Due to their complexity and expense, retirement plans are typically avoided by small firms. A recent study by ShareBuilder 401k found that only 26% of small businesses provide 401(k) plans. The majority of poll participants—nearly 60%—believe their company is too small to be eligible for one, and approximately one-third claim they cannot afford a matching payment.
A SIMPLE IRA can be exactly what small businesses need to assist with employee retirement savings.
Describe the SIMPLE IRA.
A SIMPLE IRA offers small businesses an easy and affordable method to set up a retirement plan for their employees.
An excellent approach for employees to preserve their future is through a SIMPLE IRA. Additionally, since employers sometimes make up a sizable component of a small firm, a SIMPLE IRA might assist them in creating their own retirement plan. A SIMPLE IRA can be established by employers (including self-employed people) with fewer than 100 employees who made more than $5,000 the previous year.
Here are some additional details on the SIMPLE IRA.
Workings of a SIMPLE IRA
A SIMPLE IRA is essentially different from a standard IRA or a Roth IRA, even if the plan is known as an IRA. These latter IRAs, which have different yearly contribution caps, plan regulations, and purposes, were created by employees for themselves. Instead, a SIMPLE IRA resembles a 401(k) plan more, but it is typically simpler for the business to set up and administer.
For a reason, it is called SIMPLE, which stands for Savings Incentive Match Plan for Employees. Unlike with 401(k) plans, employers are not subject to onerous regulatory reporting obligations. Additionally, individuals can establish the plan through the financial institution that will manage it.
Limits on contributions
The SIMPLE IRA enables employees to have money taken from their paychecks, just like a typical retirement plan does. In 2022, employees may defer up to $14,000. People over 50 can postpone an additional $3,000 catch-up contribution. These contributions, which are referred to as “elective deferrals,” contribute toward the yearly cap on elective deferrals to this retirement plan as well as other retirement plans.
Employers have two ways to contribute money to their employees’ SIMPLE IRA accounts, and they are required to do so:
Match employee contributions up to 3% of individual earnings, dollar for dollar.
Contribute non-electively up to 2 percent of wage earners’ salaries up to the 2022 annual salary cap of $305,000.
A SIMPLE IRA example
Consider earning $60,000 annually and having your employer match up to 3% of your salary in contributions. Including the match, you want to save a total of 10% of your income. You therefore decide to withhold 7% of your own compensation from each paycheck.
Pre-tax savings of $4,200 over the course of the year would be matched by an employer contribution of $1,800, for a combined contribution of $6,000. You will have earned the full employer match of 3% because you gave more than 3% of your pay.
In this case, in order to receive the employer match, you had to make a financial contribution. Employers may, however, provide employees with a non-elective contribution of 2%.
In the second case, regardless of whether they made a contribution from their own salaries, all qualified employees would still be given a contribution. Your employer would contribute a total of $1,200 to your retirement plan for the entire year, based on your $60,000 annual salary. After that, you could make any further contributions up to the annual contribution cap.
Rules for withdrawal
A SIMPLE IRA performs similarly to a regular IRA in terms of distributions. Only when money is withdrawn from the account is it taxed. Despite the fact that you can withdraw money at any time, there may be a 10 percent tax (and, in some cases, a special 25 percent tax), unless you wait until you are at least 5912 years old or meet another exception.
According to the IRS’s required minimum distribution (RMD) regulations, funds in a SIMPLE IRA must eventually be withdrawn. The SECURE Act upped the RMD eligibility age to 72.
Benefits and drawbacks of SIMPLE IRAs
Pros
- As soon as they begin saving, employees become fully vested, so any employer contributions are theirs right away.
- Employees can successfully contribute with pre-tax income to their SIMPLE IRAs even though they cannot deduct their contributions on their tax returns because the contributions are not considered income.
- Tax-deferred growth of earnings is possible up until withdrawal.
- 401(k) establishment fees are lower, and administrative administration requirements are less.
Cons
- For SIMPLE IRAs, there isn’t a Roth option that enables employers and employees to take tax-free distributions in retirement.
- You can still make contributions to other retirement plans on your own or through a second job, even though SIMPLE IRA contribution caps are lower than those for 401(k) plans.
- If the distribution is made within the first two years of your membership in the plan, you will be subject to a 25 percent penalty; if it is made after that, you will be subject to a 10 percent penalty. In the meanwhile, the absolute maximum penalty for early withdrawals from 401(k) plans is 10%.
- On SIMPLE IRAs, loans are not offered.
401(k) versus SIMPLE IRA (k)
Although both 401(k) plans and SIMPLE IRAs are beneficial for retirement savings, there are some significant variations between the two plans. While 401(k) plans can be formed at any workplace with one or more employees, SIMPLE IRAs are specific to small businesses and can only be used by employers with 100 or fewer employees.
In contrast to SIMPLE IRAs, 401(k) plans do not require employer contributions. Additionally, 401(k) plans have higher contribution caps than SIMPLE IRAs do.
401(k) plans have higher costs and more administrative work, whereas a SIMPLE IRA has no annual tax filing requirement and relatively cheap costs. A 401(k) plan’s investment options are also more constrained and are decided by the employer and a plan administrator.
The possibility of a Roth option in 401(k) plans, which enables pre-tax contributions and tax-free withdrawals during retirement, is a significant benefit.
To sum up
With less difficulty and price than a normal 401(k) plan, a SIMPLE IRA is a fantastic alternative for a small business to set up a retirement plan for its employees. Employees can take advantage of the tax savings and matching benefits of the plan.
A SEP IRA and a solo 401(k), both of which can allow for higher contribution limits, are other appealing alternatives available to small businesses, so it’s vital to research which one is best for your circumstances.
