What is a SIMPLE IRA?

A Savings Incentive Match Plan for Employees Individual Retirement Account, or SIMPLE IRA, is a retirement savings account that lets employers match their employees’ contributions as well as their own. The SIMPLE IRA is a traditional IRA in that the contributions come from pretax income, and the employer matches them up to a certain percentage.

Deeper definition

The SIMPLE IRA was created in 1997 to replace the SARSEP IRA. Like a traditional IRA, contributions made to a SIMPLE IRA are tax-deferred, meaning that the account holder won’t pay income tax on the amount she deposits into a SIMPLE IRA until she withdraws the money in retirement.

However, unlike a traditional IRA, the account holder’s employer makes matching contributions to the employee’s plan. That makes it similar to the 401(k) plan. Like a 401(k), the employee’s contributions are not tax-deductible, although the employer’s matching contributions can be tax-deductible for the employer.

The contribution rules for a SIMPLE IRA are different from the limit on a traditional IRA or SEP IRA. A SIMPLE IRA allows employee contributions; a SEP IRA doesn’t. Also, the contribution limit for a SIMPLE IRA is considerably higher than it is for a traditional IRA. In 2017, employees can contribute up to $12,500 to a SIMPLE IRA compared to just $5,500 to a traditional IRA, with an additional $3,000 “catch-up” contribution allowed each year after the employee turns 50.

The account holder’s employer may choose between matching the employee’s contributions to a SIMPLE IRA dollar for dollar, up to 3 percent of her salary, or contributing 2 percent of the employee’s salary to the plan, whether she makes contributions or not.

The SIMPLE IRA can be rolled over into another, non-SIMPLE IRA after the employee has participated in the plan for at least two years. But if the employee wants to withdraw from her SIMPLE IRA early, she’ll incur a 25 percent tax penalty if the withdrawal occurs within the first two years of participation and a 10 percent tax penalty for each withdrawal after that period. At age 59 ½, the employee can begin withdrawing from the SIMPLE IRA tax-free.

Need another way to save for retirement? Put some money away in a high-interest savings account.

SIMPLE IRA example

Marco just started working at a local bakery, which has 12 employees. The bakery has established a SIMPLE IRA plan for each employee. It matches employee contributions to the plan until the amount reaches 3 percent of the person’s salary. The first year that Marco worked at the bakery, he earned $25,000 and didn’t make any contributions to his SIMPLE IRA. Since it had nothing to match, the bakery didn’t make any contributions either. The second year, Marco got a raise to $30,000 and decided to contribute the extra $5,000 to his SIMPLE IRA. The bakery matched Marco’s contributions, up to $900, or 3 percent of his salary.


Other InvestingTerms

More From Bankrate