When choosing a retirement plan for your small business, consider keeping it SIMPLE.

I was inspired to write this post after a client came to me needing advice on which retirement plan to implement for their growing business. They have some employees now, a few years since they first launched, and would need to offer retirement benefits to their workers in addition to themselves. After consulting with a local financial advisor in my network, we both determined that a SIMPLE IRA (Savings Incentive Match Plan for Employees) would be the best solution due to its flexibility in employer contributions and a lower cost of maintenance than other retirement plans.

If you're a small business owner or self-employed, you may have heard of SIMPLE IRAs. A SIMPLE IRA is a retirement plan designed for businesses with 100 or fewer employees. In this blog post, I'll provide an overview of SIMPLE IRAs and how they can benefit both you and your employees.

How does a SIMPLE IRA work?

A SIMPLE IRA is a type of tax-deferred retirement plan that allows employees to contribute a percentage of their salary to their retirement savings. Employers are required to make either a matching contribution or a non-elective contribution to their employees' SIMPLE IRA accounts.

Employees can contribute up to $15,500 to their SIMPLE IRA in 2023, with an additional catch-up contribution of $3,500 if they are age 50 or older. Employers can choose to match the employee's contribution dollar for dollar up to 3% of the employee's salary or contribute a flat 2% of the employee's salary regardless of whether the employee contributes.

One of the benefits of a SIMPLE IRA is that it has lower administrative costs and is easier to set up and maintain than other retirement plans such as a 401(k). Additionally, employers are not required to file annual reports with the IRS, which further reduces administrative costs.

Employers can elect to adopt a SIMPLE IRA plan by filing Form 5304-SIMPLE or 5305-SIMPLE depending on if they want to make contributions to a Designated Financial Institution (DFI).

Who is eligible for a SIMPLE IRA?

Any business with 100 or fewer employees, that does not currently offer a retirement plan, is eligible to establish a SIMPLE IRA. Self-employed individuals can also set up a SIMPLE IRA for themselves. Employees are eligible to participate in a SIMPLE IRA if they have earned at least $5,000 in any two previous years and are expected to earn at least $5,000 in the current year. There are no age restrictions for participating in a SIMPLE IRA.

What are the tax benefits of a SIMPLE IRA?

One of the primary benefits of a SIMPLE IRA are that contributions are tax-deferred, meaning that contributions are made with pre-tax dollars, and any investment earnings grow tax-free until the employee withdraws the funds after age 59 1/2. When the employee does make withdrawals, they are taxed as regular income.

Additionally, employer contributions are tax-deductible for the business, which can lower the taxable income of the business owners(s). This can be a significant advantage for small business owners that are looking to reduce their tax liability.

What are the drawbacks of a SIMPLE IRA?

While SIMPLE IRAs have many benefits, they do have some limitations. One limitation is that the contribution limits are lower than other retirement plans, such as a 401(k). This might not fit into a retirement plan for an older business owner, who has not accumulated much in the way of savings, and needs to put away as much of their income as possible. Additionally, there are restrictions on when and how funds can be withdrawn from a SIMPLE IRA, which can limit the flexibility of the plan. However, these problems are largely mitigated if the employee is over 59 1/2 and has held the plan for more than two years.

Finally, as stated earlier in this post, if the business owner or self-employed individual has any employees, they are required to make contributions to their employees' SIMPLE IRA accounts. This can be a disadvantage if the business owner or self-employed individual would prefer to contribute more to their own retirement savings. In that case, I would generally recommend opening a Traditional IRA, which does not require the business owner to offer retirement benefits to their employees, and they can simply make their own tax-deferred contributions while receiving a tax deduction as well.

Conclusion

A SIMPLE IRA can be an excellent retirement savings option for small businesses and self-employed individuals. It offers tax benefits, lower administrative costs, and easier setup and maintenance than other retirement plans. However, it's important to weigh the advantages and disadvantages carefully before deciding if a SIMPLE IRA is the right choice for you and your employees.