Self-employed individuals and small businesses can use a SIMPLE IRA to save as much as $58,000 for their retirement in 2021.
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Available to the self-employed and businesses with fewer than 100 employees
An employer creates a SIMPLE IRA and each employee has their own IRA that’s part of the plan
Employees can contribute, with an annual limit of $13,500 in 2021
If an employee contributes, the employer must also contribute
A SIMPLE (Savings Incentive Match Plan for Employees) IRA is a retirement plan available to self-employed individuals and businesses with fewer than 100 employees.
If you’re self-employed, it basically works like a traditional IRA. You contribute money that you can deduct on your tax return. Contributions come from your pre-tax income and grow tax-free in the account. You pay income tax only when you withdraw.
When an employer establishes a plan, each eligible employee has their own IRA within the plan. Then the overall plan works much like a defined contribution plan, such as a 401(k). Employees contribute pre-tax money through what are officially known as salary reduction contributions. Employers can also contribute. If they do, they can deduct their contributions. Unlike a 401(k), employers must contribute if an employee does.
The 2021 contribution limit for a SIMPLE IRA is $13,500 for employees and self-employed individuals ($16,500 if you’re age 50 or older). This is unchanged from 2020. In 2019, the SIMPLE IRA contribution limit was $13,000, and $16,000 if you were age 50 or older.
Self-employed individuals and small businesses are eligible to open a SIMPLE IRA if they meet two criteria:
They had no more than 100 eligible employees during the previous calendar year.
They did not participate in another retirement savings plan during any part of the past calendar year.
An employer can still open a SIMPLE IRA if they are tax-exempt, a governmental entity, or the employer of a domestic worker.
If you establish a SIMPLE IRA but then your company grows to cross the 100-employee threshold, you generally have a grace period of two years to terminate or transfer it to another type of retirement account.
The Internal Revenue Service (IRS) also has special rules if you don’t meet one of the two requirements above because of a company acquisition. Consult with a tax professional to help you understand your specific situation.
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If you are self-employed or if you are an employee with access to a SIMPLE IRA, you can contribute up to a maximum of $13,500 for the 2021 tax year (unchanged from 2020). You can also make a $3,000 catch-up contribution each year if you are at least 50 years old. With the catch-up, the maximum contribution for 2021 is $16,500 if you’re 50 or older.
If you contribute to any defined contribution plans, such as a 401(k), note that your SIMPLE IRA contributions count against the total contribution limit you can make for those plans ($58,000 in 2021, up from $57,000 in 2020). Other types of accounts that count against this limit are a 403(b), profit-sharing plan, or money purchase plan.
On the flip side, SIMPLE IRA contributions do not count against your annual IRA contribution limit ($6,000 in 2021, unchanged from 2020). That means you could potentially make a maximum contribution to a SEP IRA and then to a separate Roth IRA.
It’s easy and affordable to both open and maintain a SIMPLE IRA. Once you open an account, you basically only need to worry about choosing a contribution amount. The bank or financial institution managing your account will handle most of the paperwork and administration. Employers do not have to file any annual reports with the IRS like they do with a defined contribution plan, such as a 401(k).
For self-employed individuals, a SIMPLE IRA has a higher contribution limit than the standard retirement accounts. For example, a traditional IRA has an annual contribution limit of just $6,500 ($7,500 if you’re 50 or older) for the years 2020 and 2021. Even if you save the maximum each year, that isn’t enough for you to meet your retirement goals.
The main drawback to a SIMPLE IRA is that if you’re an employer, you are required to make contributions for employees that qualify. This could be a challenge if your business doesn’t do well in a given year.
The maximum contribution for a SIMPLE IRAs also isn't as high as for some other options, like a SEP IRA (more on that later). Make sure to consider whether or not another type of account may allow you to save more.
Companies growing quickly also may not want to open a SIMPLE IRA. If you plan to surpass 100 eligible employees in a year or two, you won’t be able to actually use a SIMPLE IRA for very long. Consider a plan you can continue to use as you grow, such as a 401(k) or potentially a Simplified Employee Pension IRA (SEP IRA).
A SEP IRA is one alternative for small businesses and especially for self-employed people. SEP IRAs are easy to open and maintain. They are available to companies with more than 100 employees. The contribution limit is also up to $58,000 in 2021 (up from $57,000 in 2020), making SEP IRAs an appealing option if you're self-employed. They also offer greater flexibility because you don't have to contribute every year.
The biggest caveat with a SEP IRA is that only employers can make contributions. Employers don’t have to contribute every year but if they do, they have to contribute a proportional amount for every employee. So if a business owner wants to save 15% of their own salary for retirement, they have to contribute 15% for all other employees, too.
Sole proprietors, partnerships, and other self-employed workers who have no full-time employees can also contribute to a 401(k). If you have a regular employer but also earn income on the side from self-employment, you may be able to open a solo 401(k).
A 401(k) has a maximum contribution limit of $19,500 in 2021, but you can contribute up to $58,000 across all defined-contribution plans, including the 401(k). (These numbers are unchanged from 2020.) Because 401(k) plans are available in traditional or Roth versions, you may be able to contribute pre- or post-tax money.
Another potential benefit with a 401(k) is that you can take loans from it. This isn't an option with any IRA-based retirement plans. Borrowing from your 401(k) isn't always a good idea, and shouldn't use your 401(k) as an emergency fund, but this option is handy in a pinch.
Employers should consider a traditional 401(k), especially if they plan to have more than 100 employees in the near future. On the slip side, a 401(k) is more expensive to maintain and they aren’t as simple tax-wise. You will need to do regular reporting to the IRS about contributions, whereas your trustee does all that with a SIMPLE IRA.
A safe harbor 401(k) plan is a good option for high-level employees (who own more than 5% of their business) and those with salaries of more than $130,000 in 2021 (unchanged from $130,000 in 2020). Traditional 401(k) plans include a nondiscrimination test that limits contributions for these individuals. The goal of this test is to make sure a 401(k) doesn't favor employees with higher income. But if a company mostly has high-income employees, this test can get in the way. A safe-harbor account allows them to save for retirement without worrying about the nondiscrimination test.
Employers who want to make very large contributions for their employees should consider a profit-sharing plan.
The IRS lays out three general steps for creating a SIMPLE IRA:
Choose and execute a plan document
Provide employees with the plan details
Open individual IRA accounts for employees
Each employee has their own IRA as part of a SIMPLE IRA. When setting up your plan, you need to decide whether all employees will have an IRA with one financial institution, which is the most common, or whether they can each open an account at an institution of their choosing.
If you plan to use a single institution, as most employers do, fill out IRS Form 5305-SIMPLE. If employees can open an account at a place of their own choosing, fill out IRS Form 5304-SIMPLE. Both of these forms lay out the eligibility requirements for your SIMPLE IRA, how you will make contributions, and when the plan takes effect.
You do not need to file these forms with the IRS. They are to create a record of your plan’s details. If you keep all employee IRAs at one institution, the institution will also have similar documents that you can use instead of the generic IRS forms.
If you open all employee IRAs with one provider, you will need to choose which provider to use. This provider is called the trustee. Common trustees are banks, mutual funds, and other financial institutions. Charles Schwab, Fidelity, and Vanguard are among the largest providers of SIMPLE IRAs.
Common responsibilities of the trustee include collecting contributions, making the proper investments, providing plan participants with annual statements, and filing required documents with the IRS.
When choosing a trustee, check the fees required to open and maintain a SIMPLE IRA. Do you have to pay a one-time fee just to create a SIMPLE IRA? What investment options do they offer? The most common investments are mutual funds and exchange-traded funds (ETFs), but some providers offer access to individual stocks. You will likely have to pay a fee for each mutual fund that employees use within the SIMPLE IRA. Stock trades also come with a fee.
The final step of setting up a SIMPLE IRA is to open individual accounts for each participating employee. To do so, each employee will need to fill out a form that includes personal identification, as well as the name and address of the IRA trustee.
You, your employee, and the trustee must sign the form. The IRS provides Form 5305-S as a model. Your trustee may also have other forms you can use.
If you are not maintaining all IRA accounts with one trustee, the form is the same except that you provide the name and address of the account custodian in place of a trustee’s. Again, the IRS has a model form for you to use: Form 5305-SA.
Employers only need to include eligible employees when determining whether they meet the 100-employee threshold.
Employees are eligible to participate in a SIMPLE IRA if they received at least $5,000 from the employer in any two of the previous five years, and if they expect to earn at least $5,000 this year. There are no age requirements.
At the same time, these are only the minimum requirements from the IRS. Employers have the option to use more lenient requirements. For example, an employer can choose to include employees who earn less than $5,000 or who only earned $5,000 in one of the past five years.
Employees that can receive retirement benefits from another source, such as though a union, may not qualify for a SIMPLE IRA.
There are two ways an employer can choose to contribute, and an employer is able to use either option for a given year. They just need to notify all participating employees beforehand — at least 60 days before January 1 — of which option they’ll use in the upcoming year.
With this option, an employer matches employee contributions dollar for dollar, up to 3% of each employee's compensation. An employer is allowed to reduce their match to as little as 1% of an employee's compensation in two out of any five years.
The advantage of this option is that an employer only has to contribute if the employee does. This could potentially save an employer money. There is also flexibility to decrease the match percentage in years where business maybe isn’t as strong.
The disadvantage is that employers are required to match no matter how much employees contribute. This variability can make financial planning harder and this option is may become unaffordbale if employees are saving aggressively.
Instead of matching employee contributions, an employer can also choose to make a 2% contribution for all employees, regardless of whether or all employees contribute.
The maximum compensation level for calculating a 2% contribution is $290,000 in 2021 (up from $285,000 in 2020). So if an employee has a salary of more than $290,000 in 2020 and contributes 2% into the SIMPLE IRA, their employer only has to contribute an amount equal to 2% of the first $290,000. That brings an employer’s highest possible contribution to $5,800 annually per employee, if they use this option.
Employers save money with this option if they expect every employee to contribute more than 2% of their salary.
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