Saving for retirement is a central pillar to any personal financial plan. For employees in large companies, 401 k plans help with this goal. But, what if you don’t have access to one of these plans? What if you’re a sole proprietor, small business owner, or self-employed? These people and their employees still need to save for retirement. Enter the SIMPLE IRA. This plan provides people not covered by 401 k plans an outstanding retirement option.
As such, we’ll use this article to explain SIMPLE IRAs, their 2021 contribution limits, and other considerations. Specifically, we’ll cover the following topics:
- SIMPLE IRA Contribution Limits
- What is a SIMPLE IRA?
- SIMPLE IRA vs. Traditional IRA
- SIMPLE IRA for Employers
- Withdrawing from a SIMPLE IRA
- Conclusion: Simple IRA Contribution Limits & More
SIMPLE IRA Contribution Limits
Employees can contribute up to $13,500 per year in 2020 and 2021 to their SIMPLE IRAs. This a $500 per year increase from 2019. And, contribution limits generally increase every year or two in order to keep pace with inflation.
However, an exception exists for employees aged 50 or older at the end of the calendar year. These individuals can make catch-up contributions of $3,000 annually. As a result, they can make total annual contributions of $16,500.
What is a SIMPLE IRA?
401 k plans require a significant amount of administrative work. Accordingly, SIMPLE IRA plans exist as an alternative to these large retirement plans. SIMPLE stands for Savings Incentive Match Plan for Employees. And, it is designed to serve small businesses with 100 or fewer employees. Similar to traditional 401 k plans, your SIMPLE IRA contributions are tax-deductible. And, the earnings grow tax-free. But, the IRS taxes distributions from these accounts in retirement.
Unfortunately, SIMPLE IRAs do not have Roth options. But, they pose far fewer cost and administrative hurdles to employers compared to 401 k plans. And, the contribution limits typically increase on an annual basis, meaning employees can save more over time.
Self-Directed SIMPLE IRA
A self-directed SIMPLE IRA has similar characteristics to a self-directed IRA. With a normal IRA, plans typically limit investment options to traditional choices (e.g. stocks, bonds, and mutual funds). Self-directed IRAs and SIMPLE IRAs allow for investments in alternative asset classes like real estate, private lending, and precious metals.
Self-directed plans also require more government compliance measures. But, if you’re willing to follow government guidelines, these plans can increase investment options.
SIMPLE IRA vs. Traditional IRA
Traditional IRAs are set up by individuals for their own benefit. Conversely, SIMPLE IRAs are set up by business owners for their employees. This also includes the owner if the business is a sole proprietorship. As such, only the account holder contributes to a traditional IRA. With SIMPLE IRAs, both the account holder and the business owner may contribute to the plans.
Individuals can also contribute to both SIMPLE and traditional (or Roth) IRAs in the same year. In 2021, that means you can contribute $13,500 to a SIMPLE IRA and $6,000 to a traditional or Roth IRA. This provides an outstanding option to maximize retirement savings in tax-advantaged accounts. But, individuals should note that traditional and Roth IRA contributions are cumulative. That is, you can only contribute $6,000 total between the two types.
SIMPLE IRA for Employers
Retirement plans are regulated by the Employee Retirement Income Security Act of 1974 or ERISA. Importantly, ERISA does not mandate that any employer establish a retirement plan. But, this federal law does establish minimum standards if an employer does establish a plan.
With SIMPLE IRAs, employers can choose to contribute to employee plans. More precisely, employers have two primary options:
- Option 1: Contribute up to 2% of the employee’s salary
- Option 2: Dollar-for-dollar match employee contributions up to 3% of their salary
What Happens to a SIMPLE IRA if an Employee Leaves the Company?
Generally speaking, employees cannot transfer SIMPLE IRA funds to another retirement plan within two years of opening an account. If you leave the company during this two-year period, you must leave the funds in your account. Otherwise, you face an early distribution penalty of 25%. One exception exists to this rule, though. If you move to another company that has a SIMPLE IRA, you can transfer your funds into that plan within the two-year period.
Rules simplify significantly for employees leaving after this two-year period. After two years, employees can move SIMPLE IRA funds into any eligible retirement plan. You can complete this via a transfer, rollover, or Roth conversion.
Withdrawing from a SIMPLE IRA
When you withdraw funds from a SIMPLE IRA after age 59 ½, you must pay taxes on the withdrawn amount. Like traditional IRAs, these are pre-tax plans, meaning the IRS collects once you take money out in retirement.
Furthermore, the SIMPLE IRA plan exists to encourage retirement savings. As such, the IRS discourages early withdrawals. If you withdraw funds before 59 ½, you’ll need to pay income taxes and a penalty of 10% or 25%:
- 10% penalty: This applies to the SIMPLE IRA funds withdrawn before turning 59 ½.
- 25% penalty: This applies to any early withdrawals during the two-year period from when you first participated in a SIMPLE IRA plan.
Conclusion: Simple IRA Contribution Limits & More
SIMPLE IRAs provide an outstanding option for small businesses to establish retirement plans. In 2020 and 2021, the contribution limits for these SIMPLE IRAs are $13,500. But, if 50 or older, you can add an extra $3,000 per year in catch-up contributions. These plans also offer great employer contribution options. Employers can contribute up to 2% of an employee’s salary. Or, they can choose a dollar-for-dollar match of employee contributions up to 3% of their salary.
We believe SIMPLE IRAs are a great way for employers to support their team members’ nest eggs. And, while setting up these plans can seem complicated, that’s why we’re here to help. At Tax Hack, we live and breathe retirement planning for small businesses. Contact us to set up a strategy session!