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.

Key Takeaways

  • 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.

Tax-Deferred Savings

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.

Fast Fact

SIMPLE IRAs have fewer rules and are much less complicated to administer than some other kinds of retirement plans.

Contribution Limits

For 2020, employees can defer up to $13,500 of income to a SIMPLE IRA ($13,000 for 2019), with another $3,000 in catch-up contributions if they are 50 or older.

This is less than the $19,500 per year contribution limit for a 401(k) or another qualified plan for 2020 ($19,000 for 2019) and the $6,500 catch-up limit permitted ($6,000 for 2019). But it's more than the $6,000 contribution and $1,000 catch-up limit for an IRA for 2019 and 2020.

Tax Credit for Employers

President Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act in early January 2020. The act gives tax incentives to small businesses who set up automatic enrollment in retirement plans for its workers, or allows them to join multiple employer plans (MEPs). With an MEP, employers can band together with other companies to offer retirement accounts to their employees. The bill also eliminates the maximum age cap for contributions to traditional individual retirement accounts.

Under the SECURE Act, small businesses will receive a tax credit to offset the costs of starting a 401(k) plan or SIMPLE IRA plan with auto-enrollment. This tax credit is on top of the start-up credit they already receive, which is 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.

Tax Credit for Employee 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.