A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a way for self-employed individuals and small business employers to set up a retirement plan. It’s one of a number of tax-advantaged retirement plans that may be available to those who are self-employed, including solo 401(k)s and traditional IRAs. These plans share a number of similarities. Like 401(k)s, SIMPLE IRAs are employer-sponsored, and like other IRAs, they give employees some flexibility in choosing their investments.
SIMPLE IRA contribution limits are one of the main differences between accounts, meaning how much individuals can contribute themselves, and whether there’s an employer contribution component as well.
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Here’s a look at the rules for SIMPLE IRAs,and how to pair a SIMPLE IRA with a traditional or Roth IRA.
Related: A guide to self-directed IRAs
SIMPLE IRA Basics
SIMPLE IRAs are a type of employer-sponsored retirement account. Employers who want to offer one cannot have another retirement plan in place already, and they must typically have 100 employees or fewer.
Employers are required to contribute to SIMPLE IRA plans, while employees can elect to do so as a way to save for retirement.
Employees can usually participate in a SIMPLE IRA if they have made $5,000 in any two calendar years before the current year, or if they expect to receive $5,000 in compensation in the current year. An employee’s income doesn’t affect SIMPLE IRA contribution limits.
SIMPLE IRA Contribution Limits, 2020 and 2021
Employee contributions to SIMPLE IRAs are made with pre-tax dollars. They are typically taken directly from an employee’s paycheck, and they can reduce taxable income in the year the contributions are made, often reducing the amount of taxes owed.
Once deposited in the SIMPLE IRA account, contributions can be invested, and those investments can grow tax-deferred until it comes time to make withdrawals in retirement. Individuals can start making withdrawals penalty-free at age 59-and-a-half. But withdrawals made before then may be subject to a 10% or 25% early withdrawal penalty.
Employee contributions are capped. For 2020 and 2021, contributions cannot exceed $13,500 for most people. Employees who are age 50 and over can make additional catch-up contributions of $3,000, bringing their total contribution limit to $16,500.
Employer vs Employees Contribution Limits
Employers are required to contribute to each one of their employee’s SIMPLE plans each year, and each plan must be treated the same, including an employer’s own.
There are two options available for contributions: Employers may either make matching contributions of up to 3% of employee compensation — or they may make a 2% nonelective contribution for each eligible employee.
If an employer chooses the first option, call it option A, they have to make a dollar-for-dollar match of each employee’s contribution, up to 3% of employee compensation. (If the employer chooses option B, the nonelective contribution, this requirement doesn’t apply.) An employer can offer smaller matches, but they must match at least 1% for no more than two out of every five years. If an employee doesn’t contribute to their SIMPLE account, the employer does not have to contribute either.
Now let’s consider the second option, option B: Employers can choose to make nonelective contributions of 2% of each individual employee’s compensation. If an employer chooses this option, they must make a contribution whether or not an employee makes one as well. Contributions are limited. Employers may make a 2% contribution up to $290,000 in employee compensation for 2021 ($285,000 for 2020). (The 3% matching contribution rule for option A is not subject to this same annual compensation limit.)
Whatever contributions employers make to their employees’ plans are tax-deductible. And if you’re a sole proprietor, you can deduct the employer contributions you make for yourself.
SIMPLE IRA vs 401(k) Contribution Limits
There are other options for employer-sponsored retirement plans, including the 401(k), which differs from an IRA in some significant ways.
Like SIMPLE IRAs, 401(k) contributions are made with pre-tax dollars, and money in the account grows tax-deferred. Withdrawals are taxed at ordinary income tax rates, and individuals can begin making them penalty-free at age 59-and-a-half.
Contribution limits for 401(k)s are much higher than for SIMPLE IRAs. In 2021, individuals can contribute up to $19,500 each year to their 401(k) plans. Plan participants age 50 and older may make $6,500 in catch-up contributions for a total of $26,000 per year.
Employers may also choose to contribute to their employees’ 401(k) plans through matching contributions or non-elective contributions. Employees often use matching contributions to incentivize their employees to save, and individuals should try to save enough each year to meet their employer’s matching requirements.
Employers may also make nonelective contributions regardless of whether an employee has made contributions of their own. Total employee and employer contributions can equal up to $58,000 per year, or 100% of an employee’s compensation, whichever is less. For those age 50 and older, that figure jumps to $64,500.
As a result of these higher contribution limits, 401(k)s can help individuals save quite a bit more than they could with a SIMPLE IRA.
SIMPLE IRA vs Traditional IRA Contribution Limits
Individuals who want to save more in tax-deferred retirement accounts than they’re able to in a SIMPLE IRA alone can consider opening an IRA account. Regular IRAs come in two flavors: traditional or Roth.
When considering SIMPLE vs. traditional IRAs, the two actually work similarly. However, contribution limits for traditional accounts are quite a bit lower. For 2021, individuals can contribute $6,000, or $7,000 for those 50 and older. That said, when paired with a SIMPLE IRA, individuals could be making $19,500 in total contributions, the same as with a 401(k).
Roth IRAs work a little bit differently. Contributions to Roths are made with after-tax dollars. Money inside the account grows tax-free and individuals pay no income tax when they make withdrawals after age 59-and-a-half. Early withdrawals may be subject to penalty. Because individuals pay no income tax on withdrawals in retirement, Roth IRAs may be a consideration for those who anticipate being in a higher tax bracket when they retire.
Roth contributions limits are the same as traditional IRAs. Individuals are allowed to have both Roth and traditional accounts at the same time. However, total contributions are cumulative across accounts. (Want to learn more about IRAs? Check out these frequently asked questions.)
SIMPLE IRAs are an easy way for employers and employees to save for retirement, especially those who are self-employed (or for companies with under 100 employees). In fact, a SIMPLE IRA gives employers two ways to help employees save for retirement — by a direct matching contribution of up to 3% (assuming the employee is also contributing to their SIMPLE IRA account), or by providing a basic 2% contribution for all employees, regardless of whether the employees themselves are contributing.
While SIMPLE IRAs don’t offer the same high contribution limits that 401(k)s do, individuals who want to save more can compensate by opening a traditional or Roth IRA on their own.
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