SIMPLE IRA: The Best Retirement Option for the Self-Employed and Small Businesses?

If you’re behind on your retirement savings, you’re not alone.

If you’re self-employed, own a small business, or are employed by a business with fewer than 100 employees, one option you can use to boost your retirement savings is a SIMPLE IRA.

The best part:

Offering higher contribution limits than you’d get with a traditional IRA or Roth IRA, you can increase your savings while planning for the future. 

Here’s everything you need to know about opening a SIMPLE IRA. 

What is a SIMPLE IRA?

A SIMPLE IRA, or a Savings Incentive Match Plan for Employees, is a type of traditional individual retirement account (IRA) for small businesses and for people who are self-employed. 

Under a SIMPLE IRA, your contributions are tax-deductible and your investments grow tax-deferred until you make withdrawals in retirement. 

With a SIMPLE IRA, employees can make contributions directly into the account.

However, employers are required to make contributions on the employee’s behalf, even if the employee doesn’t make any contributions. 

SIMPLE IRAs have higher contribution limits than traditional or Roth IRAs, making them an excellent retirement savings vehicle. 

Who is Eligible?

Your eligibility for a SIMPLE IRA is dependent on your role: 

As an employer

To set up a SIMPLE IRA, the employer must have 100 or fewer employees who make $5,000 per year or more, including the number of employees who may have left over the course of the calendar year.

The employer cannot offer any other type of retirement plan; the SIMPLE IRA is the only option.

As an employee

If your employer offers a SIMPLE IRA, you can contribute to the plan if you earned at least $5,000 per year during the past two years before the plan was set up, and you expect to make at least $5,000 this year as an employee. 

If you’re self-employed

If you’re self-employed, you can contribute your net earnings into a SIMPLE IRA on your own. 

To do so, you need to complete Form 5305-SIMPLE or an IRS-approved SIMPLE IRA plan offered by mutual funds, banks, or financial institutions.

Then, you can open a SIMPLE IRA through a bank or brokerage firm.

How Do SIMPLE IRAs Work?

With a SIMPLE IRA, your contributions are tax-deferred.

That means the amount you contribute, up to the annual maximum, reduces your taxable income for the year.

For example, if your income was $50,000 and you contributed $13,000 to a SIMPLE IRA, your taxable income would be just $37,000. With a lower taxable income, you have a smaller tax obligation, helping you save money. 

As your investments grow, the gains are tax-deferred until you start taking distributions once you reach retirement age.

Contribution Limits

The amount you can contribute as an employee or as a self-employed person cannot exceed $13,000, as of 2019. 

However, if you are 50 years of age or older, you can make additional catch-up contributions. You can contribute an extra $3,000 per year. 

If you are an employee, your employer must make contributions to the SIMPLE IRA on your behalf, even if you don’t contribute anything yourself.

The employer has to contribute a dollar-to-dollar match of up to 3% of the employee’s salary, or a flat 2% of your pay.

Pros

Employee is always 100% vested

Unlike some other retirement accounts, with a SIMPLE IRA you’re automatically 100% vested.

That means:

If you leave your employer for another job, you can take the total balance of your SIMPLE IRA with you, including the amount your employer contributed.

Employer required to contribute

Unlike 401(k)s, which employers can offer without a company match, employers must make contributions to employees’ SIMPLE IRA accounts.

As an employee, that’s a valuable perk, helping boost your retirement nest egg.

Easy to set up

If you’re self-employed or own a small business, SIMPLE IRAs are easy to set up and manage.

There are minimal paperwork demands; you just need to fill out an initial document and complete annual disclosures.

More investment choices

With 401(k) plans, your investment options are limited.

With a SIMPLE IRA, you have more choices and more control over how to invest your contributions.

Cons

Lower maximum contributions than other accounts

SIMPLE IRAs have lower contribution maximums than other retirement accounts.

For example, you can contribute up to $19,000 per year with a 401(k). And, if you’re self-employed, you can contribute up to 25% of your total compensation or $56,000 per year with a SEP IRA.

Loans not available

With some types of retirement accounts, such as a 401(k), you can borrow money from your account for non-retirement expenses, such as buying a home or paying for medical expenses.

With a SIMPLE IRA, you don’t have that option.

High early withdrawal penalties

If you take out money before the age of 59 ½ and within the first two years of participating in the plan, you’ll get hit with a 25% penalty, drastically cutting into your savings.

Rollover rolls are strict

Rolling over your SIMPLE IRA into anything other than another SIMPLE IRA means you’ll have to pay steep penalties.

Moving your SIMPLE IRA to another retirement account are subject to the same 25% penalty that applies to early withdrawals within two years of joining the plan.

Alternatives to SIMPLE IRAs

While a SIMPLE IRA can be a good option for your retirement savings, they’re not for everyone.

Especially if you’re self-employed, there may be better options available to you, such as these five alternatives:

1. SEP IRA

If you’re self-employed or a small business owner with few employees, a SEP IRA could be a great fit. You can contribute the lesser of 25% of your compensation or $56,000 per year, with a limit of $280,000 on compensation that can be used to determine your contribution. 

Your contributions can be deducted on your tax return, and distributions made in retirement are taxable as income. 

2. Solo 401(k) 

A Solo 401(k) is a traditional 401(k) plan for business owners who have no employees, or just you and your spouse. With a Solo 401(k), you can contribute up to 100% of your compensation, up to $19,000 per year. If you’re 50 years of age or older, you can contribute up to $25,000 per year. 

Contributions are made on a pre-tax basis. Distributions made after the age of 59½ are taxed as income. 

3. Roth IRA

If you’re just starting out and are worried about tying up your money for the long-term, a Roth IRA can be a great compromise.

Contributions to a Roth aren’t tax deductible; instead, you contribute post-tax dollars.

While you lose out on the tax benefit upfront, it can pay off later: qualified distributions are completely tax-free. And, Roth IRAs don’t have required distributions, so you can leave the money in your account as long as you wish. 

How much you can contribute to a Roth IRA is dependent on your income and tax filing status.

If you’re single and make under $122,000, you can contribute up to $6,000 per year ($7,000 if you’re 50 years old or older). However, if your income is over $137,000, you’re ineligible for a Roth IRA.

4. Traditional IRA

Unlike Roth IRAs, Traditional IRAs do not have caps on income.

And, contributions you make to an IRA may be fully or partially deductible, depending on your situation. Your distributions, including earnings and gains, aren’t typically taxed until issued. 

Traditional IRAs are subject to the same contribution limits as Roth IRAs. 

5. Defined benefit plan

If you’re self-employed and have a high income, consider starting a defined benefit plan.

With this approach, you contribute very high amounts — often $80,000 per year or more — into a pension plan you set up for yourself.

Defined benefit plans do have high setup fees and annual maintenance costs, but it’s a quick way to aggressively boost your retirement savings during your peak earning years.

Saving for Retirement

If you’re behind on your retirement savings, it’s important to start making regular, consistent contributions.

If your employer offers a SIMPLE IRA, or if you’re self-employed, contributing to a SIMPLE IRA can help you boost your savings and increase your retirement fund.

You can even combine it with other retirement vehicles, such as a traditional or Roth IRA, to supplement your savings, helping you reach your goals sooner.

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