What is a SIMPLE IRA and How Much Can I Contribute?

Investing for the future is generally a good idea, whether you’re decades away from retirement or in the home stretch of your career. So how much money will you actually need in retirement? Experts usually suggest socking away roughly 75 percent of your pre-retirement income for every year you’ll be out of the workforce.

Tax-advantaged retirement accounts can put real muscle behind your efforts, helping your money grow more. Employer-sponsored 401(k) accounts are pretty standard these days at big companies, but if you work for a small business, a SIMPLE IRA may be part of your benefits package instead. 

Let’s break down how they work and how to maximize your contributions.

What is a SIMPLE IRA?

Individual retirement accounts (IRAs) come with unique tax benefits that make building your nest egg a little easier. SIMPLE IRAs—shorthand for Savings Incentive Match Plan for Employees’ Individual Retirement Account—are available to small businesses that want to offer their employees a tax-friendly retirement plan. They must have 100 or fewer employees to qualify, and there are some rules around contributions (more on this in a minute), but SIMPLE IRAs are typically more cost-effective and easier to manage than 401(k) plans.

They’re beneficial for employees, too. The pre-tax dollars you put in are taken directly from your regular earnings, and you’re decreasing your taxable income in the process. Plus, your money grows tax-free, meaning you don’t pay annual taxes on the gains you make in your account.

You’ll just have to pay income taxes on any money you withdraw during retirement. Like other similarly structured retirement plans, you’ll generally be hit with an additional 10 percent penalty if you tap your money before age 59 ½. (There are some exceptions.)That number goes up to a hefty 25 percent if you make a withdrawal within two years of first participating in a SIMPLE IRA.

What are the contribution limits?

SIMPLE IRAs have their perks as far as contributions go. For starters, your employer is required to kick into your account. This can happen in one of two ways: they can either deposit the equivalent of a percentage of your salary directly into your account, or match a portion of your contributions. Either way, it’s essentially free money. Another kicker is that your cash is vested from the get-go, so the balance is yours, free and clear.

You can contribute up to $13,500 into a SIMPLE IRA in 2020 if you’re under age 50. Folks who are 50 and older can throw in an additional $3,000. Whatever you contribute, your employer is typically required to match what you put in, dollar for dollar, up to 3 percent of your earnings. 

Alternatively, your employer may choose to make nonelective contributions that equal 2 percent of your compensation. If they go this route, you do not have to defer any of your salary into your SIMPLE IRA to get that 2 percent contribution. 

How do I know if I qualify for a SIMPLE IRA?

A SIMPLE IRA has to be something your employer offers, so reach out to your HR department to see if it’s part of your benefits package. If it is, and you want to get rolling, you may have to jump through some eligibility hoops. 

For example, some companies will require you to have earned at least $5,000 during any two years prior to the current calendar year to be eligible for a SIMPLE IRA. You may also be expected to earn that much during the enrollment year. Employers can also exclude workers who belong to a union that has negotiated retirement benefits on their behalf. The IRS does allow employers to adopt less restrictive eligibility requirements, so it really all depends on the company’s internal guidelines.

Am I allowed to contribute to other retirement plans at the same time?

The short answer is yes, even if you contributed to another retirement plan that’s sponsored by a different employer.

How is a SIMPLE IRA different from a 401(k)?

SIMPLE IRAs are sort of like smaller-scale 401(k)s. Both let you invest on a pre-tax basis, which reduces your taxable income, and your money grows tax-deferred (meaning you don’t pay annual taxes on gains) until you take it out. There are required minimum distributions on both the year you turn 72. In other words, you must start withdrawing a minimum amount of money from the account at that time. The main difference for employees between a SIMPLE IRA and a 401(k) is that you can contribute more to a 401(k)—$19,500 for workers under 50 or $26,000 for folks 50 and over in 2020. 

Remember that 25 percent early withdrawal penalty on SIMPLE IRAs we mentioned before? It’s only 10 percent on 401(k)s. To be clear, that’s still a lot to pay, which is why dipping into your nest egg ahead of time is rarely a good idea.

Transferability is another big difference. Rolling over a 401(k) into a traditional IRA or a new 401(k) at a different employer won’t put you on the hook for income taxes; that’s not always the case with SIMPLE IRAs.

So what happens to my SIMPLE IRA if I leave my company?

The answer depends on when you began participating in the plan. If it’s been less than two years, your balance can only be transferred into another SIMPLE IRA. Otherwise, it’s considered a distribution and you’ll have to pay taxes on that money plus those steep penalty fees we mentioned earlier. But once you’re out of that two-year window, you can roll over your SIMPLE IRA, tax-free, into another IRA (excluding Roth IRAs) or an employer-sponsored retirement plan. This includes a 401(k). 

What are the downsides of SIMPLE IRAs?

There are definite perks and drawbacks to SIMPLE IRAs. The contribution limits aren’t quite as high as what 401(k)s have to offer. And the early withdrawal fees could put a significant dent in your balance, should you need to access that money ahead of retirement. Rolling your account over into a new retirement plan can also be a pain.

That being said, SIMPLE IRAs can make a lot of financial sense if your employer offers one—especially if they’re willing to make regular 2 percent contributions on your behalf. (Yes, please.) When it comes to unlocking easy money, it doesn’t get much simpler than that.