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You may have heard of the more popular IRA (individual retirement account) plans, such as traditional or Roth IRAs, but have you heard of SIMPLE IRAs? SIMPLE stands for Savings Incentive Match Plan for Employees, and are low-cost retirement plan options for businesses of 100 employees or less. 

Like a 401(k), SIMPLE IRA plans are employer-sponsored and can include match incentives to eligible employees. Let’s take a peek under the hood and learn more about how they work.

How Do SIMPLE IRAs Work?

SIMPLE IRAs are retirement plans set up by small businesses. The major benefit of SIMPLE IRAs is in the name of it, they’re simple. Small businesses can be attracted to the low startup and maintenance costs, as well as minimal paperwork, of a SIMPLE IRA. These retirement plans are managed by a financial institution, which removes the business’s need to report to the IRS, ultimately saving the owner time and money.

To qualify for participation, an individual must earn a minimum of $5,000 in the previous two years, and expect to earn the same, if not more, throughout the rest of the current year with an employer. If the employee is part of or receiving benefits from a union, the employer may choose to not allow the individual to participate in their SIMPLE IRA plan.

What Are SIMPLE IRA Contribution Limits?

Individuals can contribute up to $13,500 per year into their SIMPLE IRA. There is a $3,000 annual “catch-up” contribution made available to those ages 50 and up (or $16,500 annually). Employees can make salary reduction contributions, either a percentage or dollar amount, to their SIMPLE IRA. These salary reductions are elective deferrals and stack up towards the annual limit. If you are contributing to other employer-sponsored plans, be sure to not exceed that limit in order to maximize your tax benefits.

Businesses can contribute to their employee’s SIMPLE plans one of two ways; either matching contributions dollar-for-dollar up to 3% of the individual’s annual salary or by making a non-elective contribution at 2% of the employee’s salary. These plans are extremely easy to set up, and any employer contributions are deductible from the businesses. Both can be large selling points to any business owner.

SIMPLE IRA Pros and Cons?

SIMPLE IRAs are easy to set up, as well as don’t cost as much as other employer-sponsored retirement plans like a 401(k). These plans are managed through a financial institution, which is great, it removes the tedious IRS reporting from the small business. 

If you’re an employee, you can qualify for tax deductions on annual contributions. These contributions grow tax-deferred until you begin withdrawing funds. Similar to other IRA plans, the IRS does penalize you with an additional 10% tax with the income tax for early withdrawal. 

Something unique to SIMPLE IRAs is their 2-year “lock-up period.” The IRS declares that an individual cannot withdraw savings within the first two years of beginning their participation in the plan. In this instance, individuals will be hit with a 25% tax penalty compared to the normal rate of 10%.

The IRS recognizes that financial hardship can occur, and individuals may need to access saving tied up in their IRA.

Listed below are events that avoid the 10% or 25% additional tax:

  • An individual becomes 59 ½ or older
  • Withdraw is packaged as an annuity
  • Individual becomes disabled
  • Beneficiary inherits the SIMPLE IRA from a deceased owner
  • Medical expenses that do not makeup 10% or your MAGI (if ages 65+, then only 7.5% of MAGI)
  • Withdraw is no more than the cost of medical insurance while employed
  • Money is used for college tuition, supplies, and student living expenses
  • Withdraw of up to $10,000 is used for a first time home purchase

How To Set up a SIMPLE IRA

Setting up a SIMPLE IRA is much easier than other employer-sponsored plans. Plans can be set up between the first of the year through October 1. If you started a new venture after October 1, this limited timeframe does not apply to your company. The IRS provides steps to establishing a SIMPLE IRA that we have summarized below.

Step 1: Pick Your Trustee

Companies will have to work with a financial institution to hold their employees’ retirement funds. This can either be one of the following: banks, insurance companies, federally insured credit unions, brokerages, and certain regulated investment companies. Whichever route you take, the institution must provide you with its fees and commissions associated with your SIMPLE IRA plan.

Step 2: Execute Agreements

The IRS provides proper documents or written agreements in order to start your SIMPLE IRA plan. This can be either Form 5304-SIMPLE or Form 5305-SIMPLE

Form 5304-SIMPLE gives employees the liberty in choosing their own financial institution. If you prefer to have all employees to work with the same financial institution, you should fill out Form 5305-SIMPLE.

Step 3: Inform Eligible Employees

Employers must inform eligible employees at the beginning of each election period. This includes giving employees the opportunity to begin or change their salary reduction choice, as well as the financial institution they would like to work with (applicable to Form 5304-SIMPLE). 

As an employer, you’re responsible for informing each employee if you choose to make matching or nonelective contributions. Last but not least, a summary of your SIMPLE IRA plan. For employees who are participating in the company’s SIMPLE IRA plan, employers must provide notice that the worker may transfer their existing balance without penalty.

Step 4: Setup a SIMPLE IRA

Once the firm’s plan is established, employees can begin setting up their SIMPLE IRA. Investment options range from which financial institution you choose. However, they can range from stocks, mutual funds, ETFs, bonds, or FDIC-insured CDs. Note that a SIMPLE IRA cannot be a Roth IRA.


Both SIMPLE and SEP IRAs are employer-sponsored retirement plans. SIMPLE IRAs give employers and employees the opportunity to contribute into the plan. This is contrary to SEP IRAs, where only the employer can choose to contribute.

Another major difference between the two IRAs is their contribution limits. In 2020, SIMPLE IRA contribution limit is $13,500. If you are 50+, are eligible for catch up contributions of an additional $3,000 ($16,500 in total).

SEP IRA contribution limits are substantially different than other retirement plans. They can be up to 25% of an employee’s salary and a maximum contribution of $57,000. Otherwise, SEP and traditional IRAs follow most of the same investment and withdrawal rules.