What Are the Benefits of a Simple IRA for Small Business Owners?

The Benefits of a SIMPLE IRA for Your Small Business

As someone who is self-employed, my retirement plan looks a little different than most. Employee-sponsored 401(k)s and pensions plans are not in the cards for me, and there are a few more tax considerations as well. So, I need something easy to implement, that will offer substantial tax breaks, and allow me to maximize my contributions. Now that I’m looking for a new retirement vehicle to add to my portfolio, a SIMPLE IRA may be the answer to my problem.

What Is a SIMPLE IRA?

A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is an Individual Retirement Account that is specifically designed for sole proprietors and small business owners. It works well for smaller employers who want to offer retirement benefits since it is easy to set up and maintain. Like other retirement plans, both the employer and employee can make contributions and receive tax benefits.

What are the Benefits of a SIMPLE IRA?

This type of retirement plan offers many benefits to both the employer and the employee.

1. It is to set up and maintain.

The first benefit is the convenience and easy process to set it up. There are fewer reporting requirements with a SIMPLE IRA than with other types of retirement accounts such as a 401(k). So, there is less paperwork involved to set up and maintain it.

2. There are fewer fees.

In that same line of thought, there are also fewer administrative fees to set them up. In general, the overall costs are lower when compared to the other alternatives. This makes it easier for small businesses to offer retirement benefits and attract more skilled employees.

3. It offers significant tax breaks.

Although you can’t claim your contributions as a deduction, you can defer part of your salary into these accounts. Since they would qualify as pre-tax income, any contributions you make to a SIMPLE IRA will lower your overall taxable income. And, your balance will continue growing, tax-deferred. The compounding interest will help you to maximize your earnings.

Additionally, it allows you to avoid the capital gains tax when you buy and sell within the account. The account is tax-deferred, so you won’t have to worry about this until you start receiving distributions.

And if your gross income is below a certain threshold, you may also qualify for the saver’s credit if you made contributions to your employer-sponsored retirement plan.

Employers also receive tax benefits as well. They can claim a 50% tax credit for up to $500 to offset the start-up costs for the first three years. The incentives make it more enticing for small business owners to set up these plans as well.

4. It has instant vesting.

With some employee-sponsored plans, sometimes there is a vesting period. This requires the employee to stay with the company for a set number of years to receive the matching contributions. However, with a SIMPLE IRA, any money deposited into the account is immediately yours, no waiting.

5. It increases the amount I can contribute.

As a sole proprietor, I can maximize my contributions as both employer and employee. In theory, it allows me to contribute double the amount that is allowed with a traditional IRA. As an employer, the contribution threshold for 2022 is $14,000. However, the maximum total is $20,500. If I can max out my contributions, it allows me a greater capacity to save for my retirement.  

Are There Restrictions on a SIMPLE IRA?

No retirement plan is perfect. So, it is important to be aware of the restrictions and requirements that are associated with a SIMPLE IRA.

Eligibility Requirements

As an employer, you must have 100 employees or less. And, you must make annual contributions to the account. You can do this in two ways: by electing to match their contributions with a limit of 3% or with a non-elective contribution of 2%. You can switch between matching or non-elective with notice.

To be eligible as an employee, you must have received at least $5,000 in compensation for the calendar year. Furthermore, you must have received at least the same minimum during two previous years as well.

Limitations

First off, a SIMPLE IRA is not available as a Roth account. It also has different thresholds for maximum yearly contributions. For 2022, you can make a maximum contribution of $14,000, or $17,000 for those over 50. The total contribution is $20,500, or $27,000 for 50 and older. You also can’t max out this account if you have already reached the limit on another employer-sponsored retirement account.

The other feature of this tax-advantaged account is that you won’t pay any taxes until you start taking withdrawals. At that point, it will be taxed like normal income. There is also a 10% penalty if you withdraw before age 59 1/2 and a 25% penalty if you withdraw within 2 years of the first contribution. However, there are some qualified exemptions for early withdrawal.

Account Setup

If you choose a SIMPLE IRA, it is fairly simple to get started. You can partner with a financial institution to offer employers an individual account. Or, you can create the infrastructure and allow employees to set up their own accounts with their chosen institution. Employees who choose to participate will fill out the SIMPLE IRA adoption agreement, and then they can open the account with the designated custodian.

Is a SIMPLE IRA Right for You?

Any time an employer offers a retirement plan, it’s a good idea to participate. Otherwise, you are leaving free money on the table. It is also a great benefit for small businesses if they want to offer retirement benefits because it’s easy to set up and manage.

However, each situation is different. For me, a SIMPLE IRA gives me another investment vehicle and increases the amount I can contribute as both employer and employee. Therefore, it’s a no-brainer when compared to a 401(k) or traditional IRA. But what works for me may not be the best solution for everyone. So, you should review your options with your financial advisor to determine which is most beneficial for your specific circumstances.

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