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Not so Simple: What Business Owners Need to Know About Simple IRAs
A SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) allows employees to save pre-tax and companies to make smaller contributions without the administrative requirements of a 401(k).
Like the name suggests, a SIMPLE IRA is just that: simple. It’s a good choice for business owners who have few employees and don’t want to manage the costs and efforts of a 401(k).
A SIMPLE IRA is easier to set up and administer than a 401(k), has fewer rules and allows greater contributions than a regular IRA. So is it good for your business? Read below to find out.
Employees Manage Their Own Accounts but Employers Are Required to Fund Them
A SIMPLE IRA plan is available for businesses with less than 100 employees that are not sponsoring another retirement plan. SIMPLE IRA accounts are individually managed by employees and are funded by both the employee and employer.
SIMPLE IRA contribution limits are slightly lower than 401(k) limits, although higher than what is permitted with a traditional IRA. Employees can contribute up to $12,500 or 100% of their annual income – whichever is less. If they are 50 or older, they can deposit an extra $3,000 a year catch-up contribution. This compares to $18,000 (+$6,000 catch-up) for a 401(k) and $5,500 (+$1,000 catch-up) for an IRA.
Employee contributions to a SIMPLE IRA are discretionary – they can decide to contribute each year or not. Employers, however, are required to make annual contributions. Employers must provide a 100% match up to 3% of employee’s contributions or provide 2% of their annual salary. All employees must receive the same formula – either a matching contribution or percentage of their salary – so your strategy and projected cash flow requirements will depend on an estimation of your employees’ behavior and participation in the plan.
Despite their administrative ease, SIMPLE IRAs are less flexible than SEP IRAs or even 401(k)s (which can be set up without employer contributions) in regards to required employer funding. Businesses with less predictable cash flow might consider SEP IRA or 401(k) options instead. If your business struggles financially, you can temporarily decrease SIMPLE IRA contributions to 1% for up to two years (out of the previous five).
A second downside of the SIMPLE IRA is that they cannot be held in conjunction with other employer-sponsored plans. This means that if you want to reward a specific set of highly compensated employees with a profit sharing plan bonus, you’ll need to establish a 401(k) or Safe Harbor 401(k) instead of a SIMPLE IRA. SIMPLE IRA plans must be established before the first of the year and stay in effect for the entire year once implemented, meaning if you want to switch plans mid-year, you won’t be able to do so. Lastly, if a business grows to more than 100 employees, it only has two years to maintain a SIMPLE IRA plan for its employees before it is no longer eligible.
SIMPLE IRAs are easy to set up and maintain. Unlike 401(k)s, there are no administration forms you need to file annually with the IRS, meaning there are no administration or management costs to keep the plan going. As a result, unfortunately, you and your employees are on your own when it comes to choosing investments. Unlike a 401(k), there is no professional investment manager providing an investment menu of fund choices for a SIMPLE IRA, so employees must either personally choose their investments or work with an advisor on their own.
SIMPLE IRAs might be a good choice if you have under 100 employees and want to minimize your administration costs and effort. However, since you are already committing to required employer contributions, it often makes sense to compare the costs and benefits of a Safe Harbor 401(k) versus a SIMPLE IRA before implementing. If you would like insight and assistance navigating your retirement plan options, give us a call at 844-377-4963 or use the “Let’s Talk” tool in the right sidebar.
Quick Facts – SIMPLE IRA
- Employee and Employer funded, up to $12,500
- Employers are required to make a minimum match up to 3% or contribution of 2% of compensation
- Cannot be used in combination with other retirement plan
- All eligible employees must receive same contribution percentage
- Easy to set up and maintain with no administration costs
- Investments self-managed by employees