What is a SIMPLE IRA?

There are many different individual retirement account options, and it’s important to select the retirement vehicle that will maximize your retirement savings. One population option is the Savings Incentive Match Plan for Employees – the SIMPLE IRA. What is an...

There are many different individual retirement account options, and it’s important to select the retirement vehicle that will maximize your retirement savings. One population option is the Savings Incentive Match Plan for Employees – the SIMPLE IRA.

What is an IRA?

An IRA is an individual retirement account, and there are more than 25 million IRAs in the United States with financial holdings in the trillions of dollars. These accounts give holders tax-deferred, post-tax savings plan options that allow holders to benefit from pre-retirement tax advantages and financial security in retirement.

Most Americans choose Traditional and Roth IRA plans, but other options include SIMPLE, SEP, Rollover and Conduit IRAs. Each option features different returns on investment based on the structure of the IRA.

What is the SIMPLE IRA?

The SIMPLE (Savings Incentive Match Plan for Employees) IRA option was formed in 1996 under the Small Business Job Protection Act and was designed for small businesses not already offering a retirement savings plan.

This type of IRA is often the choice of small companies with fewer than 100 employees. Some self-employed individuals also prefer the SIMPLE IRA because this type of IRA allows them to invest larger amounts of money.

How does the SIMPLE IRA differ from traditional retirement plans?

Only an eligible employer is permitted to establish a SIMPLE IRA plan; eligible employers have no more than 100 employees and do not have an already-established 401(k) or other plan in place. SIMPLE IRAs are easy and inexpensive to establish and maintain, and generally have no filing requirements.

Small businesses may also be eligible for a $500 tax credit for the start-up costs of a SIMPLE IRA for each of the first three years of the plan.

Contributing to a SIMPLE IRA

The Internal Revenue Service notes that there are two ways to fund SIMPLE IRAs:
Through employee salary reduction contributions, or
Through nonelective or matching employer contributions.

Employees who earned at least $5,000 during the two preceding calendar years and will most likely receive at least $5,000 in the next calendar year are eligible for a SIMPLE IRA. All eligible employees are expected to participate. Employees can’t opt out of the plan, but they can opt out of making salary reduction contributions.

Small businesses can choose to exclude employees covered by a collective bargaining agreement if retirements were the subject of good-faith bargaining; employees covered by a collective bargaining agreement between the employer and airline pilots; and nonresident aliens who received no earned income.

Employers are also allowed to make less restrictive eligibility guidelines, such as those regarding less compensation required during the preceding calendar year, but are not permitted to make more restrictive eligibility requirements.

For employer contributions, the SIMPLE IRA allows small businesses to choose between two options:

  • match each employee’s salary reduction contribution up to three percent, or
  • make nonelective contributions of up to two percent of an eligible employee’s compensation whether the employee contributes or not.

Employers could also make a lower contribution; it must be at least one percent of matching contributions or two percent of nonelective contributions for maximum two out of five years. Employers who choose either option must give their employees notification prior to the period in which employees can select their contribution amount.

Employee contributions to a SIMPLE IRA are capped at a federally-determined amount ($12,500 in 2015 and 2016).

Getting Started and Maintaining the SIMPLE IRA

SIMPLE IRAs are oft-chosen options by small business because there are very few financial or legal requirements. Employers with no more than 100 employees who have each received at least $5,000 in compensation during the preceding calendar year can start a SIMPLE IRA. These 100 employees must include all employees during the calendar, even if they don’t meet the eligibility requirements.

Employers first need to decide if all contributions will be deposited at a designated financial institution or if each employee can select a financial institution. Employers could also choose an IRS-approved prototype plan offered by banks, insurance companies, or other institutions. The employer then needs to set up a SIMPLE IRA for each eligible employee in either a trust or custodial account.

SIMPLE IRAs are maintained on a calendar-year basis. A new SIMPLE IRA needs to be set up between Jan. 1 and Oct. 1. New small businesses that began after Oct. 1 should establish their plans as soon as possible, and businesses who have previously had a SIMPLE IRA need to set up a new one effective January 1.

As employees are always 100 percent vested, they can withdraw contributions and earnings at any time. For the most part, SIMPLE IRAs are subject to income tax, and some employees may also be required to pay an additional tax if they make an early withdrawal.

Employers are not mandated to file any annual financial reports; the Department of Labor notes that the financial institution making the distribution and the financial institution handling the SIMPLE IRAs are responsible for providing annual statements to both the Internal Reven Service and the participants. The employer’s tax advisor can provide more detailed guidance not only on any filing requirements but also on finding and correcting SIMPLE IRA errors.