SIMPLE IRA: Retirement Plans for Small Businesses

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement savings plan tailored for small businesses with 100 or fewer employees. This plan allows employees to contribute a portion of their pre-tax salary to an Individual Retirement Account (IRA), while employers are required to make matching or non-elective contributions. SIMPLE IRAs provide an accessible and cost-effective solution for small businesses aiming to offer retirement benefits, streamlining the process compared to more complex retirement plans like 401(k)s.

SIMPLE IRAs are crucial for small businesses as they present a straightforward and economical method to facilitate employee retirement savings. Unlike 401(k) plans, SIMPLE IRAs have lower administrative expenses and fewer compliance burdens, making them an appealing option for employers who want to enhance their benefits package without incurring substantial costs. By offering a SIMPLE IRA, businesses can attract and retain talent, improve employee satisfaction and promote financial wellness among their workforce, which ultimately contributes to a more motivated and productive environment.

SIMPLE IRAs have specific eligibility criteria for both employers and employees:

• Employer Eligibility: To establish a SIMPLE IRA plan, a business must have 100 or fewer employees who received at least $5,000 in compensation during the preceding calendar year. The employer cannot concurrently maintain another qualified retirement plan, such as a 401(k) or 403(b), except for collective bargaining agreements or plans covering employees in other countries.

• Employee Eligibility: Generally, any employee who has received at least $5,000 in compensation from the employer during any two preceding calendar years (consecutive or not) and is reasonably expected to receive at least $5,000 in the current year must be eligible to participate. Employers may choose less restrictive eligibility requirements but cannot make them more stringent.

• Excluded Employees: Employers may exclude non-resident alien employees with no U.S. income and employees covered by collective bargaining agreements if retirement benefits were good-faith bargained for.

• Eligibility Period: Eligible employees must be allowed to participate within a reasonable period (typically 60 days) after meeting eligibility requirements. New plans must generally be established between January 1 and October 1 of a given year to be effective for that year.

SIMPLE IRAs have specific contribution structures and limits that are adjusted periodically for inflation:

• Employee Contribution Limits: For 2025, employees can contribute up to $16,000 annually through salary deferrals, increased from $15,500 in 2024. Participants age 50 or older can make additional catch-up contributions of $3,500, bringing their total potential contribution to $19,500.

• Employer Contribution Requirements: Employers must make one of two types of contributions:

  • Matching Contribution: Match employee contributions dollar-for-dollar up to 3% of the employee’s compensation. This matching percentage can be reduced to as low as 1% for no more than two out of any five consecutive years.

  • Nonelective Contribution: Contribute 2% of compensation for each eligible employee, regardless of whether the employee makes salary reduction contributions. For this calculation, compensation is capped at $330,000 for 2025.

• Compensation Definition: For self-employed individuals, compensation means net earnings from self-employment, which must be reduced by both the deduction for contributions made on behalf of the self-employed individual and by one-half of the self-employment tax.

• Contribution Deadlines: Employee salary deferrals must be deposited into employee accounts within 30 days after the end of the month in which the amounts would have been paid to the employee. Employer contributions must be made by the employer’s tax filing deadline, including extensions.

• Vesting Rules: All contributions to SIMPLE IRAs (both employer and employee) are immediately 100% vested, meaning employees have full ownership of all money in their accounts from day one.

SIMPLE IRAs offer several tax benefits along with some important tax considerations:

• Pre-Tax Contributions: Employee contributions are made on a pre-tax basis, reducing the employee’s taxable income for the year. For example, an employee in the 22% tax bracket contributing the full $16,000 in 2025 would reduce their federal income tax by $3,520 for that year.

• Tax-Deferred Growth: Investment earnings within SIMPLE IRAs grow tax-deferred, meaning no taxes are due on interest, dividends, or capital gains until distributions are taken, allowing for potentially greater accumulation over time through compounding.

• Employer Tax Deductions: Employers can deduct all contributions made to employee SIMPLE IRA accounts as a business expense, reducing the company’s taxable income.

• No Roth Option: Unlike 401(k) plans and traditional IRAs, SIMPLE IRAs do not offer a Roth option for after-tax contributions with tax-free withdrawals in retirement. All distributions are taxed as ordinary income.

• Early Withdrawal Penalties: Withdrawals before age 59½ are generally subject to a 10% early withdrawal penalty in addition to regular income tax. However, this penalty increases to 25% if withdrawals are made within the first two years of participation in the SIMPLE IRA plan.

• Required Minimum Distributions (RMDs): Like traditional IRAs, SIMPLE IRAs are subject to required minimum distributions beginning at age 73 (as of 2025, following the SECURE 2.0 Act changes, with further increases to age 75 scheduled for 2033).

• SIMPLE IRA Rollovers: Special restrictions apply to rollovers within the first two years of participation. During this period, rollovers can only be made to another SIMPLE IRA. After two years, funds may be rolled over to other types of retirement accounts.

Setting up and administering a SIMPLE IRA involves several steps and ongoing responsibilities:

• Timing for Establishment: SIMPLE IRA plans must generally be established between January 1 and October 1 to be effective for the current year. This gives employers time to notify employees and allows for meaningful salary deferral contributions during the year.

• Required Documents: Employers must complete Form 5304-SIMPLE or Form 5305-SIMPLE, depending on whether employees can select the financial institution for their SIMPLE IRAs. These IRS forms serve as the plan document and summary description.

• Employee Notification Requirements: Employers must provide eligible employees with the following information annually:

  • An explanation of the employee’s right to make salary reduction contributions
  • The employer’s decision to make either matching or nonelective contributions
  • A summary description of the plan
  • Written notice that the employee’s balance can be transferred without cost or penalty if using designated financial institutions

• Administrative Responsibilities: Compared to 401(k) plans, administrative duties are significantly reduced:

  • No annual filing of Form 5500 with the IRS
  • No nondiscrimination testing requirements
  • No top-heavy rules to ensure the plan does not disproportionately benefit key employees
  • Minimal ongoing compliance responsibilities

• Financial Institution Role: The financial institution that serves as the trustee or custodian of the SIMPLE IRA accounts typically handles much of the documentation, reporting, and disclosure requirements, further reducing the employer’s administrative burden.

SIMPLE IRAs offer various investment options similar to those available in traditional IRAs:

• Mutual Funds: Diversified investment vehicles managed by professional fund managers, available in various categories including equity funds (growth, value, blend), fixed income funds, balanced funds, and specialty sector funds.

• Exchange-Traded Funds (ETFs): Securities that track an index, commodity, or basket of assets but trade like stocks on exchanges, typically with lower expense ratios than mutual funds and greater trading flexibility.

• Individual Stocks and Bonds: Direct investment in specific company stocks or government/corporate bonds, offering more control but requiring greater investor knowledge.

• Certificates of Deposit (CDs): Time deposits offered by banks and credit unions with fixed terms and interest rates, providing capital preservation with modest returns.

• Money Market Funds: Low-risk investments focused on high-quality, short-term debt instruments and cash equivalents, offering liquidity and capital preservation.

• Target-Date Funds: Professionally managed funds that automatically adjust asset allocation to become more conservative as the target retirement date approaches, offering a “set-it-and-forget-it” option for participants.

• Investment Management Options: Depending on the custodian, SIMPLE IRA holders may have access to:

  • Self-directed accounts for participants who want to make their own investment decisions
  • Managed account options with professional investment advice
  • Robo-advisor services that provide algorithmic portfolio management

• Investment Restrictions: SIMPLE IRAs prohibit certain investments that are also restricted in traditional IRAs, including life insurance, collectibles (with limited exceptions for certain coins and precious metals), and certain derivative positions.

SIMPLE IRA distributions are subject to specific rules governing when and how funds can be withdrawn:

• Early Withdrawal Penalty: Distributions taken before age 59½ are generally subject to a 10% early withdrawal penalty in addition to ordinary income tax. However, if the distribution occurs within the first two years of participation in the plan, the penalty increases to 25%.

• First Two Years Rule: During the first two years of participation (starting with the first day contributions are deposited), rollovers or transfers can only be made to another SIMPLE IRA without incurring the 25% penalty. After two years, rollovers to other types of retirement accounts are permitted.

• Penalty Exceptions: The 10% early withdrawal penalty (but not ordinary income tax) may be waived under certain circumstances, including:

  • Death or disability of the participant
  • Substantially equal periodic payments (SEPP) under Rule 72(t)
  • Qualified higher education expenses
  • First-time home purchase (up to $10,000 lifetime limit)
  • Unreimbursed medical expenses exceeding 7.5% of adjusted gross income
  • Health insurance premiums during unemployment

• Required Minimum Distributions (RMDs): Participants must begin taking RMDs by April 1 of the year following the year they turn 73 (as of 2025, with this age increasing to 75 by 2033 under the SECURE 2.0 Act). Annual distributions must meet minimum amounts based on life expectancy tables published by the IRS.

• Inherited SIMPLE IRAs: Distribution rules for inherited SIMPLE IRAs depend on the relationship to the deceased owner and when the owner died:

  • Surviving spouses have the option to treat the inherited SIMPLE IRA as their own
  • Most non-spouse beneficiaries are now required to withdraw all funds within 10 years, following the SECURE Act changes
  • Certain eligible designated beneficiaries (minor children, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased) may still use life expectancy payout methods

Understanding how SIMPLE IRAs compare to other retirement plans helps employers and employees determine the most appropriate option:

• SIMPLE IRA vs. Traditional 401(k): 401(k) plans offer higher contribution limits ($23,500 employee contribution in 2025 vs. $16,000 for SIMPLE IRAs) and greater plan design flexibility, but come with more complex administration, potential testing requirements, and higher costs. SIMPLE IRAs require employer contributions, while 401(k) employer contributions are optional.

• SIMPLE IRA vs. SEP IRA: SEP IRAs allow higher potential contributions (up to 25% of compensation or $69,000 in 2025, whichever is less) but only employers can contribute. SIMPLE IRAs allow both employer and employee contributions. SEP IRAs can be established up until the tax filing deadline, while SIMPLE IRAs must be established by October 1.

• SIMPLE IRA vs. Traditional IRA: Traditional IRAs have lower contribution limits ($7,000 in 2025, plus $1,000 catch-up) and no employer involvement. SIMPLE IRAs include mandatory employer contributions and higher employee contribution limits. Traditional IRA deductibility phases out at higher income levels, while SIMPLE IRA contributions are always pre-tax regardless of income.

• SIMPLE IRA vs. Solo 401(k): For self-employed individuals with no employees, Solo 401(k)s allow significantly higher total contributions (up to $69,000 in 2025, plus $7,500 catch-up) compared to SIMPLE IRAs. However, Solo 401(k)s may involve more paperwork and cannot accommodate employees other than the business owner and spouse.

• Plan Selection Considerations: Key factors in choosing between retirement plans include:

  • Business size and number of employees
  • Budget for employer contributions
  • Desired employee contribution limits
  • Administrative complexity tolerance
  • Need for plan design flexibility
  • Potential future growth of the business

Practical examples help illustrate how SIMPLE IRAs work in various scenarios:

• Small Retail Business: A boutique clothing store with 15 employees establishes a SIMPLE IRA with the 3% matching contribution option. An employee earning $50,000 annually decides to contribute 6% of their salary ($3,000) to the plan. The employer provides a matching contribution of $1,500 (3% of $50,000). Over 25 years, assuming a 7% annual return and no salary increases, these annual contributions of $4,500 would grow to approximately $285,400.

• Self-Employed Consultant: A self-employed marketing consultant with net earnings of $100,000 establishes a SIMPLE IRA. As both employer and employee, she contributes $16,000 as an employee contribution and $3,000 as the required 3% employer matching contribution. Being over 50, she also adds the $3,500 catch-up contribution, for a total annual contribution of $22,500. This reduces her taxable income by the same amount, providing significant tax savings while building retirement assets.

• Growing Technology Startup: A technology startup with 40 employees and fluctuating profitability chooses the SIMPLE IRA with the option to reduce the matching percentage in less profitable years. In 2025, the company provides the full 3% match, but in 2026, facing cash flow challenges, reduces the match to 1%. In 2027, having secured additional funding, the company returns to the 3% match. This flexibility helps the company maintain a retirement benefit during financial uncertainty.

• Family Restaurant: A family-owned restaurant with 10 full-time and 15 part-time employees establishes a SIMPLE IRA with the 2% nonelective contribution option. This choice ensures that all eligible employees receive retirement contributions regardless of their ability to make salary deferrals, which is beneficial for lower-wage workers who might struggle to save. An employee earning $30,000 would receive $600 annually (2% of $30,000) from the employer, even if they cannot afford to make their own contributions.

• Transitioning from SIMPLE IRA to 401(k): A software development firm starts with 20 employees and a SIMPLE IRA plan. As the company grows to 90 employees and increases profitability, it decides to terminate the SIMPLE IRA (effective January 1 following required notice) and establish a 401(k) plan that offers greater contribution limits and plan design flexibility. The company provides employees information about rollover options for their existing SIMPLE IRA balances after the two-year participation rule has been satisfied.

The SIMPLE IRA landscape continues to evolve with regulatory changes and market trends:

• SECURE 2.0 Act Changes: The SECURE 2.0 Act of 2022 introduced several changes affecting SIMPLE IRAs:

  • Increased RMD age (73 in 2023, increasing to 75 by 2033)
  • Enhanced catch-up contribution provisions for participants ages 60-63 starting in 2025
  • Emergency savings provisions allowing certain penalty-free withdrawals
  • Increased penalties for failure to provide required notices to employees

• Enhanced Contribution Limits: Inflation adjustments have steadily increased contribution limits, with the basic limit rising from $13,500 in 2020 to $16,000 in 2025, providing greater savings opportunities for participants.

• Digital Administration Improvements: Financial institutions are increasingly offering streamlined digital platforms for SIMPLE IRA administration, making plan management easier for small employers through:

  • Electronic enrollment for employees
  • Automated contribution processing
  • Enhanced reporting and monitoring tools
  • Employee self-service portals for investment management

• Financial Wellness Integration: There is a growing trend toward incorporating SIMPLE IRAs into broader financial wellness programs that address employees’ overall financial health, not just retirement savings. This includes:

  • Educational resources on budgeting, debt management, and investing
  • Retirement readiness calculators and planning tools
  • Integration with emergency savings strategies
  • Personalized financial guidance

• Investment Option Expansion: Financial institutions are expanding the range of investment options available in SIMPLE IRAs to include:

  • ESG (Environmental, Social, and Governance) focused funds
  • Inflation-protected securities
  • More sophisticated target-date fund strategies
  • Lower-cost index fund options

• Competitive Small Business Market: With the tight labor market, more small businesses are adopting SIMPLE IRAs as a competitive benefit to attract and retain employees, recognizing that retirement benefits rank highly in employee prioritization of workplace benefits.

The SIMPLE IRA is an effective and user-friendly retirement plan for small businesses, providing both employers and employees with a viable avenue for future savings. With its low administrative costs, immediate vesting and flexible contribution options, the SIMPLE IRA stands as a valuable resource for businesses aiming to offer meaningful retirement benefits. By embracing this plan, small businesses can enhance their employee value proposition, foster financial security for their workforce and contribute to a more stable and motivated workplace.