Simple IRA Pros and Cons
Selecting the appropriate retirement plan can be daunting, particularly for business owners responsible for safeguarding their employees’ financial futures. Numerous options exist, but each comes with its own set of advantages and disadvantages.
In this article, you’ll learn about the Savings Incentive Match Plan for Employees, or Simple IRA, in greater detail. You’ll be exposed to its eligibility, benefits, drawbacks, and set up process. Lastly, you’ll be provided with actionable steps to help put the right plan in place for you and your business.
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Simple IRA Rules 2023
Employers (including self-employed individuals) may establish a Simple IRA, provided they had no more than 100 employees who received $5,000 or more in compensation during the previous year. Consequently, Simple IRAs are usually more ideal for smaller businesses.
According to the IRS, eligible participants in a Simple IRA must:
- Have received at least $5,000 during any two non-consecutive years in the past
- Be reasonably expected to earn a minimum of $5,000 in the current year
Please Note: The IRS allows for the reduction or elimination of these compensation requirements for the past or current year. For instance, an employee who earned $3,500 last year could still be allowed to participate in the Simple IRA plan.
Simple IRA Contributions Limits 2023
Simple IRAs enable substantial contributions, but these limits may change according to IRS guidelines. In 2023, the limitations on employee contributions to Simple IRAs include:
- A maximum of $15,500 per employee in salary reduction contributions
- A maximum of $3,500 in catch-up contributions for employees aged 50 or older
Regarding employer contributions, you must choose one of two methods each year and inform your employees:
- A 2% non-elective contribution: Contributing 2% of each eligible participant’s pay, irrespective of their own contributions
- A 3% matching contribution: Matching eligible participant contributions dollar-for-dollar, up to 3% of the participant’s total income
Please Note: Your match can be lower than 3% for no more than 2 years within a 5 year window, but never below 1%.
Simple IRA Benefits
Potentially Higher Contribution Maximums: Simple IRAs allow for higher contributions compared to traditional and Roth IRAs, which are capped at $6,500 in 2023 ($7,500 if age 50 or older). However, Simple IRA contributions can reach $15,500 ($19,000 if age 50 or older).
Catch-Up Contributions: In 2023, Simple IRAs permit catch-up contributions of $3,500 for individuals aged 50 or older, unlike some employer-sponsored retirement plans like SEP IRAs.
Tax-Deferred Contributions: Simple IRA contributions are tax-deferred, allowing for deductions during tax season.
Low Cost and Easy Set Up: Simple IRAs are simpler and typically less expensive to establish and maintain than plans such as a 401(k).
Simple IRA Disadvantages
Potentially Lower Contribution Limits: Simple IRA limits may be higher than standard Roth and traditional IRAs but lower than some other plans. For example, a solo 401(k) has a 2023 contribution limit of $66,000 (plus $7,500 in catch-up contributions).
No Roth Option: Simple IRAs do not offer a Roth option, meaning after-tax contributions are not possible.
No Additional Retirement Accounts: Employers cannot have a separate IRA in addition to their Simple IRA, unlike with 401(k) plans.
Severe Early Withdrawal Penalties: Simple IRAs impose a 10% penalty on withdrawals made before age 59½, and 25% on withdrawals made within 2 years after initially joining the plan.
Setting Up a Simple IRA
Setting up a Simple IRA is a straightforward process for small businesses to offer retirement benefits to their employees. Generally speaking, these are the the steps for setting up a Simple IRA:
Step 1) Determine Eligibility: Remember, to establish a Simple IRA, your business must have 100 or fewer employees. Those employees must also have earned at least $5,000 during the preceding calendar year. Additionally, your business may not maintain another employer-sponsored retirement plan.
Step 2) Choose a Financial Institution: Select a financial institution that offers Simple IRA plans (ex: a bank or brokerage firm). This institution will serve as the trustee/custodian of your Simple IRA accounts.
Step 3) Prepare the Plan Document: You need to establish a written plan document outlining the terms and conditions of your Simple IRA. You can use the IRS Form 5304-SIMPLE or Form 5305-SIMPLE as the plan document, depending on whether you want to allow employees to choose their own financial institution (Form 5304-SIMPLE) or use the same institution for all employees (Form 5305-SIMPLE).
Step 4) Notify Employees: Inform your employees about the Simple IRA plan. Tell them about eligibility requirements, and their right to participate. Provide a summary description of your plan, including contribution limits, matching contributions, and the plan’s vesting schedule.
Step 5) Employee Enrollment: Have eligible employees fill out the necessary paperwork to establish their Simple IRA accounts. This may include completing a form for enrollment, selecting investment options, and providing personal information.
Step 6) Set Up Payroll Deductions: Communicate with your payroll provider to set up automatic payroll deductions for employee contributions. Employees can choose to contribute a percentage of their wages or a specified dollar amount.
Step 7) Employer Contributions: Determine the type of employer contribution you will provide – either a dollar-for-dollar match up to 3% of each employee’s compensation or a 2% non-elective contribution for all eligible employees. Make the necessary arrangements with your payroll provider to make sure your contributions are made in an accurate and timely fashion.
Step 8) Deposit Contributions: Remit employee and employer contributions to the financial institution(s) managing the Simple IRA accounts. Employee contributions must be deposited as soon as possible, but no later than 30 days after the end of the month in which the amounts were withheld from the employee’s pay.
Step 9) Ongoing Plan Maintenance: After setting up a Simple IRA, it is crucial to periodically review the plan to ensure its ongoing effectiveness and compliance. Clear communication with your employees about the plan and any updates is vital. You may also want to consult with a tax professional for guidance on any applicable reporting requirements to maintain your compliance and overall plan success.
How Fisher Investment Strategies Can Help You
At Fischer Investment Strategies, we understand that Simple IRAs can be an attractive option for small business owners. With potentially higher contribution limits and catch-up contributions, tax-deferred contributions, and straightforward setup, they can be a great fit for you and your employees.
If you’re trying to determine what retirement plan is best for you and your business, you’re not alone. Our firm can guide you through the decision-making process. Together, we can determine if a Simple IRA or another retirement account is right for your business.
Don’t leave the financial future of your or your employees to chance. You can reach out to us at our Westlake office at (805) 418-7686. However, you can also fill out a contact card, and we’ll reach back out to you.
Ted Fischer is a Fee-Only Certified Financial Planner® & fiduciary, and the founder of Fischer Investment Strategies.
Drawing from more than 25 years of experience in the financial services industry, Ted's expertise includes retirement planning, investment analysis, tax planning, estate planning, and insurance.
Ted has an extensive academic background. He received his Certified Financial Planning (CFP®) designation from UCLA in 2011. He became a Qualified Plan Financial Consultant (QPFC®) and an Accredited Investment Fiduciary (AIF®). Ted has a Bachelor of Science in Marketing, with a minor in Finance, from San Diego State University.