Lots of small business owners want to help their employees save for a financially secure retirement by offering them a retirement plan. However, the cost and complexity of most plans, including the popular 401(k) plan, dissuade many from doing so.
This is one reason why more than 40% of full-time employees in the United States don’t have access to a retirement plan at work, according to a survey conducted by the Pew Charitable Trusts.* This lack of retirement plan access has some experts predicting a retirement crisis in the not-too-distant future.
The good news is that retirement plans don’t have to be costly or complex. In fact, there’s one retirement plan that is literally the definition of simplicity: the Savings Incentive Match Plan for Employees IRA, or SIMPLE IRA.
What is a SIMPLE IRA?
Think of a SIMPLE IRA as a small business version of a 401(k) plan. It allows eligible employees to contribute a percentage of their pre-tax earnings to a retirement account and receive matching contributions from their employer. In this way, SIMPLE IRAs are different from SEP-IRAs that only allow employer, but not employee, contributions.
The reason SIMPLE IRAs are popular among many small businesses is because, as the name implies, they are much simpler to set up and administer than 401(k) plans. For example, no annual Form 5500 filing is required with a SIMPLE IRA. Any business with 100 or fewer employees that doesn’t offer a retirement plan can establish a SIMPLE IRA.
Keep in mind that with SIMPLE IRAs, matching employer contributions are mandatory. You must match your employees’ contributions up to 3% of their salary. Or you can contribute 2% of an employee’s salary, regardless of his or her participation in the plan. However, your business’ contributions are tax-deductible, and employees’ contributions are made on a pre-tax basis.
SIMPLE IRA Contribution Limits for 2023
Employees under age 50 can contribute up to $15,500 to a SIMPLE IRA in 2023, while employees 50 years of age and over can contribute up to $19,000. As noted above, employers must make matching contributions to employees’ accounts on top of this using one of two methods:
- Make matching contributions of up to 3% of employees’ compensation (not limited by any annual compensation limit); or
- Make non-elective contributions of 2% of employees’ compensation (based on a maximum salary of $305,000).
Remember that your business can deduct all contributions made to employees’ SIMPLE IRA accounts from your gross income for federal income tax purposes. Also, employees’ pre-tax contributions lower their taxable income, which may lower their current tax bill.
Eligibility Rules for SIMPLE IRAs
Any business with 100 or fewer employees that doesn’t offer a retirement plan can establish a SIMPLE IRA. This includes sole proprietorships, S corporations, C corporations, partnerships, and LLCs.
Employee eligibility criteria are also broad. Employees are eligible to participate if they’ve received at least $5,000 in compensation during any two preceding calendar years and expect to earn at least this much during the year of participation. In certain situations, eligibility may be extended to employees who don’t meet these criteria.
Benefits of a SIMPLE IRA
There are a number of potential benefits of establishing a SIMPLE IRA for yourself and your employees, including the following:
- The startup and operating costs are generally lower than the costs associated with a 401(k) plan.
- Matching contributions made by your business are tax-deductible, which can lower your business’ tax liability.
- Employees’ contributions are pre-tax, which lowers their current taxable income.
- Employer contributions to employees’ accounts vest immediately. This means employees own all the money as soon as it’s contributed to their account and can take it with them if they change jobs.
- There tends to be more investment options for employees to choose from than there are in a 401(k)-investment menu.
Drawbacks of a SIMPLE IRA
Keep in mind that there are a few potential drawbacks to SIMPLE IRAs, including the following:
- The annual contribution limits are lower than the limits on most other employer-sponsored retirement plans. For example, the annual contribution limit for 401(k)s in 2023 is $22,500, or $30,000 for individuals 50 years of age or over, while the limit for SEP-IRAs in 2023 is $66,000 or 25 percent of annual compensation, whichever is less.
- Matching employer contributions are mandatory. While this is a benefit for employees, it might be considered a drawback for employers.
- There is not a Roth version of a SIMPLE IRA so employees can’t save for retirement on a tax-free basis.
- Unlike most 401(k) plans, SIMPLE IRAs do not allow participant loans.
Also, there may be steep tax penalties for early withdrawals from SIMPLE IRAs. If withdrawals before age 59½ are made within the first two years of plan participation, an extra 15% early withdrawal penalty will be added on top of the usual 10% penalty for a total tax penalty of 25%.
How to Set Up a SIMPLE IRA
Most IRA providers (e.g., Fidelity, E*TRADE, Charles Schwab) offer SIMPLE IRAs that employers can set up themselves online. Here are the steps involved in establishing a SIMPLE IRA:
- File either IRS Form 5305-SIMPLE or IRS Form 5304-SIMPLE. You’ll file the former if your business will deposit contributions at a designated financial institution and the latter if employees will deposit contributions at a financial institution they choose.
- Provide eligible employees with information about the plan by giving them a copy of IRS Form 5305-SIMPLE or IRS Form 5304-SIMPLE.
- Establish separate IRAs for each eligible employee using IRS Form 5305-S or 5305-SA.
How We Can Help Your Business
The team at C.W. O’Conner Wealth Advisors helps business owners set up the right retirement plans for themselves and their employees, including SIMPLE IRAs. Call us directly at 770-368-9919 or email Cliff at firstname.lastname@example.org or Kevin at email@example.com to learn more.
Editors Note: This article was originally published in August of 2022. It has been updated to reflect 2023 data.