Although many employers allow workers to save for retirement using qualified retirement plans, such as a 401(k), 403(b), or 457, these plans have rules that can be cumbersome for both employers and employees.
Some small businesses instead choose SIMPLE (Savings Incentive Match for Employees of Small Employers) IRAs. These plans have fewer rules, are much less complicated to administer, and offer key benefits.
- SIMPLE IRAs do not require non-discrimination and top-heavy testing, vesting schedules, and tax reporting at the plan level.
- Matching employer contributions belong to the employee immediately and can go with them whenever they leave, regardless of tenure.
- Tax credits may be available for both employees and employers.
Understand the Benefits of SIMPLE IRAs
Here's how employees and employers benefit.
As with other types of IRAs and employer-sponsored retirement plans, SIMPLE IRAs allow employees to defer a portion of their salaries into these plans. The money grows tax-deferred until distributions are taken at retirement. This allows savings to compound more quickly.
Easier to run
SIMPLE IRAs do not require most of the bureaucracy that comes with qualified plans, such as non-discrimination and top-heavy testing, vesting schedules, and tax reporting at the plan level. SIMPLE IRAs are relatively easy to set up and run, and employers don’t need to hire specially trained staff.
Mandatory, instant vesting
Matching employer contributions belong to the employee immediately and can go with them whenever they leave, regardless of tenure. (Employer match contributions in qualified retirement plans, such as 401(k)s, usually come with either a cliff or graded vesting schedule that requires employees to stay with at the company for a specified number of years before they own all matching contributions.) What's more, employers who set up SIMPLE IRAs are required by law to match employee contributions. This is not required for qualified plans; employers can choose to offer no match.
SIMPLE IRAs have fewer rules and are much less complicated to administer than some other kinds of retirement plans.
Contribution limits: Better than IRA, worse than 401(k)
For 2019, employees can defer up to $13,000 of income to a SIMPLE IRA, with another $3,000 in catch-up contributions allowed if they are 50 or older. This is less than the $19,000 contribution/$6,000 catch-up limit permitted for a 401(k) or other qualified plan. But it's more than the $6,000 contribution/$1,000 catch-up limit for an IRA. (Read more from the IRS here.)
Tax credit for employers
Companies that sponsor SIMPLE IRAs can receive a tax credit for 50% of necessary eligible startup costs, up to a maximum of $500 per year for the first three years of the plan.
Employers qualify to claim this credit if they had 100 or fewer employees who received at least $5,000 in compensation for the preceding year and at least one plan participant who was not a highly compensated employee, and if the same employees weren't recently covered by similar plans. (See more from the IRS.)
Tax credit for employees' contributions
Employees whose adjusted gross income falls below a certain limit may be eligible to take a non-refundable savers credit for up to $2,000 of contributions each year.
Multiple investment choices
SIMPLE IRA contributions can be invested in "individual stocks, mutual funds, and similar types of investments," according to the IRS. Many plans offer growth, growth and income, income, and specialized funds such as sector funds or target-date funds.
Subject to Taxes
While salary deferral contributions to a SIMPLE IRA are not subject to income tax withholding, they are subject to tax under the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Railroad Retirement Act (RRTA). Employer matching and non-elective contributions are not subject to FICA, FUTA, or RRTA taxes.
The Bottom Line
SIMPLE IRAs provide a convenient alternative for small employers who don’t want the bureaucratic and fiduciary complexities that come with a qualified plan. Employees still get tax and savings benefits, plus instant vesting of employer contributions. For more, visit the IRS website or consult a financial advisor.