Understanding the SIMPLE IRA for Retirement Savings
- The SIMPLE IRA offers a retirement savings option for self-employed people and those who work for small businesses. Find out how this plan works and if you can contribute.
A SIMPLE IRA, or individual retirement account, is one retirement savings option for those working for small businesses (with no more than 100 employees). You can also start a SIMPLE IRA if you're self-employed. These plans have lower maintenance fees, but they also have lower contribution limits than employer-sponsored 401(k) plans do.
How Do SIMPLE IRAs Work?
With the SIMPLE IRA, small business owners can help workers save for retirement without the stringent requirements of other types of plans. SIMPLE is an acronym for Savings Incentive Match Plan for Employees. When you put money into this type of plan, the contributions are pre-tax, which means you don't have to pay tax on that portion of your income. You pay taxes on the funds when you take them out of the IRA after you retire.
SIMPLE IRAs have a 2022 contribution limit of $14,000, or $17,000 if you're older than 50. In contrast, you can put up to $20,500 into a 401(k) during the same year.
Like other retirement accounts, SIMPLE IRAs have a required minimum distribution (RMD). This mandatory withdrawal applies once you turn 72 if you were born in 1950 or later. The IRS calculates the amount of your RMD based on various factors.
If you start taking money out of your SIMPLE IRA before age 59 1/2, you must pay a 10% early withdrawal penalty on top of your current tax rate. The tax penalty increases to 25% if you opened the account less than 2 years before the withdrawal. These penalties do not apply if you take withdrawals from someone else's IRA as a beneficiary, you have a disability or you withdraw funds in the form of an annuity.
Who Can Contribute to a SIMPLE IRA?
Employees can contribute to a SIMPLE IRA when their company offers this benefit as long as they earned $5,000 or more in 2 previous calendar years (not necessarily consecutive years). They must also be on track to earn $5,000 or more in the contribution year.
Employers must contribute to these plans if they offer them to their employees, unlike with other types of retirement plans. These contributions can consist of either 2% of annual compensation for workers earning no more than $305,000 or up to 3% of the worker's pay in the form of a matching contribution.