SIMPLE IRA: Definition, How Small Businesses Use, and Drawbacks


A SIMPLE IRA is a retirement savings plan that most small businesses with 100 or fewer employees can use. "SIMPLE" stands for "Savings Incentive Match Plan for Employees," while IRA is the acronym for individual retirement account. Employers can choose to make a non-elective contribution of 2% of the employee's salary or a dollar-for-dollar matching contribution of the employee's contributions to the plan up to 3% of their salary.

Key Takeaways

  • A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a type of tax-deferred retirement savings plan.
  • SIMPLE IRAs are easy to set up, and they can be a good option for small businesses.
  • They have some drawbacks, and businesses that can afford to set up other plans might consider it.

Understanding the SIMPLE IRA

Employees can contribute a maximum of $13,500 annually in 2021 ($14,000 in 2022). The maximum is increased periodically to account for inflation. Retirement savers ages 50 and older may make an additional catch-up contribution of $3,000, bringing their annual maximum to $16,500 in 2021 ($17,000 for 2022).

One of the many major provisions, now law, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, the government will provide a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment.

The appeal of SIMPLE IRAs is that they 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. Those who are self-employed or sole-proprietors are eligible to establish a SIMPLE IRA as well. 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.

Special Considerations

Employers establish the plan using Internal Revenue Service (IRS) Form 5304-SIMPLE if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRAs, 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.

SIMPLE IRA Drawbacks

One drawback of SIMPLE IRAs is that the business owner cannot save as much for retirement as with other small business retirement plans, such as a simplified employee pension (SEP) or a 401(k) plan, the latter of which also offers higher catch-up contribution limits. Also, a SIMPLE IRA cannot be rolled over into a traditional IRA without a two-year waiting period from the time the employee first joined a plan, unlike a 401(k).

As of December 2015, SIMPLE IRA accounts are permitted to accept transfers from SEP IRAs, traditional IRAs and employer-sponsored plans such as a 401(k).

Article Sources
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  1. Internal Revenue Service. "SIMPLE IRA Plan." Accessed Nov. 26, 2021.

  2. Internal Revenue Service. “2022 Limitations Adjusted as Provided in Section 415(d), etc.,” Page 2. Accessed Nov. 26, 2021.

  3. U.S. Congress. "H.R.1865 - Further Consolidated Appropriations Act, 2020." Accessed Nov. 26, 2021.

  4. Internal Revenue Service. "SIMPLE IRA Plan FAQs." Accessed Nov. 26, 2021.

  5. Internal Revenue Service. "401(k) Contribution Limit Increases to $19,500 for 2020; Catch-Up Limit Rises to $6,500." Accessed Nov. 26, 2021.

  6. Internal Revenue Service. "Rollover Chart." Accessed Nov. 26, 2021.

  7. Internal Revenue Service. "SIMPLE IRA Withdrawal and Transfer Rules." Accessed Nov. 26, 2021.

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