Although many employers allow workers to save for retirement using qualified retirement plans, such as a 401(k), 403(b), or 457, these plans have rules that can be cumbersome for both employers and employees.
Some small businesses instead choose SIMPLE (Savings Incentive Match Plan for Employees of Small Employers) IRAs. These plans have fewer rules, are much less complicated to administer, and offer key benefits.
- SIMPLE IRAs do not require non-discrimination and top-heavy testing, vesting schedules, and tax reporting at the plan level.
- Matching employer contributions belong to the employee immediately and can go with them whenever they leave, regardless of tenure.
- Tax credits may be available for both employees and employers.
Benefits of SIMPLE IRAs
Here's how employees and employers benefit.
As with other types of individual retirement accounts (IRAs) and employer-sponsored retirement plans, SIMPLE IRAs allow employees to defer a portion of their salaries into these plans. The money grows tax-deferred until distributions are taken at retirement. This allows savings to compound more quickly.
Easier to Run
SIMPLE IRAs do not require most of the bureaucracy that comes with qualified plans, such as non-discrimination and top-heavy testing, vesting schedules, and tax reporting at the plan level. SIMPLE IRAs are relatively easy to set up and run, and employers don’t need to hire specially trained staff.
Mandatory, Instant Vesting
Matching employer contributions belong to the employee immediately and can go with them whenever they leave, regardless of tenure. What's more, employers who set up Employer match contributions in qualified retirement plans, such as 401(k)s, usually come with either a cliff or graded vesting schedule that requires employees to stay with the company for a specified number of years before they own all matching contributions. SIMPLE IRAs are required by law to match employee contributions. This is not required for qualified plans; employers can choose to offer no match.
SIMPLE IRAs have fewer rules and are much less complicated to administer than some other kinds of retirement plans.
This is less than the $22,500 per year contribution limit for a 401(k) or another qualified plan for 2023 (rising to $23,000 in 2024), as well as the $7,500 catch-up limit permitted. But it's more than the $6,500 contribution and $1,000 catch-up limit for an IRA for 2023 ($7,000 in 2024 with a $1,000 catch-up limit).
Tax Credit for Employers
President Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act in late 2019. The act gives tax incentives to small businesses that set up automatic enrollment in retirement plans for their workers or allows them to join multiple employer plans (MEPs). With an MEP, employers can band together with other companies to offer retirement accounts to their employees. The bill also eliminates the maximum age cap for contributions to traditional individual retirement accounts.
Under the SECURE Act, small businesses can receive a tax credit to offset the costs of starting a 401(k) plan or SIMPLE IRA plan with auto-enrollment. This tax credit is in addition to the start-up credit they already receive, which is 50% of necessary eligible start-up costs, up to a maximum of $500 per year for the first three years of the plan.
Employers can qualify for the credit if they had 100 or fewer employees who received at least $5,000 in compensation for the preceding year and at least one plan participant who was not a highly compensated employee, and if the same employees weren't recently covered by similar plans.
Tax Credit for Employee Contributions
Employees whose adjusted gross income falls below a certain limit may be eligible to take a non-refundable savers credit for up to $2,000 of contributions each year. The saver’s credit offers eligible low-income and lower-middle-income individuals a tax credit of up to $1,000 ($2,000 if married filing jointly) if they contributed to an employer-sponsored retirement plan.
Single Tax Filers
Single taxpayers are ineligible if their adjusted gross income (AGI) exceeds $36,500 in 2023 (rising to $38,250 in 2024). The income limit for married filing jointly taxpayers is $73,000 in 2023 (rising to $76,500 in 2024).
However, you can get the 50% credit (the maximum credit) if you're a single tax filer and have an adjusted gross income of less than $21,750 in 2023. If your income is higher but still below the maximum income limits of $36,500 for 2023 (and $38,250 in 2024), you'll receive a reduced credit, based on your income for the year.
Married Tax Filers
For married couples filing jointly, you can get the 50% credit (the maximum credit) if your income is less than $43,500 in 2023. Again, the credit phases out as your income increases above those levels until you reach the maximum income limits of $73,000 for 2023 (and $76,500 for 2024).
Multiple Investment Choices
SIMPLE IRA contributions can be invested in "individual stocks, mutual funds, and similar types of investments," according to the IRS. Many plans offer growth, growth and income, income, and specialized funds such as sector funds or target-date funds.
Subject to Taxes
While salary deferral contributions to a SIMPLE IRA are not subject to income tax withholding, they are subject to tax under the Social Security, Medicare, and the Federal Unemployment Tax Act (FUTA). Employer matching and non-elective contributions are not subject to taxes.
How Does a SIMPLE IRA Work?
A SIMPLE IRA is a retirement plan for small businesses with no more than 100 employees. It allows small employers to contribute to their own and their employee's retirement savings. Employees can make salary reducing-contributions and employers can make matching or non-elective contributions. The contributions are made to an individual retirement account (IRA) or an annuity.
What Are the Disadvantages of a SIMPLE IRA?
Some of the disadvantages of a SIMPLE IRA are no Roth option, low contribution limits, and high penalties for non-qualified withdrawals.
What Is a SIMPLE IRA vs. a 401(k)?
Both SIMPLE IRAs and 401(k)s are retirement plans. SIMPLE IRAs are for small businesses; those with 100 or less employees. SIMPLE IRAs also require an employer to contribute to the retirement plan whereas a 401(k) does not require an employer to do so; however, many do. In addition, the contribution limits for SIMPLE IRAs are lower than for 401(k)s.
The Bottom Line
SIMPLE IRAs provide a convenient alternative for small employers who don’t want the bureaucratic and fiduciary complexities that come with a qualified plan. Employees still get tax and savings benefits, plus instant vesting of employer contributions.