A SIMPLE IRA is a retirement savings plan for employers with 100 or fewer employees. While SIMPLE IRAs are, as the name implies, pretty simple, the name is actually an acronym for Savings Incentive Match PLan for Employees. Offering one can be a cost-effective way for small business owners to give their employees a retirement savings plan without the expenses or potential limitations of a 401(k).
How a SIMPLE IRA works
At its core, a SIMPLE IRA is just like a traditional IRA. It mostly follows the same rules regarding investments, distributions, and rollovers.
However, SIMPLE IRA contributions work a lot like 401(k) contributions. There are two components to funding the SIMPLE IRA: elective salary deferrals made by the employee and nonelective contributions made by the employer.- A flat 2% of the employee’s salary. The maximum salary used to determine the employer contribution is $305,000 for 2022 or $330,000 for 2023.
- Matching contributions of up to 3% of the employee’s salary, with no salary cap. (The match rate can be temporarily reduced under certain circumstances.)
Pros and cons of a SIMPLE IRA
| Pros | Cons |
|---|---|
| Lower costs to establish and operate compared to a 401(k) plan. | Both the employee elective salary deferral and the maximum employer matching contribution percentage are lower than in a 401(k) plan. |
| SIMPLE IRA accounts usually let owners buy and sell any security or financial instrument they choose, with just a few limitations on risky stock options trades. | No Roth option: Elective deferrals are always tax deferred and pooled with employer contributions. |
| Employer contributions vest immediately. | Extra penalty for rollovers and withdrawals within two years of establishing the account. |
SIMPLE IRA rules and contribution limits
As mentioned, there are two types of SIMPLE IRA contributions: elective employee contributions and nonelective employer contributions.
In 2022, employee contributions are limited to 100% of salary or $14,000, whichever is less. The limit rises in 2023 to $15,500. Employees who are 50 or older can make an additional $3,000 catch-up contribution in 2022, or $3,500 in 2023. Contributions are made through payroll deductions and aren’t subject to income tax. They are, however, still subject to FICA and unemployment taxes.Employee SIMPLE IRA contributions do not preclude contributions to other employer-sponsored retirement plans an employee may have. Contributing to a SIMPLE IRA doesn’t prevent employees from opening their own IRAs and contributing. For those who rely on a backdoor Roth IRA, however, the SIMPLE IRA account may cause problems.
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