What is Simple IRA? | All You Need to Know about Simple IRAs

28 Jan 2021

Individual Retirement Arrangement or IRA is a favorite investment tool for retirement. It not only gives you the tax benefits but at the same time, it also lets you secure your future. But when compared to other retirement plans offered by your employer, IRA is completely taken care of by the individual. It doesn’t make the IRA less beneficial. For you to understand how IRA works for you, it is essential to understand, what IRA is and what its types are.

Types of IRA

There are different types of IRA, but when it comes to their objective, and then they are just the same. IRA is like a shell where you are holding your money for future investment. There are different types of IRA:

  • Traditional IRA
  • Roth IRA
  • Simple IRA

In this blog, we will be focusing on the Simple IRA.

What is a Simple IRA?

Simple or Savings Incentive Match Plan for employees is very different from other IRAs. Unlike the traditional IRA, the Simple IRA is the employer-sponsored plan. You can say that it is similar to the 401(k) plan. There is less paperwork in Simple IRA, thus making it easy for companies without a big HR department to offer retirement plans to their employees.

As per the specifications of Simple IRA, the employer offering this facility to his employees must contribute up to 3% of the employee’s salary to the IRA. The employee can decide whether or not to contribute to the same.

How Simple IRA differ from 401(k)?

This would have made you think that the Simple IRA is similar to the 401(k) plan, but the answer is no. There is a line of difference between the two; here is how Simple IRA differs from 401(k):

1.    Simple IRA is applicable for the employers who have employee strength of less than 100.

2.    SIMPLE IRA involves minor paperwork and thus saves administrative cost which is not the case with the 401(k) plan.

There are other parameters which distinguish the Simple IRA from 401(k):

Match in a Simple IRA-  As already mentioned above, Simple IRA is employer-sponsored retirement option, it means that they need to contribute to your Simple IRA account. This can be in the form of a match or a non-elected contribution. Matching here says that if the employee is matching 3%, then the employer also has to match 3%. 3% is the bare minimum which the employer has to match.  

Another way is non-elect contribution wherein the employer will contribute 2% of your salary to the Simple IRA account. This value will remain the same, even if the employee is making more contribution.

Freedom to invest- Many of us don’t know, but the Simple IRA offers the employee the freedom to spend. Whereas the 401(k) limits the investment option, it is not the case with Simple IRA, and it gives the employee the discretion to invest in a wide array of options like mutual funds, stocks, CDs, etc.

More contributions- The best part about taking Simple IRA is that it allows you to contribute more, although, it may be not as high as SEP IRA. But it is more than Roth IRA and Traditional IRA. In 2019, one can contribute $13,000 in 2019 which is higher than in 2017 and 2018 contribution limits. If the contributor’s age is 50 years, then your contribution remains $3000.  This amount is more than the Traditional IRA and Roth IRA. Simple IRA contribution by 50 years old is 2 ½ times higher than $6500 limit of traditional and Roth IRAs.

An important point to note about Simple IRA is that there is no percentage limit, the amount is defined in dollars, and the contributor can put in that portion of the amount from the salary to his Simple IRA account.

If you are self-employed and your income is less than $100,000 per year, then Simple IRA is the best choice for your business. What makes Simple IRA more preferable is that there is no need to file special reports with the IRS.

You cannot take loans- A vital point note about Simple IRA is that you cannot take a loan against the amount deposited in your Simple IRA account. Whereas 401(k)s allows the person to take borrower loan against money if required, but that is not the case with IRAs. It is a provision where you can store money for future investment and get the tax benefit. So, if you are thinking of taking a loan against money in your IRA account, then the answer is NO. The same applies to the Traditional IRA or Roth IRA.

The two-year rule- Simple IRA looks lucrative and is advantageous in many aspects, but at the same time, we must understand that there is always a condition applied to the investment. Simple IRA comes with a two-year rule. When we talk about Traditional IRA or Roth IRA, then there is a 10% penalty if you withdraw early and are under 59.5 years of age. With Simple IRA, the penalty percentage shoots up even higher. If you haven’t completed two years with Simple IRA and try to withdraw cash from your account, then you will be charged 25% penalty plus the income tax.

So, if you have applied for Simple IRA and are willing to cash it out, it is essential that you keep these two rules in mind. Even if you try to rollover your IRA then to 25% penalty rule applies.

Rise in contribution- The best part about the Simple IRA is that the contribution limit has increased from $12,500 in 2018 to $13,000 in 2019. However, the catch-up contribution limits remain the same as $3000.

Wrapping Up - The crux of the matter is that Simple IRA is an excellent option for companies with 100 employees or less to offer them a retirement plan and to secure their future, but it comes with its conditions. In simple words, the Simple IRA is an inexpensive retirement plan which the companies can offer to their employees. Make sure as a business owner consider all the points into consideration before providing Simple IRA to your employees.