Skip links

What Is A Simple IRA?

When choosing among available retirement plans, employers can get a pretty good deal with the SIMPLE IRA.  Not only will employers generally attract more candidates to fill jobs, the SIMPLE IRA net cost to the employers is one of the lowest – if not the lowest, among all retirement plans.  There are many other retirement plans available that may serve as better tools for specific companies, but for the most part, SIMPLE IRA’s are still the premier choice for small companies.

What Is A SIMPLE IRA?

In a nutshell, a SIMPLE IRA is a small company retirement plan that offers the employees the ability to defer some portion of their earned income into an account, thereby bypassing taxation on that amount.  Furthermore, employees get the benefit of an employer contribution into their account, which is based on the employee annual earnings.  Here are a few bullet points that are specific to the SIMPLE IRA:

  • Employers considering the SIMPLE IRA must be aware that they can only offer the plan if they employ 100 employees or less.
  • If employers offer a SIMPLE IRA, the employer can have no other retirement plan in place.
  • Employers must choose among two types of contribution programs.  Employers can either match dollar for dollar of employee contributions up to 3% of an employee’s annual earnings, or employers may contribute 2% to their employees’ accounts, without regard to whether an employee contributes or not.  
  • In general, all employees must be enrolled in the plan whether the employee defers into his or her own account.  Employers are not required to make contributions to an employee’s account, if that employee does not defer – unless, of course, the 2% option is selected.  If the 2% option is selected by the employer, employers must contribute to every employee’s account at that rate of 2% of employee earnings.
  • Employers may switch between the two above formulas in a new calendar year, so long as the employees are notified within 60 days of January 1.
  • Employees are fully vested with not only their contributions, but the employer’s contributions to the employee’s account as well.
  • All deferrals made by the employee in to his account reduce his/her taxable income, and therefore, may reduce their overall tax bill.  Of course, this depends on several other tax factors.
  • Employer contributions into the employee’s account are also deductible as an employee benefit tax deduction.
  • For 2017, the employee contribution limit cannot exceed $12,500, unless the employee is 50 years of age or older.  In this case, a catch-up contribution in the amount of $3,000 is allowed for 2017 deferrals.  Both of these amounts are considerably less than what is allowed in 401k’s.
  • Unlike 401k’s, SIMPLE IRA employee account owners may not borrow money from their account.
  • SIMPLE IRA’s are generally cheaper in terms of plan administration, as plan testing typically required with 401k’s are not needed with a SIMPLE IRA.  Other factors should be considered when choosing a company plan, however.
  • Even though employee deferrals escape Federal Income Tax, they do not escape FICA taxes.  In other words, for payroll tax calculations, taxable income is not reduced by SIMPLE IRA employee deferrals.

Many 501(c)3 organizations and government entities are allowed to establish SIMPLE IRA’s. This would certainly include charities, country clubs, chambers of commerce in local communities and churches, which are considered de facto 501(c)3 organizations.

How Much Does It Cost An Employer To Manage A SIMPLE IRA?

Typically, the cost to actually manage a SIMPLE IRA is very, very limited.  However, one can run a rough calculation of the net cost to an employer.  

If the employer chooses the non-discretionary method of contributing 2% to employees’ SIMPLE IRA account, the business owner could simply multiply the total annual payroll times 2%.  For example, a total annual payroll of $500,000 would cost an employer about $10,000.

If, on the other hand, the employer chooses the matching method of 3%, the calculations are a little trickier.  In the above example, the business owner would multiply total payroll of $500,000 times 3%, or a maximum annual match of $15,000 would be needed.  Of course, since this method involves an employer match, owners need to know that not every employee will contribute, or contribute fully.  Owners would need to estimate the total participation of the employee force to determine exactly the amount of match they would need.