Understanding SIMPLE IRAs

Important Note

This information is for educational purposes only. Our firm does not provide legal, tax, or accounting advice. This guide should not be considered legal, tax, or accounting advice. Please consult with qualified professionals about your specific situation before making retirement planning decisions.

What Is a SIMPLE IRA?

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement plan designed for small businesses with 100 or fewer employees. It’s simpler to administer than a 401(k) but offers many of the same benefits—tax-deferred growth, employee contributions, and required employer contributions.

Think of a SIMPLE IRA as a “starter 401(k)” for small businesses. It provides meaningful retirement benefits without the complexity and cost of traditional qualified plans, making it accessible to small employers who might otherwise offer nothing.

How SIMPLE IRAs Work

The basic structure:

1. Employer establishes plan (minimal paperwork)
2. Employees contribute via payroll deduction
3. Employer must contribute (matching or non-elective)
4. Money grows tax-deferred
5. Withdrawals taxed as ordinary income in retirement

Key Features

• Employee salary deferrals (pre-tax)
• Mandatory employer contributions
• Immediate 100% vesting
• Individual IRA accounts for each participant
• Lower contribution limits than 401(k)

2026 Contribution Limits

Employee Contributions

• Under age 50: $16,500
• Age 50-59 or 64+: $20,000 (includes $3,500 catch-up)
• Ages 60-63: $21,750 (enhanced catch-up of $5,250)

Employer Contributions (Required)

Employers must choose one:

Option 1: Matching Contribution

• Match employee contributions dollar-for-dollar
• Up to 3% of compensation
• Can reduce to 1% for 2 of any 5 years

Option 2: Non-Elective Contribution

• 2% of compensation for ALL eligible employees
• Even those who don’t contribute
• Based on compensation up to $350,000 (2026)

SIMPLE IRA vs. Other Plans

SIMPLE IRA vs. SEP IRA

SIMPLE IRA vs. 401(k)

SIMPLE IRA vs. Solo 401(k)

Who Can Establish a SIMPLE IRA?

Eligible Employers

• 100 or fewer employees earning $5,000+ in prior year
• No other qualified retirement plan
• Any business structure (sole prop, partnership, corporation, nonprofit)

Eligible Employees

Must be allowed to participate if:

• Earned at least $5,000 in any 2 prior years
• Expected to earn $5,000 in current year
• Can exclude union employees and nonresident aliens

Employer Contribution Options

The Matching Formula

Standard approach:

• Match 100% of employee deferrals
• Up to 3% of employee’s compensation
• Employee contributes 3%+ to maximize match

Reduced Match Option:

• Can reduce match to as low as 1%
• Only for 2 years in any 5-year period
• Must notify employees in advance

The Non-Elective Formula

Alternative approach:

• Contribute 2% of compensation for ALL eligible employees
• Whether they contribute or not
• Compensation capped at $350,000 (2026)
• Maximum employer contribution: $7,000 per employee

Which to Choose?

Matching: Lower cost if not all employees contribute Non-Elective: Simpler, benefits all employees equally

Tax Treatment

For Employees

• Contributions reduce taxable income
• Growth is tax-deferred
• Withdrawals taxed as ordinary income
• Same as Traditional IRA/401(k)

For Employers

• Contributions are tax-deductible
• Reduces business income
• Immediate deduction in year of contribution
• No complex discrimination testing

The Two-Year Rule

Critical SIMPLE IRA restriction:

The Rule

During the first two years of participation, transferring SIMPLE IRA assets to a non-SIMPLE IRA triggers:

• 25% early withdrawal penalty (instead of normal 10%)
• Plus ordinary income tax

After Two Years

• Normal 10% early withdrawal penalty applies
• Can roll to Traditional IRA, 401(k), etc.
• Full portability restored

Planning Implication

• Track your two-year anniversary
• Don’t consolidate accounts too early
• The clock starts with first contribution

Establishing a SIMPLE IRA

Timeline

• Must be established by October 1 for that year
• New businesses: can establish later in first year
• Must be in place before first contribution

Required Steps

1. Choose financial institution
2. Complete IRS Form 5304-SIMPLE or 5305-SIMPLE
3. Notify eligible employees
4. Set up payroll deductions
5. Begin contributions

Form 5304 vs. 5305

• 5304-SIMPLE: Employees choose their own financial institution
• 5305-SIMPLE: Employer designates one institution for all

Employee Participation

Enrollment

• Employees elect to participate
• Choose contribution amount (up to limit)
• Can change elections during designated periods

Election Periods

• At least 60-day period before each calendar year
• Employer can allow more frequent changes
• Many plans allow changes anytime

Automatic Enrollment

• Permitted since SECURE 2.0
• Can automatically enroll employees
• Must allow opt-out

Investment Options

SIMPLE IRA investments are self-directed:

• Employees choose their own investments
• Options depend on financial institution
• Typically include mutual funds, ETFs, stocks, bonds
• Same as regular IRA options

Roth SIMPLE IRA Option

Starting in 2023, SIMPLE IRAs can offer Roth contributions:

How It Works

• Employees can designate contributions as Roth
• No tax deduction now
• Tax-free growth and withdrawals
• Same limits as Traditional SIMPLE

Considerations

• Not all plans offer Roth option
• Employer contributions always pre-tax
• Employee choice for their deferrals

Advantages of SIMPLE IRAs

For Employers

• Easy to set up and administer
• Low cost compared to 401(k)
• No annual Form 5500 filing
• No discrimination testing
• Tax deduction for contributions

For Employees

• Pre-tax savings opportunity
• Guaranteed employer contributions
• Immediate 100% vesting
• Portable accounts
• Roth option available

Disadvantages of SIMPLE IRAs

Lower Contribution Limits

• $16,500 vs. $23,500 for 401(k)
• Less tax-deferred savings opportunity
• May not be enough for high earners

Mandatory Employer Costs

• Must contribute every year
• Can’t skip contributions
• Ongoing expense commitment

Two-Year Penalty Rule

• 25% penalty for early transfers
• Limits flexibility initially
• Must track participation dates

No Loans

• Can’t borrow from SIMPLE IRA
• Unlike many 401(k) plans
• Less emergency flexibility

Limited Features

• No profit-sharing component
• No vesting schedules
• Fewer customization options

Who Should Consider a SIMPLE IRA?

Ideal Candidates

• Small businesses (under 100 employees)
• Employers wanting simple administration
• Businesses where employees want to save
• Companies unable to afford 401(k) costs
• Employers wanting immediate vesting

Less Suitable

• Self-employed with no employees (Solo 401(k) better)
• High earners wanting maximum savings (SEP or 401(k))
• Businesses wanting plan loans
• Companies with complex benefit needs

Transitioning from SIMPLE IRA

Moving to 401(k)

If business grows or needs change:

• Can terminate SIMPLE IRA
• Must be done properly
• 2-year waiting period for some changes
• Employees roll SIMPLE IRAs to new plan

Timing

• Can only terminate at end of calendar year
• Must notify employees
• Plan alternative contributions

Common Mistakes to Avoid

Missing Contribution Deadlines

• Employee deferrals: as soon as possible (generally within 30 days)
• Employer contributions: due by tax filing deadline

Violating Two-Year Rule

• 25% penalty is harsh
• Track participation dates carefully
• Educate employees

Incorrect Matching

• Must match correctly per plan terms
• Calculate on correct compensation
• Apply limits properly

Missing Eligible Employees

• Must include all who meet requirements
• Can’t discriminate
• Review eligibility annually

SIMPLE IRA Withdrawal Rules

Before Age 59½

• 10% early withdrawal penalty (standard)
• 25% if within first two years of participation
• Plus ordinary income tax
• Some exceptions apply

After Age 59½

• No penalty
• Ordinary income tax applies
• Same as Traditional IRA

Required Minimum Distributions

• Begin at age 73 (or 75 starting 2033)
• Same rules as Traditional IRA
• Must calculate and withdraw annually

Making the Most of Your SIMPLE IRA

For Employees

1. Contribute at least 3% to maximize employer match
2. Increase contributions over time
3. Choose appropriate investments
4. Consider Roth option if available
5. Track your two-year date
6. Don’t withdraw early if possible

For Employers

1. Communicate plan benefits to employees
2. Make timely contributions
3. Consider matching vs. non-elective annually
4. Review plan competitiveness
5. Consider transition to 401(k) if appropriate

The Bottom Line

SIMPLE IRAs offer small businesses an accessible path to providing retirement benefits without the complexity and cost of traditional 401(k) plans. The mandatory employer contribution ensures all participating employees receive retirement savings support, while immediate vesting means employees own their accounts from day one.

While contribution limits are lower than 401(k) plans, the simplicity and low administrative burden make SIMPLE IRAs attractive for small employers. The Roth option adds flexibility for employees wanting tax-free retirement income.

For small businesses looking to offer retirement benefits without significant administrative burden, SIMPLE IRAs provide an excellent balance of features and simplicity. Employees benefit from tax-advantaged savings and guaranteed employer contributions, while employers enjoy straightforward administration and tax deductions.

The key is understanding the limitations—lower contribution limits, mandatory employer costs, and the two-year transfer penalty—and ensuring they align with your business and employee needs.

This guide provides general educational information about SIMPLE IRAs. Individual circumstances vary, and specific rules may change. Consult with qualified professionals for advice about your personal situation.