Table of Contents

SIMPLE IRA: Definition, How Small Businesses Use, and Drawbacks

By

Julia Kagan

Updated March 30, 2024

Reviewed by Eric Estevez

Fact checked by Jiwon Ma

Financial advisor having a meeting with clients — Bloom Productions / Getty Images

What Is a SIMPLE IRA?

A SIMPLE IRA is a retirement savings plan that most small businesses with 100 or fewer employees can use. "SIMPLE" stands for "Savings Incentive Match Plan for Employees," while IRA is the acronym for individual retirement account. Employers can choose to make a non-elective contribution of 2% of the employee's compensation or a dollar-for-dollar matching contribution of the employee's contributions to the plan, up to 3% of their compensation.

Key Takeaways

A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a type of tax-deferred retirement savings plan.
SIMPLE IRAs are easy to set up, and they can be a good option for small businesses.
However, they do have some drawbacks, such as the business owner cannot save as much as with other small business retirement plans.

Understanding the SIMPLE IRA

Employees can contribute a maximum of 16,000 annually in 2024 ($15,500 in 2023). The maximum is increased periodically to account for inflation. Retirement savers ages 50 and older may make an additional catch-up contribution of $3,500 (for 2024 and 2023), bringing their annual maximum to $19,500 in 2024 ($19,000 for 2023).

One of the many major provisions, now law, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, the government will provide a maximum tax credit of $500 per year for three years to small employers who create a plan with automatic enrollment.

The appeal of SIMPLE IRAs is that they have minimal paperwork requirements, just an initial plan document and annual disclosures to employees. The employer establishes the plan through a financial institution that administers it. Startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees.

To be eligible to establish a SIMPLE IRA, the employer must have 100 or fewer employees. Those who are self-employed or sole-proprietors are eligible to establish a SIMPLE IRA as well. To participate in the plan, employees must have earned at least $5,000 in compensation in any two previous calendar years and be expected to earn at least $5,000 in the current year. Employers can choose less restrictive participation requirements if they wish. An employer may also choose to exclude from participation employees who receive benefits through a union.

As of December 2015, SIMPLE IRA accounts are permitted to accept transfers from SEP IRAs, traditional IRAs and employer-sponsored plans such as a 401(k).

Special Considerations

Employers establish the plan using Internal Revenue Service (IRS) Form 5304-SIMPLE if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRAs, or using Form 5305-SIMPLE if the employer wants to choose the financial institution where employees will hold their IRAs. Employees must fill out a SIMPLE IRA adoption agreement to open their accounts. Once opened, the employee must wait two years before they can transfer those funds to another retirement account.

Once the plan is established, employers are required to contribute to it each year unless the plan is terminated. However, employers may change their contribution decision between the 2% mandatory contribution and the 3% matching contribution if they follow IRS rules.

Is a SIMPLE IRA Better Than a 401k?

It depends on what your goals and priorities are. The main advantage if a SIMPLE IRA is right in the name: it's easy to set up and maintain. The 401(k) is trickier and often comes with higher management fees. However, the 401(k) offers a higher contributions limit; with the SIMPLE IRA, the annual limit is lower.

What Is the 2 Year Rule for the SIMPLE IRA?

The two year rule says you must wait two years to do a tax-free SIMPLE IRA rollover to another plan, like a traditional IRA or an employer-sponsored retirement plan, like a 401(k). The clock starts when the SIMPLE IRA is created. A SIMPLE IRA may be rolled over to a Roth account after two years, but you "must include any untaxed money rolled over in your income," according to the Internal Revenue Service (IRS).

What Are the Disadvantages of a SIMPLE IRA?

One disadvantage of a SIMPLE IRA is that the business owner cannot save as much for retirement as with other small business retirement plans, such as a simplified employee pension (SEP) or a 401(k) plan, the latter of which also offers higher catch-up contribution limits. Also, a SIMPLE IRA cannot be rolled over into a traditional IRA without a two-year waiting period from the time the employee first joined a plan, unlike a 401(k).

The Bottom Line

A SIMPLE—"Savings Incentive Match Plan for Employees"—IRA is a tax-advantaged retirement savings plan for most small businesses with 100 or fewer employees. Employers have two options: match an employee's contribution up to 3%, or contribute 2% of the employee's compensation, whether or not the employee contributes to the plan. There are drawbacks, however, so take the time to evaluate whether a SIMPLE IRA is right for your small business.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

Internal Revenue Service. "SIMPLE IRA Plan."
Internal Revenue Service. “Retirement Topics—SIMPLE IRA Contribution Limits."
U.S. Congress. "Further Consolidated Appropriations Act, 2020." Page 616.
Internal Revenue Service. "SIMPLE IRA Plan FAQs."
Internal Revenue Service. "SIMPLE IRA Withdrawal and Transfer Rules."
Internal Revenue Service. "Form 5304-SIMPLE."
Internal Revenue Service. "Form 5305-SIMPLE."
"401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000."
Internal Revenue Service. "Rollover Chart."

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