least $5,000 in compensation in any two previous calendar years and be expected to earn at least $5,000 in the current year. Employers can choose less restrictive participation requirements if they wish. An employer may also choose to exclude from participation employees who receive benefits through a union. Employers establish the plan using IRS form 5304-SIMPLE, if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRA, or using form 5305-SIMPLE, if the employer wants to choose the financial institution where employees will hold their IRAs. Employees must fill out a SIMPLE IRA adoption agreement to open their accounts. Once the plan is established, employers are required to contribute to it each year unless the plan is terminated. However, employers may change their contribution decision between the 2% mandatory contribution and the 3% matching contribution if they follow IRS rules. A drawback of SIMPLE IRAs is that the business owner can’t save as much for retirement as with other small business retirement plans, such as a SEP or 401(k).

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