As a small or medium-sized business owner, one of the top things you can do for your employees is to provide options for contributing to their financial future. A basic, cost-effective option you can provide is called a Simple IRA.
A Simple IRA plan is a retirement plan for small businesses with no more than 100 employees. These plans allow employers and their employees to contribute to the employee’s retirement savings. Each Simple IRA employee account within the plan is very closely related to a Traditional IRA and is generally subject to the same rules. Employees can make salary-reducing contributions, while employers are required to make contributions for eligible employees.[i]
Simple IRAs might be a valuable retirement plan option for your small business. Unlike their somewhat cumbersome and pricey counterparts – like the 401(K), 403(B), or 457 – Simple IRAs do not require non-discrimination testing or vesting schedules, and only necessitate minimal reporting. Yet the tax credits are usually still available for the employers with the tax-deferral benefit to employees.
There are typically two ways a Simple IRA plan is set up. The first is that the employee will contribute a percentage of their pre-tax salary and the employer will match up to 3%. The other is that the employer will contribute 2% on behalf of the employee whether that employee chooses to defer some of their pre-tax salary or not. Simple IRAs are required by law to match employee contributions, according to how the plan is set up.[ii] This is not the case for their qualified counterparts.[iii]
Simple IRA plans run during the calendar year, making the annual notifications to employees a more natural part of the annual calendar.
Contribution limits often change from year to year, so keeping employees updated with their options is one of the few necessary aspects of reporting. Employees can defer up to $15,500 of income to a Simple IRA in 2023, with another $3,500 in catch-up contributions if they are 50 or older. This is less than the $22,500 per year contribution limit for a 401(k), and the 2023 catch-up limit of $7,500. But it's more than the $6,500 contribution and $1,000 catch-up limit for a Traditional IRA for 2023.[iv]
The salary deferrals elected by employees grow tax-deferred until distributions are taken in retirement. More importantly, there is no vesting period so funds in the account belong to employees immediately.
A Simple IRA participant (employee) may withdraw money from the IRA at any time. However, if funds are withdrawn before the employee reaches the age of 59 ½, a 10% penalty is assessed on the distribution in addition to the income tax. That penalty is increased to 25% if the employee has had the IRA for less than two years.[v]
Small business owners are usually best served by working with an advisor who will help them oversee and administrate the Simple IRA plan. This is also a benefit to employees, who will have access to the plan’s advisor for questions and might benefit from engaging in financial services they may not have otherwise chosen to use.