If you work for a small business or are self-employed, a SIMPLE IRA is an easy way to start saving for retirement. It can be a great alternative to other employer-sponsored retirement accounts like a 401(k).
This type of investment account has its own specific rules and guidelines that you’ll need to be aware of before you start using it, though.
These rules include things like contribution limits, early withdrawal penalties, and more.
This article will explain the key things you should know if you’re thinking about using a SIMPLE IRA.
You’ll also learn about the SIMPLE IRA contribution limits for 2021 and some SIMPLE IRA alternatives that are worth considering.
What is a SIMPLE IRA?
SIMPLE stands for Savings Incentive Match Plan for Employees, and IRA stands for Individual Retirement Account.
A SIMPLE IRA is a tax-deferred defined contribution plan that employers can set up for their employees to help them save for retirement.
Companies with 100 or fewer employees, including sole proprietors, can establish one of these retirement plans.
The benefits of a SIMPLE IRA for employers and employees
SIMPLE IRAs offer several advantages to employers and employees alike. These include:
- Easy setup and operation: To establish a SIMPLE IRA, an employer must use IRS Form 5304-SIMPLE to allow employees to choose the financial institution that’ll hold their SIMPLE IRAs. They could also fill out Form 5305-SIMPLE if they want to choose the institution for the employees. From there, employees can open their accounts by filling out a SIMPLE IRA adoption agreement.
- Pre-tax contribution: As an employee, your contributions are pre-tax. That means any income you contribute to your SIMPLE IRA account reduces the amount of income the IRS taxes. This leaves you with more money to invest in the account. You can also take maximum advantage of compounding.
- Investment choice: The classic 401k limits your investment choices to a few funds the plan administrator chooses. On the other hand, SIMPLE IRAs let you invest in any stocks, bonds, mutual funds, and other traditional investments the IRA provider offers. Employees can better customize their portfolios to increase their chances of hitting retirement goals.
- No employer match vesting: Some retirement accounts make you work for an employer for a specific period before matching contributions are yours. This is called vesting. SIMPLE IRA employer matches are 100% vested immediately, meaning that money is yours for your account right away.
- Employer tax credits: Tax benefits extend to employers, too. Eligible employers may be able to claim up to $5,000 in tax credits for establishing a SIMPLE IRA for employees.
Simple IRA vs Traditional IRA: What’s the difference?
SIMPLE IRAs are employer retirement plans. Eligible employers can adopt a SIMPLE IRA plan for their employees.
Traditional IRAs are personal retirement accounts that let employees supplement their retirement savings.
Traditional IRA contribution limits are $6,000 per year for tax year 2021 or $7,000 if you’re 50 or older. That’s much less than the 2021 SIMPLE IRA limit of $13,500.
We also have 401ks, another type of employer-sponsored retirement plan. These offer even higher contribution limits of $19,500 in 2021 or $26,000 if you’re 50 or older.
That said, 401k investment options are limited to a few funds that the administrator chooses.
Both forms of IRAs generally let you pick from any stocks, bonds, mutual funds, and other investments offered by the IRA provider.
SIMPLE IRA Commonly Asked Questions
SIMPLE IRAs aren’t as publicized as 401k plans and traditional or Roth IRAs. On top of that, the rules for contributions, withdrawals, and other aspects can get fairly complex.
Here are some frequently asked SIMPLE IRA questions that we’ve answered in an attempt to demystify this type of retirement plan.
What is the maximum SIMPLE IRA contribution limit for 2021?
In 2021, the maximum SIMPLE IRA contribution limit for employees under age 50 is $13,500. This number may increase in future years to help adjust for inflation.
What is the maximum SIMPLE IRA contribution for 2021 if you’re over 50?
In 2021, the maximum SIMPLE IRA contribution limit for employees age 50 and older is $16,500. This number may be adjusted in subsequent years for inflation.
How much can a self-employed person contribute to a SIMPLE IRA?
Self-employed people and sole proprietors have the same contribution limits as employed people.
In 2021, you can contribute up to $13,500 for the year if you’re self-employed, plus another $3,000 if you’re over 50.
Does an employer have to contribute to a SIMPLE IRA?
Employees can choose to make contributions that come out of their salary.
Employers have to contribute, but they have two options:
- Contribute 2% of each eligible employee’s compensation regardless of whether the employee contributes
- Match each eligible employee’s contributions dollar-for-dollar for up to 3% of their eligible compensation
If an employer chooses the latter, they can reduce the 3% limit to a lower percentage, but never lower than 1%.
What is the maximum employer contribution to a SIMPLE IRA?
The maximum employer contribution varies depending on which contribution option the employer chooses.
If they match each employee’s contribution dollar-for-dollar, they can contribute up to 3% of their salary. There is no maximum limit on that salary amount here.
For example, if an employee makes $50,000 per year and contributes $10,000 throughout the year, the employer can match up to $1,500 (3% of $50,000).
If the employer chooses to make nonelective 2% contributions, they can contribute 2% of an employee’s salary, up to the first $290,000 for 2021. This $290,000 may increase in subsequent years due to inflation.
For example, if an employee makes $300,000 this year, the employer will have to contribute $6,000 (2% of $300,000), regardless of how much the employee contributed.
Can I contribute to two SIMPLE IRAs?
Yes, but your maximum contribution limit is across all SIMPLE accounts. If you put $13,000 into one SIMPLE IRA account, you can only put $500 into any other SIMPLE IRAs for the year.
Your employer isn’t responsible for keeping track of contributions to a SIMPLE IRA that you’ve set up with another employer, either.
Is a SIMPLE IRA a good retirement plan?
SIMPLE IRA plans are good alternatives for small employers who want to avoid the bureaucratic and fiduciary complexities of plans like the 401k.
Employers and employees still get tax benefits from establishing a retirement account, while employer contributions instantly vest for employees (instantly become the employee’s money).
Can I contribute 100% of my income to a SIMPLE IRA?
Yes, in theory — if your income is low enough.
You can contribute up to 100% of your income to a SIMPLE IRA up to $13,500 per year for 2021.
For example, if you make $13,000 in one year, you can put all of it into a SIMPLE IRA. If you make $14,000, you can only contribute $13,500.
Can you lose money in a SIMPLE IRA?
Yes. If you withdraw early, you will pay a penalty, depending on how long you’ve had the account.
- Less than two years: 25% penalty
- After two years: 10% penalty
Once you reach age 59 ½, you can withdraw without incurring a penalty.
Your investments in the account can also decrease in value, depending on what they are and how the market fluctuates.
For instance, if your SIMPLE IRA is primarily invested in the stock market, you could see the value decrease when a huge, unexpected event (like a pandemic) causes the stock market value to drop.
But, keep in mind that prices can also increase again, so these types of drops aren’t really losses unless you withdraw your money and remove any chance of your investments regaining their value.
Can I withdraw from my SIMPLE IRA to pay for my child's education?
You can make early withdrawals from your SIMPLE IRA to pay for your child’s college without penalty as long as you use the funds for qualifying educational expenses.
Anything you withdraw beyond the costs of these expenses will be subject to penalty.
Additionally, you can only do this for your own child. You will still owe the penalty if you make withdrawals to pay for unrelated people and other young relatives like nieces and nephews.
With all that in mind, if you’re 59 ½ or older, you can withdraw funds without penalty for any reason. Thus, you can pay for your child’s education with SIMPLE IRA funds at that age without worry.
SIMPLE IRA Alternatives
SIMPLE IRAs can be good retirement plans for some employers and their employees, but not always.
Fortunately, there are numerous SIMPLE IRA alternatives with varying pros and cons. Here are a few of the most common.
As mentioned earlier, the 401k is among the most common alternatives to a SIMPLE IRA.
Companies larger than 100 employees don’t qualify for the SIMPLE IRA, so they may offer a 401k instead.
Traditional and Roth IRAs
Traditional and Roth IRAs are two tax-advantaged retirement accounts you can open in addition to a workplace retirement plan. Both have the same contribution limits of $6,000 and $7,000 for anyone 50 and older in 2021.
However, the difference lies in when you get the tax advantage.
Traditional IRAs let you contribute pre-tax like a 401k or SIMPLE IRA. This lowers your taxable income. Withdrawals in retirement are taxed at your ordinary income tax rate.
On the other hand, Roth IRAs make you use after-tax income. However, withdrawals in retirement are tax-free.
Roth IRAs do have an income limit for contributions, after which your contribution limit gradually decreases.
Choosing the best one for you depends on your current income, desired income in retirement, and what you think your tax bracket will be.
Getting kids started with saving and investing is a fantastic idea.
However, most children won’t have access to traditional retirement options. They likely won’t have a job that offers them a retirement plan, and they can’t open a traditional or Roth IRA unless they have earned income.
These accounts — owned by the child and managed by an adult custodian — allow adults to gift funds for children to invest. Children can contribute their money as well.
Once the minor turns 18 or 21, depending on their state, they get full access to manage the funds themselves.
Starting kids early with custodial accounts gives them a head start on building generational wealth for their children, grandchildren, and beyond.
Start Saving Today
SIMPLE IRAs can be excellent options for smaller employers as long as they keep track of the rules and contribution limits.
Small companies can avoid some of the complexities of bigger retirement accounts while taking advantage of tax savings. Meanwhile, employees can defer taxes with contributions, and all employer matches vest right away.
Still, SIMPLE IRAs aren’t for every employer or employee since they were designed for small businesses.
There are many alternatives out there, but even then, most children can’t access them because of their financial circumstances. That makes custodial accounts the best choice for getting children ahead of the financial game early.
Get started on saving for your child’s future by downloading the Earlybird app today.