There are so many small business retirements plans it’s impossible to know which one is best for your business. The ones you’ve heard the most about are SEP-IRAs, SIMPLE IRAs and 401(k). If you’re a solopreneur, or have only a couple employees, SEP-IRAs are best. But once you start scaling and have more employees, you’ll want a better tax savings retirement plan. The two everybody compares are Simple IRAs vs 401(k). We’re are going to tell you everything you need to know about Simple IRAs, how to set them up, and the SIMPLE IRA contribution limits.
What’s a SIMPLE IRA?
SIMPLE IRA stands for Savings Incentive Match Plan for Employees. Congress wanted a less complicated retirement plan for small businesses that would be easy to set up. It’s called “simple” because business owners only need to follow a few of rules and don’t have to file anything extra with the IRS.
They are popular with small businesses that want to offer more to their employees, but don’t want the costs or burdens that are associated with 401(k)s.
Who can setup a SIMPLE IRA?
Any employer that doesn’t already have an employer retirement plan (such as a 401(k) or SEP-IRA) for their employees can set up a SIMPLE IRA. Like SEP-IRAs, every employee that is eligible will have an IRA setup for them (which the employee controls).
IRA Refresher: for those of you that don’t know what an IRA is, an IRA stands for individual retirement arrangement (often mis-defined as individual retirement accounts). IRAs are accounts that allows you to put away money for retirement while helping you pay less tax. For example, if you made $50,000 and put $5,000 into your IRA, you would only have to pay tax on $45,000 (if you would like more details on what IRAs are or how they work, please refer to our article on Traditional and Roth IRAs here).
How do I setup a SIMPLE IRA?
There are 3 simple steps to opening a SIMPLE IRA:
Create a written agreement for the plan – You may create your own written agreement or use the one that the IRS already has for you on their website (Form 5305-SIMPLE).
Provide the information to your employees – Every year you must notify your employees, as soon as they are eligible, that they can participate in your SIMPLE IRA plan. You must also let them how the employer contributions are paid (more on that later).
Set up an IRA account for each employee – Either the employer or the employee can choose where the SIMPLE IRA can be set up. Most small businesses that I work with have their SIMPLE IRAs have them set up at Fidelity. However, you can set them up any financial brokerage that offers them (such as Vanguard or Wealthfront).
Which employees are eligible for a SIMPLE IRA?
Any employee that meets the $5K-Rule must be included in the plan. There are two $5k-Rules, any employee that meets either one of these are eligible. They are:
- The employee made at least $5,000 during any 2 years before the current year
- They’re going to make at least $5,000 in the current year
If any of your employees meet one of these rules, they must be included in the SIMPLE IRA plan. You may always implement lower prerequisites, but never more restrictive ones (e.g., we will allow any employee that made over $3,000 this year to be included in the plan).
SIMPLE IRA Contribution Limits
There are two sides to SIMPLE IRA contributions. The employee side and the employer side. The employee side is what the employee put into the SIMPLE IRA. That reduces their income, and therefore the employees pay less tax; the employer side (sometimes called “match” or “profit-share) is what your boss puts in. Let’s go over both sides.
Employee SIMPLE IRA Contributions
Also referred to as salary reduction contributions are the amount an employee takes from their paycheck and directly funds their SIMPLE IRA. The IRS sets the yearly limit. Here is a table that shows the maximum you can contribute to your SIMPLE IRA if you’re an employee.
| Tax Year | Employee Contribution | Catch-Up Contribution* |
|---|---|---|
| SIMPLE IRA Contribution Limits 2018 & 2019 | $13,000 | $16,000 |
| SIMPLE IRA Contribution Limits 2020 & 2021 | $13,500 | $16,500 |
*If you’re over 50 years old, the IRS allows you to fund an extra $3,000, called Catch-Up Contribution
The employee side gets deposited into your SIMPLE IRA every time you get your paycheck.
Employer SIMPLE IRA Contributions
This is the amount that the employer adds to your account as a profit-share (the amount the boss gives you from the company profits, not from your paycheck). Employers must choose one of two methods to give employees their profit-share. The 3% matching method or 2% non-elective method.
3% Matching Method – The employer must match whatever the employee contributes to their SIMPLE IRA, up to 3% of their compensation. Here’s an example:
HH Inc. is a company that offers a SIMPLE IRA 3% match to its employees. One of their employees, Steve, made $20,000 in 2021. Steve decides to fund to his SIMPLE IRA $1,200 (6% of this pay). HH Inc. must contribute $600 (3% of Steve’s $20,000 salary) to Steve’s SIMPLE IRA. This is on top of the $1,200 that Steve has already contributed. The $600 paid by HH Inc. is tax deductible for HH Inc. However, since this is a matching contribution, if Steve hadn’t put in any money from his paycheck into the SIMPLE IRA, HH Inc. wouldn’t have to include him in the profit-share.
2% Non-Elective Method – The employer must fund the employees 2% of the employees’ compensation into their SIMPLE IRA, regardless of if the employees’ funded anything themselves or not. Example, assume that Mark makes $40,000 working for ABC Inc. ABC Inc. also has a SIMPLE IRA, but decides to use the 2% non-elective method instead of the 3% matching method. Mark doesn’t put any money into his SIMPLE IRA. ABC Inc. would still have to fund Mark’s SIMPLE IRA with $800 (2% of Mark’s $40,000 salary).
Most small business that I’ve worked with elect to use the 3% matching method, since they would only have to contribute to the profit-share if their employees contribute first.
Q&A of SIMPLE IRAs
Here are some common questions I get asked about SIMPLE IRAs
Q: When do I have to set it up? –
A: You must set up a SIMPLE IRA between January 1st thorough October 1st of the year in which you would like to start using the plan.
Q: By when do I have to fund the employer contribution?
Employer contribution must be funded before the small business tax return is filed (which is either March 15th or April 15th, depending on the type of entity). This includes extensions, so that be extended as long as October 15th.
Q: Can an employee retroactively fund a SIMPLE IRA plan?
A: In general no. Employee contributions from their paychecks must be funded within 30 days of their paycheck.
Conclusion
Remember, the tax code is complicated, so we covered the most common questions about SIMPLE IRAs, but not everything. That’s why we recommend that you contact a CPA to decide what is best for your small business.