Unlike SEP IRAs, where only employers can make contributions, employees are allowed to contribute part of their pretax compensation to their SIMPLE IRA. Individual employees are able to make “salary reduction contributions” or “elective deferral contributions” of up to $12,500 in 2016.
Next is where the “incentive match” part comes into play. With SIMPLE IRAs, employers are required to contribute on the employee’s behalf, whether or not the employee contributes. Employer contributions may match the employee's contribution dollar-for-dollar, up to 3% of their salary. Or, employers can contribute a fixed 2% in a “nonelective contribution.” Note that 3% is the maximum an employer has to match, and employers can choose to reduce the matching amount to 1% for 2 years in a 5-year period. However, if an employer chooses to do this, they have to match the full 3% for the other 3 years.
To be eligible for a SIMPLE IRA, employers must have 100 or fewer employees that earned more than $5,000 during the previous calendar year. Employers cannot exceed the 100-employee limit while maintaining the SIMPLE IRA. Once they surpass that number, employers may maintain the SIMPLE IRA for two years (after the year they exceeded it), but after this period, they are no longer eligible.
As an employee, you qualify to contribute if you earned at least $5,000 during any two years before the plan was set up and “reasonably expect” to receive at least $5,000 during the current year. Unlike some 401(k) plans, employer contributions to SIMPLE IRA plans are 100% vested whenever they are deposited into the account.
The second stipulation of SIMPLE IRAs is that employers cannot participate in any other plans, such as SEP IRAs, 401(k) plans, qualified annuity plans, employee-funded pension trusts, and so on.
Many self-employed individuals meet both stipulations, and SIMPLE IRAs are great options for self-proprietors or small business owners that have yet to set up a work-related retirement plan. Like SEP IRAs, SIMPLE IRAs are easy to set up and administer, not to mention affordable. Your financial institution will take care of most of the details and all contributions are deposited directly into IRAs, making them “simple” to operate. And of course, all contributions are tax-deductible.
Another advantage of SIMPLE IRAs is they make it easier to add full-time employees, which can be more challenging with SEP IRAs. If you are self-employed but considering hiring employees, then a SIMPLE IRA is likely a better option for your situation. This plan will make it easier for your business to grow.
Though SIMPLE IRAs have many benefits, one important potential limitation is their contribution limits. The contribution limits for SIMPLE IRAs are much lower than SEP IRAs: $12,500 (SIMPLE IRA) versus $53,000 (SEP IRA) in 2016. The lower limit may make it difficult to sock away as much as you would like as you work towards your plan for retirement.
In sum, most sole-proprietors and small business owners are eligible for a SIMPLE IRA, assuming they have under 100 employees and are not maintaining another retirement savings plan. These plans reflect their name in their simplicity to set up and administer. This, combined with low costs and fees, make SIMPLE IRAs an appealing option for the self-employed. If you have your sights set on growing your business, and do not need to save a significant amount of money quickly, SIMPLE IRAs may be the best option for you.