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Navigating SIMPLE IRAs: A Guide for Businesses

Navigating SIMPLE IRAs: A Guide for Businesses

April 18, 2024

In today’s competitive job market, offering an attractive retirement saving plan is a strategic method for businesses to attract and retain talents. In selecting a plan, businesses must carefully weigh factors such as employer offerings, individual preferences, and compliance with government regulations. Some of the most well-known retirement plans include 401(k), Roth 401(k), 403(b), Traditional IRA, and SEP IRA. Today, we will delve into a retirement saving plan particularly favored by small businesses: the SIMPLE IRA. 

What is a SIMPLE IRA?

The SIMPLE IRA (Saving Incentive Match Plan for Employees) is a tax-deferred retirement saving plan tailored for small businesses with 100 employees or fewer. Eligible criteria for employees entails having received a minimum compensation of $5,000 in any two out of the last five years and an expectation to earn at least $5,000 in the current year.

Employers are mandated to contribute each year either a:

  • Dollar-to-dollar matching contribution of up to 3% of compensation, or
  • 2% nonelective contribution for each eligible employee (even if an eligible employee does not contribute, the employer must contribute 2% of employee’s compensation to his or her SIMPLE IRA account)

However, employees can only contribute a maximum of $16,000 annually in 2024 ($15,500 in 2023), with individual contributions subject to annual inflation adjustments. Additionally, employees aged 50 and over have the option of a $3,500 catch-up contribution in the year 2024.

According to the Secure 2.0 Act issued by the IRS in February 2024, it introduces provisions for an automatic increase or an allowable increase in SIMPLE IRA contribution limits. For employers with 25 eligible employees or fewer, both the contribution limit and catch-up limit are automatically increased by 10 percent. For employers with more than 25 eligible employees, the increased limits are applicable if the employer commits to a 4% matching contribution (versus standard 3%) or a 3% nonelective contribution (versus standard 2%).

How does a SIMPLE IRA plan work?

Operationally, a SIMPLE IRA functions as follows: Consider Iris, an employee at Cooper Transportation Company, a small business with 70 employees. Cooper decides to establish a SIMPLE IRA for its employees, offering a dollar-to-dollar matching contribution up to 3% of each employee’s compensation. Iris makes $60,000 annually and contributes 4% of her compensation ($2,400) to her SIMPLE IRA account. The Cooper matching contribution would amount to 3% of Iris’ compensation ($1,800), resulting in a total contribution of $4,200 to Iris’ SIMPLE IRA. These funds will be held by a financial institution and Iris can make investment choices according to her risk tolerance and preference.

What are some of the benefits of SIMPLE IRAs?

  • Ease of Administration: One of the primary benefits of a SIMPLE IRA is its minimal administrative management. Small businesses, often operating with limited resources, find SIMPLE IRAs easier to manage than other retirement saving plans. The straightforward setup process and low maintenance costs alleviate business operation. Unlike 401(k) plans, SIMPLE IRAs are exempt from nondiscrimination testing. Additionally, the company is not subject to annual tax filing requirement, further simplifying administrative tasks.
  • Inclusive Employee Eligibility: SIMPLE IRAs feature relatively lenient eligibility requirements for employees, ensuring accessibility to a wide range of workers. Employees who have earned at least $5,000 in compensation in any two of the last five years and are expected to earn the same in the current year are eligible to participate. Furthermore, a SIMPLE IRA does not impose an age requirement, whereas participation in 401(k) requires employees to be 21 years of age or older.
  • Flexibility in Contributions: Although SIMPLE IRAs have lower contribution limits, the plan offers flexibility to employers. Employers have the choice between matching contribution or non-elective contribution each year, which provides businesses some space to choose their preferable option based on business performance.

What are some of the drawbacks of SIMPLE IRAs?

  • Low Contribution Limit: One drawback of the SIMPLE IRA is its relatively lower contribution limit compared to other retirement plans. For instance, the contribution limit for SIMPLE IRAs in the year 2024 stands at $16,000, with an additional $3,500 catch-up allowance for individuals aged 50 or above. In contrast, 401(k) plans offer higher contribution ceilings, with a $23,000 contribution limit and $7,500 catch-up allowance in the year 2024.
  • Early Withdrawal Penalties: If a participant makes a withdrawal before he or she attains age 59½, generally a 10% additional tax applies. If this withdrawal occurs within the first 2 years of participation, 10% tax is increased to 25%. This penalty can deter employees from accessing their retirement savings before reaching retirement age.
  • No Loans: Another drawback of the SIMPLE IRA is the absence of loan provision. Unlike some other saving plans such as the 401(k), the SIMPLE IRA does not allow participants to borrow against their retirement savings.

How to decide if a SIMPLE IRA is a good choice for your business

Deciding if a SIMPLE IRA is the right choice for your business involves careful consideration of various factors. Firstly, assess the size and the structure of your company. SIMPLE IRAs are designed for businesses with 100 employees or fewer. Secondly, evaluate your resources and budget. You should consider whether committing to an annual contribution aligns with the financial goal of your business. Moreover, weigh the needs and preferences of your employees. Some employees may prefer a 401(k) because of its higher contribution limits. If you are a solo business owner or a self-employed individual aiming to maximize your retirement savings, other plans may offer higher contribution limits such as solo 401(k) and SEP IRA. Lastly, consult with your financial advisor to discuss the suitability of a SIMPLE IRA for your business and explore alternative retirement saving plans.

Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM. Insurance services offered through an Avantax affiliated insurance agency.