***Updated with 2022 information******
A Savings Incentive Match Plan for Employees, referred to as a SIMPLE IRA, is a retirement plan specifically for small business owners. The SIMPLE IRA is a cost-effective, simple (duh) solution. It’s appealing for small business owners because it avoids the reporting requirements and is much less expensive than a 401(k), yet allows employee contributions, unlike a SEP IRA.
Small business owners have a much more difficult time saving for retirement. That’s a fact. Whether it’s inconsistent cash flow, employee turnover, or focusing on business growth, all too often, saving for retirement is allowed to fall by the wayside. It shouldn’t have to be that way.
A SIMPLE IRA may be the answer. Easy to set up, maintain, and with comparatively small financial commitment, a SIMPLE IRA checks off all of the boxes for many small businesses.
SIMPLE IRA Employer Requirements
The first step is determining if your business can meet the requirements to offer a SIMPLE IRA plan.
- Employee limit: Employers must have 100 employees or less.
- Employee eligibility: The employer has options.
- Full Eligibility: All employees are eligible, regardless of income
- Limited Eligibility: The employer can choose an income limit of any amount between $0 and $5,0000. Any employee who has received at least that amount during any two of the preceding calendar years and expects to receive at least that much in the current year can participate.
- Employer matching contributions: Employers must make matching contributions each year. However, they do have choices.
- Elective Match: Employers are required to match each employee’s salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee’s compensation. However, there is another limited matching option. An employer has the option to make an elective matching contribution of less than 3%, but it must be at least 1% for no more than 2 calendar years out of the 5 years ending with the calendar year the reduction takes place.
- Alternative Non-elective Match: The employer can instead make a contribution equal to 2% of wages, regardless of whether a worker participates in the SIMPLE IRA plan.
SIMPLE IRA plans can be set up between January 1 and October 1, provided you did not previously maintain a SIMPLE IRA plan. The exception is if it’s a new business created after October 1.
If your business grows beyond 100 employees, you have two years to keep the SIMPLE IRA plan before it is no longer eligible.
SIMPLE IRA Employee provisions
Employee Contributions: For 2022, the SIMPLE IRA contribution limits are $14,000, or $17,000 for those 50+.
Employees cannot max out both a SIMPLE IRA and another employer-sponsored retirement plan, like a 401(k). The total annual contributions allowed for an employer retirement plan such as a SIMPLE IRA or 401(k) can’t be more than $20,500 in 2022 or $27,000 if 50 or older.
Since an employer cannot offer both a 401(k) and a SIMPLE IRA, this would only occur if the employee changed employers or the employer changed plans mid-year.
You’re allowed to roll over a SIMPLE IRA account into another SIMPLE IRA at any time without incurring taxes or penalties. Like other tax-deferred retirement plans, income taxes are due when you make withdrawals.
Withdrawals made before age 59 ½ are subject to a 10% penalty in addition to any income taxes. Please note, if you make a withdrawal or roll the SIMPLE IRA it over to a Traditional IRA or other types of employer-sponsored plans within two years of when you started contributing to the SIMPLE IRA, the penalty is increased to 25%
There are several qualified exemptions to avoid the early withdrawal penalty. Exemptions such as unreimbursed medical expenses, qualified higher education expenses, or a first home purchase, to name a few.
SIMPLE IRA Advantages
Help employees: The SIMPLE IRA provides a way for employees to save for retirement with a company match! Contributions reduce their taxable income, providing a tax benefit while at the same time growing tax-deferred.
Tax credit for employers: When employers set up a SIMPLE IRA, they can receive a tax credit equal to 50% of startup costs, up to a maximum of $500 per year, for three years. Visit the IRS page to learn more.
Minimal annual requirements: The SIMPLE IRA’s beauty is the ease and cost-effectiveness. Less costly than a 401k and without the cumbersome paperwork, the SIMPLE IRA is the perfect retirement plan for many small employers.
There are a few annual requirements to operating the SIMPLE IRA plan, including employee notifications. However, they can be quickly done by the employer, advisor, or even possibly the custodian. Visit the IRS SIMPLE IRA page for more info.
SIMPLE IRA Disadvantages
Lower Contribution limits: As previously mentioned, the SIMPLE IRA’s contribution limits in 2022 are $14,000, or $17,000 for participants aged 50+, less than a 401ks contribution limits of $20,000 or $27,000 for people 50+.
No Roth Option: There is no Roth SIMPLE IRA option.
No vesting of employer matching contributions. All money deposited by an employer into your SIMPLE IRA is immediately the employees. This kind of immediate vesting does not always happen with other employer-sponsored retirement plans. If you have a high employee turnover, this could pose a problem.
Is the SIMPLE IRA right for your business?
Even though we’ve covered the rules, requirements, advantages, and disadvantages, when the rubber hits the road, when is a SIMPLE IRA plan is right for you and your business? There are several variables you have to consider.
- The financial strength of the business
- Retirement savings goals of the owner
- The number employees & employee turnover
- Tax benefits and costs
The financial strength of the business
Remember, you have to provide participants with one of the required matching provisions. If revenue is inconsistent or subject to prolonged downturns, the matching requirements could become problematic.
Instead, maybe a SEP-IRA is the answer. The employer contributions are optional and not required. However, in years when there are contributions, all employees and the business owner must receive the same percentage of salary contribution, any ratio up to 25%, or $57,000, whichever is less. The critical difference in a SEP IRA- employees are not allowed to make their own contributions. It’s only funded with employer contributions.
What are your retirement savings goals?
How much do you want to save for yourself? How much do you want to help your employees? Remember, what you save for your employees applies to your own retirement savings. The SIMPLE IRA contribution limits may not be as beneficial to the owner due to the lower contribution limits compared to a 401k.
If you want to save more for yourself and a few highly paid employees, then you’ll want to think about a 401k.
The number employees & employee turnover
When the only employees are yourself or your spouse, it may be more advantageous to have a Solo 401(k) with a higher contribution limit, matching, and a Roth 401k option.
When employees other than yourself and your spouse start to enter the equation, more analysis is required. How many employees? What is your employee turnover? Do you want to help them save for retirement? What is the average employee income?
Tax benefits and Costs
In addition to the already mentioned tax credit employers can receive when setting up a retirement plan, owners contributing to their own retirement reduce their taxable income. Also, remember when contributing to a SIMPLE IRA, the company matching is deducted as an expense.
Then finally, since you are running a business, cost, of course, is a factor. 401k’s can get pricey due to the compliance requirements. While the SIMPLE IRAs are much less costly than a 401k, they could become time-consuming with many employees or high employee turnover.
Analyze the cost-benefit
There isn’t a single formula to determine if a SIMPLE IRA Plan is right for your business. A business owner must weigh all factors to determine if the SIMPLE IRA is in the retirement savings sweet spot for their business.
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