A traditional IRA is set up by an individual on his or her own behalf to save for retirement, whereas a SIMPLE IRA is set up by a small business owner on behalf of an employee (including the owner if he or she is a sole proprietor). Only the owner of a traditional IRA makes contributions to the account, whereas both the employee and the employer make contributions to a SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees.
To open a traditional IRA requires only having earned income during the year and being under the age of 70.5 by the end of the year, whereas small business owners who open SIMPLE IRAs for their employees may make additional stipulations about who can participate.
The contribution limits are also different. For Traditional IRAs, the maximum allowable contribution in 2014 is the smaller of $5,000 (or $6,500 for those 50 and older) or total income for the year, whereas an employee may contribute up to $12,000 of his or her pay (or $14,500 if over the age of 50) per year to a SIMPLE IRA in 2014. This can then be either matched dollar for dollar by the employer, up to 3% of the employee's compensation, or the employer's contribution can be a set amount of 2% of the employee's compensation.
Both plans allow for deferment of income tax on amounts contributed to the plans until they are dispersed, and on any earnings as long as they remain in the plans. Contributions to a traditional IRA can be tax deductible, whereas employee contributions to a SIMPLE IRA are not (except for sole proprietors, who may deduct both salary reduction contributions and matching contributions from form 1040). With certain exceptions, both plans incur penalties for early distribution of funds -- 10% in 2014 -- plus the payment of income tax on the amount withdrawn. For a SIMPLE IRA, with a few exceptions, such as being over the age of 59.5, the penalty rises from 10% to 25% if the money is withdrawn within two years of an employer making the first deposit.