TheStreet

If you've had a full-time job at a large company, there's a good chance you've perused through the benefits they offer. That could include retirement savings like a 401(k) or, depending on your field, a 403(b).

What if you don't work at a particularly large company, though? What if you're employed at a small business, or even self-employed? What are the options for retirement savings in cases like these? One is the Savings Incentive Match Plan for Employees, also known as a SIMPLE IRA.

It's important to understand all of your options for saving for retirement; the average retirement savings in the U.S., for a growing number of reasons, is far less than what is needed to retire comfortably. So should you be looking into a SIMPLE IRA, be it as employee or employer, here is what you should know.

What Is a SIMPLE IRA?

A SIMPLE IRA is a retirement savings account for employees who work in a small business, including those who are self-employed. It is an option for employers and employees alike in these situations when they do not have other retirement plan options for their job.

Generally, the way a SIMPLE IRA works is: a small part of your salary is taken and put into a financial institution, and because the contributions being made are pre-tax, they can compound and grow quicker. The financial institution that handles the IRA plan will have options as to what investment your funds will be put into. As an employee contributing to the SIMPLE IRA, you can look through the stocks, mutual funds and whatever other options are being offered and decide for yourself where your money goes.

With a SIMPLE IRA, the employer is required to make a contribution to it along with the employee. These employer contributions are also vested immediately, which means once the employer contributions are made, they are yours, and when you leave that position those contributions can go with you.

However, the rollover process can get a little complicated depending on how long you as an employee paid into your SIMPLE IRA. If you've had your SIMPLE IRA for under two years, it can only be transferred into another SIMPLE IRA. If it has been two years or longer, the plans you can rollover expands to qualified employee plans like a 401(k), a Roth IRA and a Traditional IRA.

Technically, you are able to withdraw from your SIMPLE IRA anytime, but:

  • if you withdraw from it at less than 59½ years old, you incur a 10% penalty tax.
  • If you withdraw before 59½ and within the first two years that you are participating in the plan, that penalty increases to 25%.

There are some exceptions to this: 

  • if your withdrawal doesn't exceed your non-reimbursed medical expenses (provided they're more than 10% of your adjusted gross income) or
  • if you received the SIMPLE IRA from the prior owner who is now deceased.

SIMPLE IRA Eligibility Rules

Whether you're an employer wondering whether you can set up a SIMPLE IRA for your employees, or an employee who works for a qualifying company wondering whether you qualify, you need to know what makes you eligible.

For an employer, your business must have no more than 100 employees who made at least $5,000 in the year prior to be able to set up a SIMPLE IRA. Should you qualify and then expand to more than 100 employees who fit this model in the future, your business is given a grace period of two calendar years after to maintain the SIMPLE IRA. If your business still has more than 100 employees after the grace period, you are no longer eligible.

You also, as an employer, cannot already have an existing retirement plan in place like a 401(k) or a simplified employee pension (SEP IRA). The exception to this is if you have unionized employees whose plan is covered by their collective bargaining agreement.

As for employees, if you're at a company that qualifies for offering SIMPLE IRAs, you have to have made at least $5,000 in two previous years with the company and be reasonably expected to do so again this year. Employees that can be excluded from participating in SIMPLE IRAs are:

  • Employees already covered via the terms of their collective bargaining agreement
  • Employees who are nonresident aliens who did not receive any U.S. source income

While there isn't technically an "opt out" for a SIMPLE IRA, if you do not contribute any of your salary to it your employer won't contribute any matching contributions.

SIMPLE IRA Contribution Limits

A recent change means that in 2019, your contribution limits as an employee have undergone a minor change.

Prior to this change, for the past several years the dollar limit for employees to contribute into their SIMPLE IRA was $12,500. If you are 50 or over, you're allowed to have a "catch-up" contribution of up to $3,000. The catch-up contribution remains the same, but as of 2019 the limit for contributions increased to $13,000.

Employers, in accordance with IRS guidelines, have to also contribute to your SIMPLE IRA. They have two different options for how to contribute.

One option is to contribute a 2% nonoption contribution. Here, the business does not factor in how much the employee has deferred for the SIMPLE IRA and simply contributes the equivalent of 2% of that employee's salary.

The other option is a 3% matching contribution. Here, the employer does take the employee's contribution into account, and matches the contribution all the way up to 3% of the employee's yearly compensation. In some instances, the employer won't go as high as 3%, but they cannot go lower than 1%.

SIMPLE IRA vs. 401(k)

How does the SIMPLE IRA differ from a 401(k) plan, one of the most common retirement plans available for full-time employees with benefits? Well, as mentioned, the SIMPLE IRA is a retirement option for smaller employers. It's easier to set up than a 401(k), but doesn't necessarily offer the same flexibility as one.

There is no limit to the number of employees required to set up a 401(k) like the 100-employee cap on a SIMPLE IRA. And while common practice is for employers to have some sort of matching contribution for it, it is not an absolute requirement for employers to match 401(k) contributions.

Your contribution limit in a 401(k) is also higher than that of a SIMPLE IRA. In 2019, the contribution limit for a 401(k) is $19,000, up from the 2018 limit of $18,500. The catch-up contribution for over-50 employees is an additional $6,000 - twice as much as that of a SIMPLE IRA.

Eligibility requirements are also different for the two. Whereas SIMPLE IRA eligibility for employees requires making $5,000 in two previous years, you are eligible for a 401(k) at your employer if you:

  • Are 21 years of age or older
  • Exceed one year of service

Is There a SIMPLE IRA Tax Deduction?

Looking to get a tax deduction for your SIMPLE IRA contributions? If you're an employee, you're unable to do that. The reason for this is that the contributions being taken from your salary and put into your SIMPLE IRA are pretax.

The exception to this is if you are self-employed, as employers can deduct their SIMPLE IRA contributions. This can create some confusion, as Line 28 on your Form 1040, Schedule 1 has room for SIMPLE IRA contributions. However, this line is specifically for someone self-employed to deduct their contribution as an employer.

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