SIMPLE IRAs
Simple IRAs are a strange type of retirement account, so today, I will outline them in a tell-all guide that I hope you will find helpful! As a friendly reminder, today’s content is strictly educational and not advice (and you can read my full website disclosure statement here).
New job, new retirement plan
With the Great Resignation in full swing, more and more Americans are up and leaving toxic job environments for new and more rewarding opportunities. Consequently, many people are finding themselves with new retirement plans. If you happen to find yourself working for a small business, then the chances are high that you will receive access to a SIMPLE IRA. But, what is a SIMPLE IRA, and how does it enable you to save for your future? Well, without further ado, let’s find out!
The SIMPLE IRA
The SIMPLE IRA, or Savings Incentive Match Plan for Employees Individual Retirement Account, is a retirement plan for small businesses that employ 100 people or less. With minimal costs to establish and maintain, SIMPLE IRAs are common for employers to incentivize employee saving and retention.
Unlike 401(k)s, SIMPLE plans require employers to contribute to employee accounts. And notably, once an employer contribution occurs, employees are 100% vested, meaning that the money is theirs to keep without retention stipulations (refreshing, I know).
All contributions to SIMPLE IRAs before 2023 were pre-tax, which grew tax-deferred until taken out; once removed, distributions were taxed as ordinary income. As of January 1st, 2023, the SECURE Act 2.0 implemented Roth SIMPLE IRA contributions, meaning that contributions by employees (and even employers now) can go into these accounts after taxes and then grow tax free.
How do company contributions work with SIMPLE IRAs?
Mandatory employer contributions are a staple of the SIMPLE IRA. Therefore, when making contributions to employee accounts, employers choose from two formats to meet the government requirements, both of which are determined using gross employee pay.
The first option that an employer can elect requires a 2% contribution to all employee accounts regardless of individual worker participation in the plan (i.e., employees don’t have to save their own money to qualify for the 2% employer contribution). Such contributions are known as non-elective employer contributions.
The second option employers can choose from is to match employee contributions. If elected, employers must match employee contributions dollar for dollar up to 3%. Notably, employers can elect to lower this percentage to a minimum of 1% for up to two years during a rolling five-year period.
What is the employee SIMPLE IRA contribution limit for 2023?
As of 2023, employees may choose to contribute up to $15,500 of their pay a year to a SIMPLE plan. Notably, this limit is exclusive of employer contributions. However, if you are 50 years or older, your limit is raised to $19,000 to help facilitate additional savings as retirement nears. The extra $3,500 limit afforded to individuals who are 50 plus is known as the catch-up contribution limit. A nice gesture for those who are behind on their retirement savings, I know.
Can I make traditional or Roth IRA contributions if I make SIMPLE IRA contributions?
Suppose you are qualified to make a Roth IRA or deductible traditional IRA contribution based on your income level. In that case, you may do so, regardless of your participation in your employer’s SIMPLE plan. Therefore, you could contribute up to $22,000 a year to retirement plans or $26,500 a year if you are 50 plus (assuming you only have access to a SIMPLE and traditional/Roth IRA for saving). However, you may always save in an ordinary brokerage account once you have maxed out all of your retirement accounts!
If I already made 401(k) contributions during the year, can I still save in my new SIMPLE IRA program?
All 401(k), 403(b), and SIMPLE IRA plans share a cumulative limit on tax-preferential contributions $22,500 (or $30,000 for those 50+). Therefore, you can contribute to both a 401(k) and SIMPLE plan during the same year, so long as your pre-tax or Roth contributions between the two do not exceed the cumulative and individual limits. Notably, SEP-IRAs have a separate limit not shared with 401(k), 403(b), and SIMPLE plans.
Moreover, those who have after-tax contribution options available through their 401(k) plan may contribute after-tax dollars to their 401(k) plan even if they have reached the $22,500 or $30,000 pre-tax or Roth cumulative limit for their workplace retirement accounts. (Not familiar with after-tax 401(k) investing? Read After-Tax IRA & 401(k) Investing: A Beginners Guide here.) However, the maximum contribution limit, including all employer contributions, employee traditional/Roth contributions, and employee after-tax contributions, is $66,000 (or $73,500 if 50 plus) as of 2023 for all 401(k), 403(b), and SIMPLE IRA plans.
What investments are available in SIMPLE IRA plans?
While it will vary by employer, generally, employees can invest in various securities, including stocks, bonds, mutual funds, ETFs, money markets, and CDs in their SIMPLE IRA. Therefore, SIMPLE plans generally provide more investment flexibility than their 401(k) brethren. Not shabby at all!
What withdrawal options are available with SIMPLE IRAs?
Since all money within a SIMPLE IRA belongs to the employee once contributed, various withdrawal options are available. However, unlike any other retirement plan, SIMPLE ones are governed by the two-year holding rule.
The two-year holding rule for SIMPLE plans requires that all monies deposited into a SIMPLE cannot be removed from the plan without a 25% tax penalty until two years have passed from the first employee contribution. A stiff penalty to deter people from draining their savings immediately.
Further, once the two-year holding period has passed, if you are under the age of 59.5 and withdraw your funds, a 10% penalty is imposed on the gross withdrawal. However, this penalty and the 25% penalty are not applicable if you have an exemption or qualifying reason for using the funds.
Previously, I wrote a comprehensive list of penalty-free withdrawals, located here: How To Withdraw From IRA & 401k Plans Without Penalty. All penalty-free provisions for withdrawing from a traditional IRA apply to SIMPLE IRAs.
Notably, you cannot rollover a SIMPLE IRA to a traditional IRA, 401(k), 403(b), SEP-IRA, SARSEP, or another retirement plan until two years have passed from your first contribution (unless the destination is another SIMPLE IRA). Additionally, you cannot roll funds into your SIMPLE IRA (unless they are coming from another SIMPLE plan) until this same two-year period has elapsed. (If you just started working at a company with a SIMPLE plan and have an old 401(k) plan that you are unsure what to do with, read my guide here: Left your job or old 401(k): Now what?)
Despite these unique stipulations outlined above, SIMPLE IRAs allow you to process one-time and recurring withdraws. Resultantly, SIMPLE IRAs tend to offer greater withdrawal flexibility than 401(k) plans. But, they do not provide the ability to take a loan against their account value like the former.
In closing and final thoughts
While different than the prototypical 401(k) many have through their employer, you should never hesitate to save in a SIMPLE IRA if given a chance. Because, after all, saving for retirement is something that you must consciously do.
Have you ever saved in a SIMPLE IRA? If so, how was your experience using one, and what type of match did your employer provide? Let me know in the comments below, and as always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time
Hi, I’ve some basic questions which are:
– If both 401K and Simple IRA are pre-tax contributions, tax-deferred withdrawals, what are the advantages to contributing to both instead of keeping money in one? Is it mainly that they offer different products and therefore more diversification, or something else?
– After you put the $20.5K into a 401K pre-tax, is there any advantage to putting more after-tax money into a 401K (vs. say just putting it on E-trade or Vanguard in a regular brokerage account)?
Hi Angie!
Regarding making 401(k) and SIMPLE IRA contributions, you can only do this if you have two different jobs since firms that employ SIMPLE IRAs cannot offer any other retirement plans. Therefore, this option won’t be available unless you change jobs during the year or contribute to both through separate employers. Additionally, there is no diversification benefit of contributing to both, but you may have access to different investments through each. However, if you can receive match by contributing to both, you should; otherwise, there is little reason to use them concurrently.
As for after-tax 401(k) contributions, you do not receive a tax deduction, and the money then grows tax-deferred. Resultantly, after-tax brokerage investing is usually a better bet. However, if someone’s 401(k) plan offers Roth-in-plan-conversions, they should consider it since it raises the practical Roth limit to $61,000 for those folks. Here is an article I previously wrote on the subject: https://milehighfinanceguy.com/backdoor-roth/
Olaf, the Mile High Finance Guy
Ahh, thanks for that! Clears up a bunch of confusion. Tax-deferred growth on 401K is definitely quite useful, especially for longer time horizons. I’ll definitely start shifting some monies into after-tax 401K contributions.
Angie
Generally tax-deferred growth of after-tax money will not be as beneficial as doing ordinary brokerage investing and taking advantage of longterm capital gains rates since you do not receive a deduction on the contributions. I generally only suggest people consider after-tax contributions when Roth-in-plan-conversions are offered on these monies. Does that make sense?
Olaf, the Mile High Finance Guy