SIMPLE IRA contribution limits is an abbreviation for Simple Incentive Match Plan for Employees, is a retirement scheme that is available to both self-employed individuals and businesses with less than 100 employees.
For self-employed individuals, it is akin to a conventional IRA (Individual Retirement Account). Your contribution towards the SIMPLE IRA is tax-deductible.
Contribution towards this scheme will deduct from your pre-tax income.
They are tax-exempt till you hold them in the SIMPLE IRA account. However, once you withdraw money from the scheme, it is taxable.
When an employer sponsors the SIMPLE plan, each employee will have an individual IRA within the plan.
Employee contributions will deduct from their pre-tax remunerations.
Eligibility for Holding a SIMPLE IRA
There are some criteria for becoming eligible for a SIMPLE IRA:-
- Small organizations desiring a SIMPLE IRA should not have more than 100 employees in the previous year.
- Both small businesses and self-employed individuals desiring to hold a SIMPLE IRA should not invest in other retirement schemes in the past year.
- An employee should receive minimum remuneration of $5000 p.a in the previous two calendar years as well as in the present year.
Once the employee headcount in an organization crosses the 100+ mark, within a duration of 2 years maximum, the organization must switch over to some other retirement plan.
In the case of mergers and acquisitions, if your organization doesn’t fit into any of the above criteria, then the IRS (Internal Revenue Service) has special rules.
Benefits of a SIMPLE IRA
Some of the advantages of a SIMPLE IRA are listed below:-
- It is easy-to-use and cost-effective to hold and maintain a SIMPLE IRA
- You have the flexibility to decide the contribution amount within the prescribed limits.
- The financial institution or bank with which you open the SIMPLE IRA is entrusted with the responsibility to handle most of the related documentation and formalities.
- As opposed to other contribution plans, no annual reports pertaining to the SIMPLE IRA have to be filed with the IRS. It is less expensive too.
- The prescribed contribution limits for SIMPLE IRA are higher than most of the similar plans available in the market.
- Thus, you will be able to build a bigger retirement corpus at a faster rate with this plan.
- You can defer taxes on contributions and capital appreciations from the investment till the money is used in your retirement years.
- Thus, it is a tax-advantageous retirement scheme.
- Participants of a SIMPLE IRA plan can roll over their money into a conventional IRA scheme two years after the first contribution was made to the SIMPLE IRA.
Pitfalls of SIMPLE IRA
SIMPLE IRA has some drawbacks, especially for employers. They are listed below:-
- Business opting for this plan is required to make contributions for every employee who meet the desire eligibility conditions. This may be a prime challenge in those years in which the business is incurring losses.
- Organizations or businesses can try exploring other options that may help them to maximize their savings or reduce costs.
- Fast-growing companies may not benefit much from a SIMPLE IRA as they may surpass the 100+ employee headcount limit within a year or two.
- A SEP (Simplified Employee Pension) IRA or 401(k) plan may work better for them.
- Unlike a 401(k) plan which allows you to borrow a loan against it, the SIMPLE IRA offers no such facility.
- Thus, it may not be suitable for emergency or contingency planning.
- In case of a premature withdrawal, that is, prior to the age of 59.5, you have to incur heavy penalty charges. You have to incur 10% penalty charges over and above the taxes your pay.
- In case you withdraw before two years lapse from the date of the first contribution made, then you have to incur a 25% penalty.
Opening a SIMPLE IRA
There are three main steps involved in opening a SIMPLE IRA. They are as follows:-
Selecting a Plan Document
Businesses opting for the SIMPLE IRA can open accounts with a single financial institution or allow employees to open an IRA with an institution of their choice.
If the business is planning to open accounts with a single institution, it needs to fill out the form 5305 – SIMPLE.
If employees are opening a SIMPLE IRA account on their own in an institution of their choice, then they need to fill out form 5304 – SIMPLE.
An organization doesn’t need to file these forms for tax purposes but just needs to maintain records of all the plan details.
Selecting a Trustee
You need a trustee for maintaining a SIMPLE IRA. This trustee can be a bank, a mutual fund, an ETF, or any other financial institution.
The common responsibilities of trustees are collecting contributions, filing requisite IRS paperwork, mailing annual statements to plan holders, collecting contributions, and much more.
The trustees charge some fees for their services. Principal Financial, Charles Schwab, Edward Jones, etc are some notable examples of SIMPLE IRA providers.
Opening Individual Employee IRA
Each participating employee has to fill out a form that asks for details like personal identification number, name, address of the trustee, etc.
This form must be signed by both the employee and the trustee.
SIMPLE IRA Contribution Limits
The prime purpose of setting contribution limits for tax-advantaged accounts like SIMPLE IRA is to ensure equitable distribution of wealth.
Thus, it will not work as a tax haven for the rich and incentivize the average citizen through tax rebates.
If you are self-employed or an employee with access to a SIMPLE IRA, then the maximum contribution you can make for the fiscal year 2021 is $13500.
This SIMPLE IRA contribution limit remains unchanged from the fiscal year 2020.
Besides, you can make a catch-up contribution of up to $3000 per tax year, if you are age above 50.
In short, for individuals age above 50, the maximum SIMPLE IRA contribution limit per fiscal year is $16500.
If you hold more than one job, you can also subscribe to another employer-sponsored plan and contribute up to $19,500 per annum.
The total contribution limit permitted per year towards define contribution schemes like 401(k) stands at $58000 for the tax year 2021.
Your SIMPLE IRA contribution will be count against this limit. Some other types of accounts that count against this limit are 403(b), money purchase plan, or profit-sharing plan.
The contribution deadline is January 30 of every calendar year – 30 days after the end of a calendar year, for self-employed individuals.
For organizations, the deadline is within 30 days from the end of the month in which the contributions were retained.
Employees have to make their contribution within the tax filing deadline each tax year.
SIMPLE IRA Employer Contribution Limits
Two options are available to employers to make contributions. They are as follows:-
Employer Contribution Matching Employee Contribution
Under this option, employers can contribute up to 3% of employee remuneration. In two out of five years, the employer may reduce the contribution to 1% of employee compensation.
Thus, during lean years, it will be beneficial for a business to contribute less.
However, under any circumstances, an employer cannot lower the contribution amount below 1% of the employee’s salary.
In case of any changes to the matching contribution amount, the employer must notify the employees a minimum of 60 days prior to effecting such a change.
Another major benefit of this option is that an employer has to contribute only if an employee does. This may result in higher savings for an organization.
However, since this option requires the employer’s contribution should match with that of employees, aggressive saving by employees may render this option expensive for businesses in the long run.
Employers Can Contribute a Minimum Amount for All Employees
An employer or organization can choose to contribute a minimum of 2% for all employees irrespective of what employees individually contribute towards the plan.
Such a contribution is also known as a non-elective contribution.
The maximum remuneration limit for calculating the 2% contribution in 2021 is $2,90,000 per annum.
The remuneration limit has increased from $2,85,000 prescribed in 2020.
This is a cost-efficient model for an organization if most of its employees contribute more than 2% of their compensation to the SIMPLE IRA.
Annual SIMPLE IRA Contribution Limits Vs Annual Contribution Limits of Other Plans in 2021
As mentioned earlier, the contribution limits of the SIMPLE IRA are $13,500 for individuals whose age below 50 and $16500 for individuals age above 50.
The contribution limits for the 401(k) plan are $19,500 and $26,000 respectively.
A traditional IRA places contribution limits at $6000 and $7000 respectively.
Thus, the SIMPLE IRA contribution limits are higher than the Roth IRA but lower than the 401(k) plan.
The Bottom Line
Once the SIMPLE IRA plan comes into effect, employers have to keep contributing to the scheme till termination.
It is a great employer-sponsor scheme for small businesses with less than 100 employees.
At an individual level, it is a great scheme to save for your retired life. It helps you build a robust lump-sum retirement corpus.
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