If you’re among the 28 million small business owners in the U.S., or one of the 15 million self-employed workers in the U.S., then January may be an important month for you to consider establishing a Savings Incentive Match Plan for Employees, better known by its acronym: a SIMPLE IRA.
The SIMPLE can be among the easiest ways for self-employed people and businesses with fewer than 100 employees to set aside tax-deferred money for retirement.
If you meet eligibility requirements, setting up a SIMPLE IRA can allow you to sidestep much of the heavy lifting required for other sponsored retirement plans like the 401(k), which require hefty reporting and administrative duties. SIMPLE IRAs—dare we say it?—are as simple to set up as a regular IRA, albeit with a couple of more forms.
Here’s what you need to know about the SIMPLE IRA rules, contribution limits, and benefits.
What Are SIMPLE IRAs?
SIMPLE IRAs are retirement savings plans available to any small business with 100 or fewer employees in a calendar year, or self-employed workers without employees. They are established by filling out two IRS forms, 5304 SIMPLE and 5305 SIMPLE, or an individually designed plan document. The filing period for new SIMPLE IRAs runs from January 1 to October 1, unless you start the business after October 1. Those already maintaining SIMPLE IRAs have to re-up on January 1.
There are no other filing requirements for the employer, who also cannot have any other retirement plan in place. Any employee earning at least $5,000 during any two years before the current calendar year who expects to make at least that in the current calendar year can participate, according to the IRS. Employees must be notified of the plan before the beginning of the election period, or in recurring SIMPLE IRAs, ahead of January 1 with enough time for them to make or change a salary reduction.
Here’s a potential plus for some employers: They can be less restrictive in their participation rules, but cannot add higher limits or any other rules. For example, Joe’s Grocery can allow participation for store clerks who may have made only $3,000 the prior year. That works for the self-employed as well.
What Are the Rules and Contribution Limits?
The SIMPLE IRA contributions may not exceed $12,500 of an employee’s salary for 2016 and 2017; employees 50 and older may make additional “catch-up” contributions of as much as $3,000.
The employer may either match that contribution on a dollar-for-dollar basis (of no less than 3% of the employee’s salary), or with what’s called a nonelective contribution chosen by the employer. If an employer chooses this route, he or she must make a 2% contribution even if the worker doesn’t take any salary withdrawal at all.
The rules surrounding withdrawals from a SIMPLE IRA are like those of traditional IRAs. You may begin taking scheduled withdrawals at age 59 1/2. When you reach age 70 1/2, you must begin taking a certain amount each month, in what's called a "required minimum distribution" (RMD). And when you withdraw, that is when you will begin paying taxes as well—remember, your contributions are tax-deferred, not tax-free. Remember this also: If you don’t take the RMD, you could face a 50% excise tax on that amount.
Are there Tax Benefits?
Because the match plan gives both employers and employees a retirement contribution route, the tax benefits are similar to most other company-related plans in that the employer’s ante is tax deductible while the worker’s contributions are pre-tax. That allows for tax-deferred growth potential on contributions. Investment gains are not taxed until withdrawal.
And, like other retirement savings plans, there are penalties for early withdrawal. Not only are the dollars pulled out subject to an income tax, but that amount is coupled with an extra 10% tax if the employee is younger than 59 1/2. If the distribution was made in the first two years of participation in the plan, that penalty escalates to 25% from 10%. Like traditional IRAs, there are some exemptions from early withdrawal. Refer to this list on the IRS website.
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