What Is A Simple IRA And Who Can Have One?

Small businesses tend to avoid retirement plans, largely due to their complexity and cost. Just 30 percent of small businesses offer a retirement savings plan to employees, according to a 2024 survey by Fidelity Investments.

A SIMPLE IRA may be just what small businesses need to help their employees save for retirement. Let’s review how these plans work, as well as the pros and cons.

How a SIMPLE IRA works

Short for Savings Incentive Match Plan for Employees, a SIMPLE IRA is a retirement plan designed for small businesses — generally those with 100 or fewer employees. While it’s a type of IRA, a SIMPLE IRA is fundamentally different from a traditional IRA or Roth IRA. 

Traditional and Roth IRAs are established by workers for themselves, with different annual contribution limits, plan rules, and purposes. A SIMPLE IRA looks more like a 401(k) program, but it tends to be easier for the company to set up and manage.

Employers don’t have to worry about complex federal reporting requirements like they do with 401(k) plans. And they can set up the plan through a financial institution, which operates it.

A SIMPLE IRA can be set up as either pre-tax (traditional) or after-tax (Roth):

• If the SIMPLE IRA is traditional, any employee contribution goes into the account before tax. The money can grow tax-deferred for decades and then is taxed as ordinary income when it’s withdrawn at retirement, defined as beginning at age 59 ½.
• If the SIMPLE IRA is a Roth, the employee contribution goes into the account after tax. Then the money can grow tax-free for decades and will be tax-free when withdrawn from the account at retirement, defined as beginning at age 59 ½.

Contribution limits

Like a traditional retirement plan, the SIMPLE IRA allows employees to have wages deducted from their paycheck. Employees can defer up to $16,500 in 2025. Those over age 50 can defer an additional catch-up contribution of $3,500. And per the SECURE Act 2.0, beginning in 2025, employees age 60, 61, 62 and 63 who participate in a SIMPLE IRA can make a higher catch-up of $5,250 instead of $3,500. These contributions are “elective deferrals” that count toward the total annual limit on elective deferrals to this and other retirement plans.

Employers are required to chip in to their employees’ SIMPLE IRA accounts, and they have two options to contribute funds:

1. Match workers’ contributions on a dollar-for-dollar basis, up to 3 percent of individual earnings.
2. Make non-elective contributions up to 2 percent of wage earners’ compensation up to the annual compensation limit of $350,000 for 2024.

Example of a SIMPLE IRA

Imagine you earn $60,000 a year, and your employer matches the contributions you make for up to 3 percent of your salary. You would like to save a total of 10 percent of your salary, including the match. So you decide to defer 7 percent of your own pay in each paycheck.

Over the course of the year, you would save $4,200 in pre-tax or after-tax dollars, while your employer would contribute $1,800, for a total contribution of $6,000. Since you contributed more than 3 percent of your salary, you will have received the full employer match of 3 percent.

In this scenario, you had to contribute money in order to receive the employer match. But employers may instead offer a 2 percent non-elective contribution to employees.

In this second scenario, all eligible employees would receive a contribution regardless of whether they contributed from their own salary. Based on your salary of $60,000, you would receive a total contribution of $1,200 for the year from your employer. Then you could contribute any additional amount up to the annual contribution limit.

Withdrawal rules

The withdrawal rules for SIMPLE IRAs are the same as for the respective traditional and Roth IRAs.

In terms of distributions, a traditional SIMPLE IRA functions like a traditional IRA. Money in the account is subject to tax only when it is withdrawn. While you can withdraw money at any time, a 10 percent penalty may apply (as well as a special 25 percent penalty in certain circumstances), unless you withdraw the funds after the standard retirement age of 59½ or under some other exception. Money in a traditional SIMPLE IRA must eventually be withdrawn under the IRS’s required minimum distribution (RMD) rules starting at age 73 or later, depending on year of birth.

The distribution rules for a Roth SIMPLE IRA work as they do for a Roth IRA. Money will be tax-free if withdrawn after the retirement age of 59 ½. Contributions may be withdrawn at any time without tax or penalty, but any earnings will be subject to a penalty. The Roth SIMPLE IRA has no required minimum distributions and can be held indefinitely.

Pros and cons of SIMPLE IRAs

SIMPLE IRA vs. 401(k)

While SIMPLE IRAs and 401(k) plans are both useful for saving for retirement, there are some key differences between the two plans. SIMPLE IRAs are unique to small businesses and can only be used by employers with 100 or fewer workers earning more than $5,000 annually, while 401(k) plans can be opened at any workplace with one or more employees.

Employer contributions are optional in 401(k) plans, but mandatory for SIMPLE IRAs. You’ll also have higher contribution limits in 401(k) plans than in a SIMPLE IRA.

The fees and administrative tasks involved are higher in 401(k) plans — though they’re relatively easy in a solo 401(k) plan — whereas a SIMPLE IRA has no required annual tax filing and relatively low fees. Also, investment options may be more limited in a 401(k) plan and are chosen by the employer and a plan administrator.

Both SIMPLE IRAs and 401(k) plans may come with a Roth option that allows you to make pre-tax contributions and tax-free withdrawals during retirement.

Here’s a comparison so you can see the differences between the two plans:

Bottom line

A SIMPLE IRA makes a great option for a small business to set up a retirement plan for its employees, often with less hassle and expense than a typical 401(k) plan, and employees can benefit from the tax advantages and matching benefits of the plan. But small businesses may have other attractive options, too — a SEP IRA and solo 401(k), both of which can offer higher contribution limits. It’s important to investigate which plan works best for your situation.