What is a SIMPLE IRA?
The SIMPLE IRA is an employer sponsored retirement plan available to small businesses with less than 100 employees including sole proprietorships, partnerships, S corporations and C corporations.
The SIMPLE IRA consists of 2 parts: an optional employee salary deferral and a mandatory employer match. The SIMPLE IRA is easy to administer and IRS filings are not required. The SIMPLE IRA must be established by October 1st in order to contribute to a plan for the current year.
In 2020 a sole proprietor can elect to defer up to 100% of their income up to a maximum of $13,500 or $16,500 for those age 50 or older. SIMPLE IRA participants age 50 or older are permitted to make an additional $3,000 catch-up contribution. In general, contributions made to a SIMPLE IRA are 100% tax deductible and investment earnings grow tax deferred and can be withdrawn after age 59 ½. Withdrawals prior to age 59 ½ are likely to incur taxes as well as IRS penalties for premature withdrawal.
A sole proprietor must make mandatory contributions into a SIMPLE IRA on behalf of their eligible W-2 employees (if any) and into their own SIMPLE IRA account. In general, employer SIMPLE IRA contributions made into these accounts are 100% tax deductible. Contributions must be made annually by the employer's tax filing deadline (including extensions).
Employer contributions can be made in one of the following ways:
- A 3% employer match is made only for those employees electing to defer a portion of their salary. Employers match employee salary deferrals dollar for dollar up to 3% of employee compensation. An employer can reduce the employer's match to 1% of each participating employee's compensation for any two years in a five year period.
- A 2% employer contribution based on an employee’s compensation (up to $5,700 in 2020) for all eligible employees regardless of whether the employee is electing to defer a portion of their salary or not.
Are you a sole proprietor and have no W-2 employees?
If you are then you should consider an Individual 401k as an alternative to a SIMPLE IRA. Sole proprietors who would like to contribute in excess of the limits of a SIMPLE IRA should consider an Individual 401k since it has higher contribution limits.
- A SIMPLE IRA is easy to set up and has low administrative responsibilities.
- 2020 SIMPLE IRA contribution limit is $13,500 or $16,500 if age 50 or older. In addition there is a maximum 3% employer contribution.
- Relatively low maximum annual contribution limits.
- Loans are not permitted.
What are the advantages of a SIMPLE IRA?
Self employed business owners that have a SIMPLE IRA are able to contribute up to 100% of their income up to the maximum contribution limits of $13,500 or $16,500 if age 50 or older. As a result, significant contributions can be made into a SIMPLE IRA even at lower income levels. A good candidate for this plan doesn't mind the relatively low maximum contribution limits. Sole proprietors who would like to contribute in excess of the limits of a SIMPLE IRA should consider an Individual 401k since it has higher contribution limits.
- 2020 Individual 401k contribution limit is $57,000 ($63,500 if age 50 or older due to a "catch-up" provision).
- Tax free loans are permitted with an Individual 401k plan. Loans are permitted up to 50% of the total value of the Individual 401k up to a maximum of $50,000.
- Roth 401k - There is an option to make Roth 401k contributions with the salary deferral portion of the Individual 401k. Contributions into a Roth 401k are not tax deductible, but withdrawals are tax free after age 59 ½.
- Potentially greater administrative responsibilities and administrative fees compared to a SIMPLE IRA.
SIMPLE IRA Calculator
Compare how much could be contributed to a SIMPLE IRA versus an Individual 401k based on your income. Use the SIMPLE IRA Calculator.