The Small Business Guide to SIMPLE IRAs

What is a SIMPLE IRA?

A SIMPLE IRA is a retirement plan through which employees and employers contribute to employees’ retirement accounts. A SIMPLE IRA is an excellent option for small businesses that want to start sponsoring employee retirement plans as part of their employee benefits plans. They’re easy to launch and nearly as comprehensive as more complex retirement accounts.

How does a SIMPLE IRA work?

Remember the following rules and considerations when starting and administering a SIMPLE IRA for your business:

• SIMPLE IRAs have employee limits. Any business with 100 employees at most can establish a SIMPLE IRA. You’re not eligible if you have more than 100 employees. However, for very small businesses – those with just a few employees – a Simplified Employee Pension (SEP) IRA may be easier to start and perhaps more beneficial for tax purposes. SEP IRAs also work far better as self-employed retirement plans than SIMPLE IRAs.
• A SIMPLE IRA must be your only plan. Another key difference between SIMPLE and SEP IRAs is that only the latter can be combined with other IRAs. If you start a SIMPLE IRA for your business, it must be your only retirement plan.
• Your SIMPLE IRA plan provider will handle most of the paperwork. Although your SIMPLE IRA provider may ask you to complete specific IRS forms, you’ll never have to file paperwork to set up or administer your plan. Your plan provider will take care of all paperwork for you.
• A SIMPLE IRA has inclusion qualifications. Any employee you paid at least $5,000 in any two previous years or to whom you’ll pay at least $5,000 during the current year qualifies for inclusion in your SIMPLE IRA. You can modify these requirements to make them less restrictive – i.e., to include all employees regardless of their income or how long they’ve worked for your company. However, you cannot make your requirements more restrictive than the IRS’ base-level criteria.

SIMPLE IRA contribution rules

The above considerations are straightforward. However, SIMPLE IRA account contribution rules can be complex. Keep the following contribution rules in mind:

• Employee-matching contributions: Employers are generally required to match employee contributions with a SIMPLE IRA up to 3 percent of each employee’s income. For example, if an employee makes $50,000 per year and contributes $2,000 (4 percent) to their account, you need to match only up to $1,500 (3 percent) of this contribution. You can opt to contribute less than 3 percent; however, you must match at least 1 percent of employee contributions during two calendar years of any five-year period. These rules don’t apply if you make nonelective contributions instead (see below).
• Nonelective contributions: Alternatively, you can make nonelective contributions of 2 percent to all employee IRAs. This rule means that whether or not an employee chooses to contribute any money to their IRA, you must still contribute 2 percent of their income. (As with SEP IRAs, but unlike many other retirement plans, employees are not required to make annual contributions.)
• Income limitations apply. For both previous contribution rules, you are required to match or make nonelective contributions only up to the first $330,000 (in 2023) of an employee’s income. This means a 2 percent contribution on a $350,000 salary isn’t 2 percent of $350,000 – it’s 2 percent of $330,000.
• Employee contribution limits: Employees cannot contribute more than $15,500 of their salary to a SIMPLE IRA in 2023. However, employees age 50 and older can contribute an additional $3,500 as a catch-up contribution at the end of the year.
• Employees are fully vested. No matter how much money employees do or don’t contribute, they are always fully vested in the money in their accounts. This means that your employees take ownership of your contributions the moment you make them.

SIMPLE IRA rollover rules

After an employee’s first two years with your company’s SIMPLE IRA, they can transfer money to employer-sponsored retirement plans and non-Roth IRAs without paying taxes. During those first two years, tax-free rollovers are available only to other SIMPLE IRAs. Additionally, SIMPLE IRAs cannot receive funds from Roth IRAs.

SIMPLE IRA tax considerations

Administering a SIMPLE IRA can help lower your business taxes. That’s because all contributions your company makes to your employees’ SEP IRA accounts are fully tax deductible. If you’re a sole proprietor or a partner in your business, these tax deductions pass through to your personal income. However, your employees cannot deduct their own SIMPLE IRA contributions from their taxes.

All money in SIMPLE IRAs grows tax-deferred, meaning an employee won’t pay taxes on the income they put into their retirement account. However, when your employees begin taking required minimum distributions (at either age 70.5 or 72, depending on when they were born), these withdrawals will be taxed as income.

If an employee withdraws money from their SIMPLE IRA before they’re required to take minimum distributions, their withdrawals will be taxed as income. If employees younger than 59.5 withdraw money from their plans, they’ll pay an additional 10 percent tax. This tax increases to 25 percent if taken during the first two years of the SIMPLE IRA’s lifetime.

Pros and cons of SIMPLE IRAs

Like all retirement plans, SIMPLE IRAs’ features and complexities give them specific advantages and disadvantages over other plans. We’ve broken down the pros and cons of SIMPLE IRAs below to help you make a more informed decision about your company’s retirement benefits.

Pros of SIMPLE IRAs

• SIMPLE IRAs are straightforward and affordable to start and administer. Starting a 401(k) retirement plan for your team is often expensive and laborious. With a SIMPLE IRA, your startup paperwork is minimal. You’ll also pay less to start and administer your plan than you would with many other retirement plans.
• SIMPLE IRAs have no discrimination testing. Unlike a 401(k) plan, a SIMPLE IRA doesn’t require discrimination testing to ensure your retirement plan benefits all employees equally. The absence of this requirement makes a SIMPLE IRA easier to manage.
• SIMPLE IRAs have no filing requirements. You’re not required to file any paperwork with the IRS to set up or administer a SIMPLE IRA. You won’t have to spend time on this task when you could be working on more important business matters. Your SIMPLE IRA provider will handle this need for you.

Cons of SIMPLE IRAs

• SIMPLE IRAs have relatively low contribution limits. The SIMPLE IRA contribution limit of $15,500 and the catch-up contribution of $3,500 are smaller than other plans’ limits. Yes, $15,500 is more than the contribution limits of traditional and Roth IRAs, but it’s significantly less than the traditional 401(k) contribution limit. It’s also a mere fraction of the SEP IRA contribution limit, which can reach $66,000 for certain participants.
• SIMPLE IRAs have no Roth version. With Roth IRAs, you can choose to pay taxes on contributions and not withdrawals. SIMPLE IRAs do not allow for this inversion of IRAs’ usual tax-deferred salary contributions and taxed retirement withdrawals.
• SIMPLE IRAs require employer contributions. If you were to offer your employees a 401(k) plan instead of a SIMPLE IRA, you wouldn’t have to match employee contributions (though it would still be a meaningful gesture). However, a SIMPLE IRA requires employer-matching contributions, potentially making it more expensive in the long run.
• SIMPLE IRAs penalize withdrawals. Although the vast majority of retirement plans penalize early withdrawals, not all do, so it’s fair to classify this standard retirement plan drawback as a key disadvantage of SIMPLE IRAs.

How to set up a SIMPLE IRA

If the pros and cons above have persuaded you to start a SIMPLE IRA for your business, then you’re in luck – setup is typically hassle-free and affordable. Here’s how to get started:

1. Complete IRS Form 5305-SIMPLE. Although SIMPLE IRAs have no official filing requirements, completing this form may be helpful. Alternatively, your SIMPLE IRA provider may fill it out because this form officially designates your provider.
2. Educate your employees on your SIMPLE IRA. During your SIMPLE IRA setup, tell your employees about the IRA and explain how their accounts will work. Employees who choose to participate can set the withholdings from their paychecks to fund their accounts and choose the assets into which they want their money invested.
3. Create individual SIMPLE IRAs for your employees. To officially welcome an employee into your SIMPLE IRA program, you must create a SIMPLE IRA for them individually from your provider’s dashboard. This typically takes just a few minutes.

The best employee retirement plan providers

To begin setting up a SIMPLE IRA or another retirement plan for your business, start by consulting our reviews of the best employee retirement plans. You’ll find ample information to choose the right provider for your company. Here are a few excellent ones to consider.  

ADP

ADP offers many different retirement plans, so it can grow with your business as your needs change. If you already use ADP’s payroll system, your ADP retirement plans will automatically integrate to create a comprehensive and time-saving employee benefits interface. Read our full ADP retirement plans review  for more details.

Paychex Retirement

Like ADP, Paychex offers payroll and other human resources-related services; its retirement plan software seamlessly integrates with its other platforms. Paychex gives you multiple retirement plan options, including SIMPLE IRAs, traditional 401(k) plans, owner-only 401(k) plans and solo 401(k) plans. Read our Paychex retirement plans review to learn more.

ShareBuilder 401k

Not every business needs an expensive, full-service retirement plan service. ShareBuilder is an automated, do-it-yourself system that leads you through several prompts to help you choose the right plan for your business. Everything is online, with no salespeople or support staff needed (although support is just a phone call away). Learn more in our ShareBuilder 401k review.

Fidelity Investments

If you want an affordable plan with hands-on help, consider Fidelity Investments. It has some of the lowest trading fees and gives employees free access to advisors to help them customize their portfolios. The service charges no commissions on U.S. stocks, ETFs and options trades. Explore the details in our Fidelity Investments review. 

Jennifer Dublino contributed to this article.