SIMPLE IRAs are employer-sponsored retirement plans allowing participants to save up to $25,000 pre-tax in deferrals and matching. Using a SIMPLE IRA, employers must match employee deferrals on a dollar-for-dollar basis between 1% – 3%. To use a SIMPLE IRA, employers must implement their plan before October 1 of the year it becomes effective.
How a SIMPLE IRA Works
A SIMPLE IRA is called a “poor man’s 401(k)” because it provides many 401(k) advantages at a lower cost. However, a SIMPLE IRA has lower contribution limits than alternatives like SEP IRAs. Still, while SIMPLE IRA contribution limits are lower than other options, they only require that an employer matches between 1% – 3% of employee deferrals and are a great choice if you want to incentivize employee retirement savings.
Unlike 401(k) plans, SIMPLE IRAs cost virtually nothing for employers to administer – generally less than $20 per employee per year. Also unlike 401(k) plans, they do not require annual filings or compliance testing to ensure the plan remains in balance. This exclusion from testing is something that SIMPLE IRAs have in common with Safe Harbor 401(k)s.
Contribution limits for SIMPLE IRAs are $25,000 if deferrals and employer matching are maximized, nearly 5 times higher than the limit on Traditional IRAs (which is $5,500). However, SIMPLE IRA contribution limits are lower than alternatives like 401(k) plans and SEP IRAs, both of which have contribution limits of $55,000.
SEP IRAs are attractive options for many solopreneurs or companies with few employees and are popular alternatives to SIMPLE IRAs. With SEPs, however, you’re required to fund all employee contributions proportional to your own contributions, but with a SIMPLE, the only requirement is that you match employee deferrals dollar-for-dollar between 1%-3%, making it a more inexpensive option for businesses with more than 5-8 employees.
Contribution Limit Comparison: How SIMPLE IRAs Stack up
|Type of Plan||Total Contribution Limit||Contribution Limit with Catch-Up|
|SEP IRA or Solo 401(k)||$55,000||$61,000|
SIMPLE IRA contribution limits include employee contributions and employer match. SEP IRAs and Solo 401(k) contributions must be from employers, rather than through employee deferrals. 401(k) contribution limits include employee contributions, employer match, and profit sharing.
“A SIMPLE IRA is literally more simple than a 401(k). They are typically less expensive to administer and less time-consuming to operate. A SIMPLE IRA has lower contribution limits than a SEP IRA and is easier to set up…Otherwise, a SIMPLE IRA plan follows the same investment, distribution, and rollover rules as traditional IRAs. Contributions made to traditional IRAs and SIMPLE IRAs during the year are tax-deductible, but you pay taxes on the money when you take it out in retirement.” – Josh Zimmelman, President, Westwood Tax & Consulting
Who a SIMPLE IRA is Right For
SIMPLE IRAs are ideal for business owners who have more than 5-8 employees but want to avoid the cost of administering a 401(k) plan. SIMPLE IRAs can also benefit small business owners who want to encourage employee saving through salary deferrals rather than through the employer-only contributions of a SEP IRA.
In many cases, a SIMPLE IRA fits well for small business owners who aren’t making substantial profits or aren’t capable of maximizing contributions under a SEP or 401(k). A SIMPLE can also be cheaper than a SEP, so owners can defer their own income without having to make proportional contributions for each employee.
Situations where a SIMPLE IRA can be particularly beneficial include:
- Young companies still in growth stages – SIMPLE IRAs can be great In the early years of a new company when owners still need to reinvest revenue to continue growing the business. Most owners in this situation can’t afford to take full advantage of the higher contribution limits of a SEP or 401(k).
- Small companies with few employees – Small business owners with few employees often look first to a SEP IRA, but SEPs require employers to fund all employee contributions. This makes SIMPLE IRAs far more economical for businesses with more than 5-8 employees.
- Businesses with few employees and high turnover – Many small businesses with high employee turnover find it difficult to take full advantage of a 401(k) plan. For companies with higher-than-average employee turnover, business owners and high-earners can be prohibited from maximizing contributions to a 401(k), while still paying the full administrative costs.
- Business with employees and low profitability – Many small businesses provide employees and owners with a decent living but do not produce excessive profits for the large contributions possible with a SEP IRA or 401(k).
- Employers who want to encourage employee retirement savings – SIMPLE IRAs allow employees to save more for retirement through salary deferrals than Traditional IRAs. Savings are further incentivized through mandatory matching from the employer.
- Employers who want to contribute more than their employees without matching – In choosing a SIMPLE IRA vs SEP IRA, employers can contribute to their own savings through a SIMPLE, without having to make proportional contributions to each employee, as with a SEP.
“SIMPLE IRAs feature higher employee contribution limits than traditional or Roth IRA but lower than SEPs or 401(k)s. While employees can withdraw contributions and earnings at any time, the traditional tax penalty of 10 percent applies to those under the age of 59 ½ and can be as high as 25 percent if the employee withdraws within two years of participating. In addition, employees cannot take loans from their SIMPLE IRAs or SEPs in the event of a financial emergency, unlike the penalty-free loans of a 401(k).” – Gerri Walsh, Senior Vice President for Investor Education, FINRA
Top SIMPLE IRA Providers
Most banks and mutual fund companies are structured to help small business owners implement and administer SIMPLE IRAs at relatively low costs. Generally, SIMPLE IRAs cost virtually nothing to set up or maintain – less than $20 per participant per year. However, each provider has a different menu of offerings, investments, and add-on services to benefit business owners.
Some of the top SIMPLE IRA providers include:
Scottrade is generally known as an online/discount brokerage service that also has a number of branch offices around the company. However, Scottrade’s recent expansion into diversified financial services has left them well-poised to provide SIMPLE IRA and other retirement plan services to employers around the country.
While day-trading isn’t recommended for retirement accounts, Scottrade offers a great platform for investors who want to trade listed securities in their SIMPLE IRA.
As one of the more established financial services firms in the United States, Schwab provides an array of services and solutions to meet most needs. In addition to brokerage and investment advisory services, Schwab also provides full banking, employer benefits and other solutions as needed.
Small business owners who may need additional services separate from retirement planning may benefit from using an institution like Schwab, which can serve as a one-stop-shop.
As the largest asset manager in America by assets, Vanguard has established itself as the company to beat in many categories including retirement plan services. While generally retirement plan investments are restricted to Vanguard’s funds, the firm offers competitive fee arrangements that are difficult to beat.
If you want to set up a simple, straightforward, cost-effective SIMPLE IRA with a few diversified investment options, you should definitely look at Vanguard.
Fidelity is another well-established financial services company – the largest in the United States, in fact. In addition to its discount brokerage and investment advisory services, Fidelity also offers an array of retirement plan solutions including SIMPLE IRAs.
Where business owners can really benefit from Fidelity over another provider is through the individual, in-person service available via their offices around the country.
TD Ameritrade is also known primarily as an online trading platform but is also a provider of employee benefits including SIMPLE IRAs. It allows investors to trade in most listed securities and offers competitive incentive programs for employers to open sponsored retirement programs.
If you already have a relationship with TD Ameritrade, adding a SIMPLE IRA can be an easy way to start a retirement plan for your small business.
SIMPLE IRA Costs
One of the biggest advantages of a SIMPLE IRA relative to likely alternatives is the incredibly low cost. In SEP IRAs, employers are required to fund all employee contributions and 401(k) plans have high administrative costs. SIMPLE IRAs, however, cost between $10-$20 per employee and require only modest employee matching programs of 1-3%.
The specific costs for a SIMPLE IRA include:
- Custodian Fee – Custodians typically charge $10 – $20 per year per employee to hold an IRA, which is deducted from individual employee accounts.
- Employer Matching Contributions – SIMPLE IRAs require employers to match employee salary deferrals between 1%-3%.
- Payroll Provider (if applicable) – Employers who choose can elect to use a payroll provider like Gusto that can further streamline matching contributions and other items. However, this isn’t necessary for a SIMPLE IRA and is purely optional.
SIMPLE IRA Contribution Limits 2018
SIMPLE IRA Contribution Limits for 2018 total $25,000. Contributions are broken into two categories, with employee salary deferrals limited to $12,500 and another $12,500 potentially coming from matching employer contributions. Ultimately, the total amount will depend on the employer’s matching formula. Remember that business owners are required to match between 1% – 3% of employee deferrals.
These contribution limits are far higher than some alternatives (Traditional IRAs) and lower than others (SEPs and 401(k) plans). SIMPLE IRAs represent a good middle ground in terms of contribution limits while keeping annual administrative costs as low as possible.
“SIMPLE’s are better when an employer (under 100 employees) wants to put away between $5,500-$25,000 for retirement but also wants to help their employees and doesn’t want to have a lot of administrative issues doing it. The best part is that there is no administrative testing of the plan which is costly but more important to small business owners, time-consuming.” – T. Eric Reich, CIMA, CFP, CLU, ChFC, President, Reich Asset Management
SIMPLE IRA Tax Deductibility
In a SIMPLE IRA, employee deferrals are excluded from their respective taxable incomes. At the same time, matching employer contributions are tax-deductible to the employer. Though different mechanically, this is essentially the same as SEP IRAs, 401(k) plans, and Traditional IRAs under current U.S. tax law.
“In addition to business contributions being tax-deductible, there is a tax credit of up to $500 available for businesses that start a SIMPLE IRA plan for their business. The credit can cover costs to set up, administer the plan, and educate employees, and can be claimed for 3 years.” – Matt Hylland, President, Hylland Capital Management
SIMPLE IRA Rules
In order to qualify for a SIMPLE IRA, employers must abide by certain rules set by the IRS. Unlike many other retirement plans, SIMPLE IRAs are not “qualified” plans, and annual nondiscrimination compliance testing is not required.
SIMPLE IRA rules include:
1. Follow Proper Setup Process
Any employee who earns more than $5,000 during the calendar year becomes eligible for a SIMPLE IRA. Those who decide to participate can enroll, start deferring income, and receive matching contributions. However, employers can decide on less stringent eligibility requirements, if they’re outlined in plan documents.
2. Implement a Compliant Matching Program
To use a SIMPLE IRA, an employer must establish a deferral matching program that meets IRS requirements. Employers must match between 1%-3% of employee salary deferrals. However, matching can’t fall below 3% for more than 2 years of the preceding 5. Alternatively, employers can choose to contribute 2% of an employee’s salary, regardless of whether they elect to contribute themselves.
3. Enroll Eligible Employees
In order to qualify a SIMPLE IRA with the IRS, employers must immediately offer employees the opportunity to enroll as soon as they become eligible. Newly-eligible employees must receive appropriate disclosures about the plan, along with information about the benefits of tax-deferred retirement savings, employer matching, etc.
4. Immediately Vest All Contributions
SIMPLE IRAs, like many retirement plans, require immediate vesting of all contributions for employees. It’s not uncommon for some employers to use vesting schedules to deter employees from leaving early, but these vesting schedules aren’t available for use in SIMPLE IRAs.
“SIMPLE IRA’s have a crazy tax penalty if you decide to withdraw your funds within the first two years of opening and under the age of 59.5. For most retirement plans, under these terms your withdraw would be assessed a 10% early withdrawal penalty. For A SIMPLE IRA, the penalty is a whopping 25%. Bottom line, if you are going to use a SIMPLE IRA, don’t take withdraws until you retire, and if you can’t wait that long, definitely wait at least 2 years.” – Ryan Miyamoto, CFP, Managing Director, Derive Wealth
SIMPLE IRA Deadlines
SIMPLE IRAs offer greater flexibility than some alternatives, but not with regard to deadlines. New SIMPLE IRAs must be formed between January 1st and October 1st of the year they take effect, and prior-year contributions are prohibited. Failure to meet these deadlines can result in unforeseen tax liability or even penalties for employers.
The SIMPLE IRA deadlines to know include:
1. SIMPLE IRA Formation
An employer can set up a SIMPLE IRA anytime between January 1 and October 1. If you are establishing a new SIMPLE IRA for a company formed after October 1st, a SIMPLE IRA must be established as early as is practicable for the new company.
2. Employer Deposit Deadlines
SIMPLE IRA contributions are a combination of employee salary deferrals and matching employer contributions. In order for a SIMPLE IRA to comply with IRS regulations, matching employer contributions must be within 30 days of an employee salary deferral.
How to Set up a SIMPLE IRA in 4 Steps
Compared to 401(k)s, SIMPLE IRAs are incredibly cheap and for employers to establish and administer. These steps will typically be carried out by your administrator, but are still important to know. Unlike 401(k)s and other retirement plans, SIMPLE IRAs make payroll and plan administration easy for employers to handle themselves.
To properly establish a SIMPLE IRA, business owners need to follow certain steps that include:
1. Choose & Contact SIMPLE IRA Provider
When you’re opening your account, the first step is to choose and contact the best provider for you. This is because it’s important to get the necessary forms and materials to establish your plan, choose investment options, and get ready to enroll employees. Further, they will walk you through the rest of the process.
2. Execute a Plan Agreement
A plan agreement for a SIMPLE IRA is similar to a plan document for a 401(k) plan. The plan agreement outlines plan rules and restrictions, employee eligibility, the employer matching formula, etc. This document will typically be prepared as part of the new account process with a provider.
3. Provide Annual Notice to Eligible Employees
IRS regulations require that employees eligible for a SIMPLE IRA be provided with annual notice that includes certain important information about the plan. Much of this information will be based on the plan agreement from Step 2, including disclosures about employer matching contributions, contribution limits, etc.
4. Setup and Maintain Employee Accounts
The final step of a SIMPLE IRA involves establishing individual accounts for each eligible employee and making matching employer contribution based on the formula outlined in the plan agreement. New account applications need to be completed for each participating employee, and employer contributions must be made for each employee who elects to participate within 30 days of an employee salary deferral.
For a more detailed breakdown of these steps, be sure to check out our ultimate guide on How to Set Up a SIMPLE IRA.
Pros and Cons of a SIMPLE IRA
In determining whether to use a SIMPLE IRA, you need to think carefully about the advantages and disadvantages offered by these types of accounts. In some cases, the benefits will outweigh the drawbacks, while the majority of those who consider a SIMPLE IRA will ultimately find a better alternative.
Pros of a SIMPLE IRA
There are many advantages to SIMPLE IRAs, including:
- Higher contribution limits than Traditional IRAs – SIMPLE IRAs allow for $25,000 in annual contributions, compared to $5,500 for Traditional IRAs.
- Almost no administration cost – 401(k) plans involve administration, recordkeeping, and auditing costs that make them far more expensive than SIMPLE IRAs.
- No nondiscrimination testing – Unlike 401(k)s and some other qualified retirement plans, SIMPLE IRAs are not required to under annual testing.
- Employers only required to make matching contributions – Employers who use SEP IRAs are required to make employee contributions proportional to their own, but under a SIMPLE, employees must decide to participate.
- Good investment flexibility – SIMPLE IRAs have the same investment flexibility and mobility that’s found with other types of IRAs.
Cons of a SIMPLE IRA
Though SIMPLEs have their benefits, they also have drawbacks that include:
- Lower contribution limits than SEPs and 401(k)s – While contribution limits for SIMPLE IRAs are higher than Traditional IRAs, they’re still far lower than the $55,000 limits for SEPs and 401(k)s.
- Required matching – Unlike 401(k) plans that give employers flexibility with matching, SIMPLE IRAs are subject to strict matching guidelines set by the IRS.
- Tighter deadlines – SIMPLE IRAs must be formed before October 1st of the year they become effective – far earlier than some other options. Also, unlike many types of retirement plans, prior-year contributions are prohibited.
- No profit-sharing – While 401(k)s and SEP IRAs allow for profit-sharing with employees, SIMPLE IRAs only allow for employee deferrals and matching employer contributions.
Alternatives to a SIMPLE IRA
In mid-2017, there were more than 630,000 SIMPLE IRA plans with more than 2.7 million participants. While SIMPLE IRAs can be a popular choice, that doesn’t mean there aren’t alternatives that may be more appropriate. To decide what’s best, consider contribution limits, plan administration costs, and overall flexibility of employer contributions and investment selection.
Alternatives to SIMPLE IRAs include:
1. SIMPLE IRA vs. SEP IRA
SEP IRA contribution limits are twice as high as SIMPLE IRAs. However, There are no salary deferrals and there is no matching. Instead, business owners with employees are required to fund contributions for each individual employee proportional to the contributions they make to their own account. SEPs are great for small businesses with few or no employees, while SIMPLEs are better if you have 5-8+ employees or want to avoid the administrative costs of a 401(k).
“A SEP IRA is a Simplified Employee Pension. In this type of plan, there are only employer contributions, and the contributions must be the same for all employees. SEPs have generous contribution limits — up to $54,000 or 25% of total compensation (up to $270,000). However, since the contribution has to be the same for all employees, unless it’s just you or you and your spouse, you’re unlikely to be able to take full advantage. As such, SEPs are a great option for solo practitioners or a couple that works together, but not for a larger team.” – Lucy Shair, Financial Advisor, Action Point Financial
2. SIMPLE IRA vs. 401(k)
SIMPLE IRAs offer a tremendous benefit over 401(k)s by eliminating administrative costs and increasing investment flexibility. However, the contribution limits for SIMPLE IRAs are also less than half those of a 401(k), but that’s often fine for small or growing companies who can’t maximize contributions to a 401(k) plan.
3. SIMPLE IRA vs. Traditional IRA
Traditional IRAs are good alternatives for some employers but have contribution limits of just $5,500 – far less than any other type of account. Traditional IRA contribution limits are one-fifth those of a SIMPLE IRA and just 10% of a SEP IRA or 401(k). Still, Traditional IRAs are the best option for some people who can’t contribute a lot. They offer the great investment flexibility and have no administrative cost or employer matching.
“Compared to qualified plans, a SIMPLE IRA is relatively easy and inexpensive to setup and administer, there are no filing requirements for the employer. This plan is suited as a start-up vehicle until your business can afford a qualified employer plan. Any business with less than 100 employees can adopt this plan. If you decide to go with this option you are not allowed to have any other retirement plan at the same time.” – Dmitriy Fomichenko, President, Sense Financial
SIMPLE IRAs are nuanced plans that provide tremendous benefits for some small business owners. Employers need to consider alternatives, which may be more appropriate. Using a SIMPLE IRA, employers can contribute up to $25,000 pre-tax annually while continuing to grow their business. To qualify, they need to implement a matching program and follow IRS rules.