For small business owners and employees seeking an easy way to save for retirement, the Simple IRA is one of the most efficient and affordable choices available. While it is designed to be simple, details like eligibility, contribution limits, rollover rules, and employer requirements can sometimes be confusing. This guide explains the Simple IRA with real-world examples, case studies, and clear explanations to help both employers and employees understand the plan and use it effectively.
What is a Simple IRA? Understanding the Basics of the Plan
A Simple IRA, or the “Savings Incentive Match Plan for Employees Individual Retirement Account” (quite a mouthful), is a retirement plan aimed at small businesses with 100 or fewer employees. It is easier and cheaper to manage than a 401(k), yet it still offers valuable tax benefits.
What are the key characteristics of a Simple IRA, you ask? They are:
- Availability only to businesses with 100 or fewer employees who earned at least $5,000 in the previous year.
- Employees can make pre-tax contributions that reduce their taxable income.
- Employers must either provide a 3% match or a 2% non-elective contribution.
- Employees control the investments in their individual IRAs.
- There is no annual IRS reporting requirement for employers, making it simpler to manage than a 401(k).
Let’s look at a case study to understand what is possible with Simple IRAs in action.
Case Study: BrightStar Physical Therapy, a health clinic with 12 employees, wanted to offer retirement benefits to its team members without the high administrative costs of a 401(k). By offering a Simple IRA, they gave employees a tax-advantaged way to save for retirement while keeping their internal processes easy to manage. The health clinic chose a 3% matching option, and within six months, most employees participated. This retirement option helped the health clinic to boost overall employee retention and satisfaction while reducing the overall turnover rate.
Simple IRA Contribution Limits: How Much You Can Contribute in Tax Year 2025
Understanding Simple IRA contribution limits helps both employees and employers plan effectively. These limits are higher than standard IRA limits and change periodically due to inflation.
Employees can contribute for the tax year 2025 (note that these limits have increased by $500 in tax year 2026):
- Up to $16,500 in salary deferrals.
- An additional $4,000 catch-up contribution if they are age 50 or older.
- For employees 50 and older, the total contribution limit is $20,000.
Note that all contributions are made before taxes are withheld, which lowers overall taxable income.
Employers must choose one of two options for contribution requirements:
- 3% Matching Contribution: The employer matches the employee’s contributions dollar-for-dollar up to 3% of the employee’s salary.
- 2% Nonelective Contribution: The employer contributes 2% of compensation for all eligible employees, even if the employee does not contribute.
Tereza earns $70,000 per year and contributes the full $16,500. Her employer matches 3% of her salary, which is $2,100. In this case, her total contribution for the year is $18,600. If Tereza were 50 or older, she could contribute an additional $4,000, increasing the total contribution to her retirement plan even more.
How a Simple IRA Compares to Other Retirement Plans
Comparing a Simple IRA to other plans can help businesses decide if it is the best choice. Let’s compare some of the options.
Simple IRA vs. 401(k)
A Simple IRA has:
- Much lower administrative costs
- Mandatory employer contributions
- Lower employee contribution limits
- No annual IRS filing requirement
A 401(k) offers higher contribution limits and more plan flexibility, but it requires much more administrative work and costs.
Simple IRA vs. SEP IRA
A Simple IRA allows both employers and employees to contribute. Alternatively, a SEP IRA (“Simple Employee Pension”) only allows employer contributions. Also, Simple IRAs require annual employer contributions, while SEP IRA contributions are optional and can change each year based on profits.
Practical Tips for Employers on Using a Simple IRA Effectively
Here are some practical tips and considerations for employers considering Simple IRAs for their employees.
Tip 1: Select the right employer contribution strategy.
Businesses with changing staffing levels may benefit from the 2% non-elective contribution. Those looking to encourage employee participation, though often prefer the 3% match option.
Tip 2: Provide employee education.
Many employees do not fully understand pre-tax benefits or the value of employer contributions. Annual training or short informational sessions can greatly increase participation and appreciation for the benefit.
Tip 3: Ensure timely deposits.
Late contribution deposits can cause compliance problems. Automating payroll deductions helps maintain clean and accurate deposit timelines.
Tip 4: Review the plan provider regularly.
Investment options, customer service, and administrative support can differ among retirement providers. Conduct an annual review to make sure the plan meets the needs of the business and its employees.
Common Mistakes Employees Make With Simple IRAs
Now let’s take a look at some common mistakes that employees tend to make when managing their Simple IRA contributions.
Mistake 1: Not using catch-up contributions.
Employees age 50 and older often forget they can add an extra $4,000 during tax year 2025 (remember the increase by $500 in tax year 2026).
Mistake 2: Triggering the 25% early withdrawal penalty.
The two-year rule is one of the most overlooked aspects of the Simple IRA. This can lead to costly mistakes, which can negatively impact your overall retirement portfolio.
Mistake 3: Overlooking periodic review of investment.
Employees should periodically monitor their asset allocation and adjust it according to their retirement goals and risk tolerance.
Mistake 4: Missing Out on the Employer Match.
Not contributing enough to get the full employer match is like passing up free money.
Case Study: How a Simple IRA Helped a Business Reduce Turnover
Akasha Dental, a small practice with 27 employees, set up a Simple IRA and chose a 3% match. They also started automatic enrollment. Within 18 months, employee turnover fell by 22%, and overall employee satisfaction scores rose significantly. The practice found that providing a retirement plan, supported by proper information and training, helped to boost employee loyalty, reduce turnover, and lower overall hiring and training costs.
What are Some Frequently Asked Questions About Simple IRAs?
Can self-employed individuals use a Simple IRA?
Yes, they can contribute both as an employer and as an employee. Can I contribute to both a Simple IRA and a Traditional or Roth IRA?
Yes, but income limits might affect your eligibility for a Roth IRA.
Can an employer switch from a Simple IRA to a 401(k)?
Yes, but the transition must start on January 1, and employees need to be notified properly.
Can I stop contributing during the year?
In most cases, yes. However, employers may set limits on how often you can change your contributions.
Conclusion: Is a Simple IRA Right for You or Your Business?
The Simple IRA provides a clear, cost-effective way for small businesses to offer retirement benefits to their employees. By understanding what a Simple IRA is, the contribution limits, and overall rules, business owners and employees can make informed choices that support their long-term financial health and needs. Whether you are a small business looking into retirement benefits or an employee wanting to increase your savings, the Simple IRA offers flexibility, tax benefits, and can be easy to use. This makes it a solid foundation for retirement planning and contributes to the overall financial well-being of your employees.
Looking for more financial information, useful recommendations, and tips concerning your financial well-being? Contact Preferred Trust Company today for a free consultation to help maximize your retirement options and meet your financial investment needs.
