What is a SIMPLE IRA?

A SIMPLE IRA is like a small business planting a vegetable garden for each employee…

Vegetable gardens are a long game — Once you plant the seeds, you have to wait patiently for the vegetables to grow. There's no guarantee your garden will be productive, but if the vegetables grow, you’ll have food to feed your family. A SIMPLE IRA is like an employer planting a vegetable garden for each employee. They contribute money on behalf of their workers, and the workers may contribute also. Then the money grows in the account until the employees withdraw it during retirement.

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a type of employer-sponsored retirement plan that allows both employees and their employers to save for the employee’s retirement. This type of individual retirement account is specifically for small businesses with 100 employees or fewer.

Like other retirement-savings plans, a SIMPLE IRA holds contributions from employers and employees in accounts that are designed to grow over time with certain tax advantages - no income taxes are levied on the contributions or the investment returns until the employee withdraws money from the account during retirement. A SIMPLE IRA is a straightforward, easy-to-set-up way for an employer to offer this type of retirement plan.

Employers that choose to offer a SIMPLE IRA must contribute to each eligible employee’s account in one of two ways. They can match an employee’s contributions up to 3% of the employee’s wages, or they can contribute 2% of an employee’s salary to their account, regardless of how much the employee contributes.

Employees can contribute up to $14,000 to their SIMPLE IRA in 2022. (In 2023, this contribution limit will increase to $15,500.) Employees who are age 50 or older, and thus closer to retirement, are also allowed to make additional “catch-up” contributions.

Under the SIMPLE IRA requirements, employees are vested as soon as they join the plan. That means all of the money in the account is theirs to keep, regardless of how long they’ve worked at the company.

Any employer with no more than 100 employees can offer a SIMPLE IRA. Any employees who expect to make $5,000 or more in compensation in the current calendar year, and have done so for any two years before the current year, are eligible to participate. Employers don’t have to be this restrictive - they could offer participation to employees as soon as they start work, or at lower income levels - but they can’t place more restrictions on top of these existing Internal Revenue Service (IRS) rules.

A SIMPLE IRA is one of the easiest types of retirement plans for an employer to start. All they have to do is choose a financial institution to act as the plan’s trustee and hold its assets (though employers can also let employees pick the institution); create a written agreement for the plan; give employees basic information about the plan; and set up IRA accounts for each eligible employee to hold contributions to the plan.

Both employers and employees make contributions to the employee’s SIMPLE IRA. For employer contributions, the contribution limits for SIMPLE IRA contributions are either a flat 2% of an employee’s salary, or a match of an employee’s contributions up to 3% of the employee’s salary. Contributions by employees, known as salary reduction contributions, are limited to a maximum of $14,000 for 2022. (In 2023, this contribution limit will increase to $15,500.) Workers age 50 or older can make an additional catch-up contribution of $3,000, for a total of up to $17,000. (In 2023, the catch-up contribution will increase to $3,500, for a total of $19,000.)

In general, SIMPLE IRA participants can begin withdrawing money from their account without penalty after they reach age 59 ½. They can also make withdrawals without penalty under certain other circumstances - if they’re disabled, or the money is going toward medical expenses or higher education costs, for instance. They can also withdraw up to $10,000 without penalty for buying or building a first home

Any withdrawals that don’t meet these conditions will be subject to an early withdrawal penalty in the form of a 10% tax, in addition to the taxes you’d ordinarily have to pay on the withdrawal. The penalty goes up to 25% if you make the withdrawal within two years of joining the plan.

Participants may also be able withdraw money for a tax-free transfer, or rollover, to a traditional IRA (a retirement account that individuals open for themselves) or another employer-sponsored retirement plan.

Not exactly. While both are tax-deferred ways for workers to save and invest for retirement, putting away pre-tax dollars and paying income taxes only when they pull money out after they’re retired, they have a few key differences.

First, SIMPLE IRAs are sponsored by employers. Traditional IRAs are set up by individuals, outside of any employer-sponsored plan.

The contributions also differ significantly. SIMPLE IRAs have a contribution limit for employees of $14,000 in 2022 (increasing to $15,500 in 2023), which comes out of an employee’s salary before taxes. Traditional IRAs have a contribution limit of $6,000 in 2022 (increasing to $6,500 in 2023), which can be tax-deductible, but the deduction may be limited if an employee or their spouse is covered by an employer-sponsored plan or has income above certain levels.

A Simplified Employee Pension (SEP) IRA, like a SIMPLE IRA, is a type of retirement account sponsored by employers, but there are key differences between the two.

First, while only businesses with 100 employees or fewer can offer a SIMPLE IRA, any company can offer a SEP IRA. Also, while both employers and employees can contribute to a SIMPLE IRA, only the employer can contribute to an employee’s SEP IRA account.

Contribution limits also differ. With a SIMPLE IRA, an employer contributes 2-3% of an employee’s income, depending on whether they’re contributing a flat amount or matching an employee’s contributions. The limit for SEP IRAs is much greater, generally up to 25% of an employee’s pay or $61,000 for 2022 (increasing to $65,000 in 2023), whichever is lower.

Like a traditional IRA, a Roth IRA allows individuals to save and invest for retirement on their own, separate from an employer-sponsored retirement plan. But unlike traditional and SIMPLE IRAs, contributions to Roth IRAs aren’t tax-deductible — People contribute to these accounts with post-tax dollars. The money then grows in the account tax-free, and retirees can in most cases withdraw money during retirement without having to pay taxes on it.

In 2022, traditional IRAs and Roth IRAs have a combined contribution limit of $6,000 (in 2023, this will increase to $6,500). People can generally contribute this $6,000 above and beyond any contributions they make to an employer-sponsored plan like a SIMPLE IRA.

Both a SIMPLE IRA and a 401(k) plan are retirement accounts sponsored by employers, but SIMPLE IRAs are available only to businesses with 100 employees or fewer, while any employer can choose to offer a 401(k) plan. And while a 401(k) plan gives employers the option to contribute to their workers’ accounts, they aren’t required to do so.

Employees’ contribution limits are also different. While the contribution limit for employees to a SIMPLE IRA is $14,000 in 2022 ($15,500 for 2023), employees participating in a 401(k) plan can contribute up to $20,500 in 2022 ($22,500 in 2023).