The SIMPLE retirement plan for small business owners and employees
How the plan works
In a SIMPLE IRA plan, the employer establishes a retirement account for each employee. Both the employer and employees can contribute to these accounts. Both the employer and employees receive tax benefits at the time of contribution.
Eligibility to establish a SIMPLE IRA
The SIMPLE IRA is designed for small businesses. To establish one, the company must have no more than 100 employees, and each employee must earn at least $5,000 per year. For companies that meet these qualifications, it is sufficient to fill out forms with the IRS and create IRA accounts for employees and inform employees of their options regarding the SIMPLE IRA plan.
Benefits of the SIMPLE IRA
There are many benefits for both business owners and employees in establishing a SIMPLE IRA plan. First, the administrative costs of establishing and maintaining a SIMPLE IRA plan are lower compared to other alternatives. It is also easy to set up.
As with other types of retirement accounts, employees covered by a SIMPLE IRA plan enjoy the benefit of making payroll deductions to contribute to their individual SIMPLE IRA accounts through regular payroll deductions. They will receive a tax advantage: contributions to the SIMPLE IRA by employees, although not deductible on Form 1040, have a deduction effect since they are excluded from the wages and other compensation reported on Form W-2 and therefore are not reported as income on your Form 1040. Furthermore, investments in the account can grow without being taxed until withdrawn at retirement.
For business owners, there is the advantage of flexibility in contributions. They can choose to match employee contributions to their individual SIMPLE IRA accounts, or the company can contribute a fixed percentage of the salaries of all eligible employees to each account. Specifically, the employer can either match employee contributions dollar-for-dollar up to 3% of salary, or opt for a regular and non-elective contribution of 2% for each eligible employee.
If the employer chooses the latter, it can be an added benefit for employees, as it means that even employees who do not save anything from their salaries will receive the employer contribution of 2% in their SIMPLE IRA account.
Typically, the employer sponsoring the SIMPLE IRA plan has no filing requirements with the IRS, making the system easier for the employer. The financial institution handling the investments in the SIMPLE IRA usually takes care of most of the work.
Note: Salary reduction contributions by employees cannot technically be deducted but are excluded from the income reported on Form W-2, so they have the effect of reducing your income as happens with the deduction.
Contribution limits for the account
Business owners who wish to save more for retirement may find the contribution limits for the SIMPLE IRA more generous than other IRA options. This is because both the company and the individual can contribute, which means that self-employed individuals in the SIMPLE IRA can contribute more than the limit allowed in a regular IRA retirement account.
For the year 2021, employees can contribute up to $13,500 to the SIMPLE IRA. This limit increases to $14,000 in 2022. Employees over age 50 can make an additional “catch-up” contribution of $3,000. Additionally, if an employee participated in any other plan during the year and made elective salary reductions under those plans, the employee can contribute a maximum of $19,500 across all plans. This increases to $20,500 in 2022.
Note:
Make additional contributions of up to $3,000 to the SIMPLE IRA to achieve retirement savings goals faster.
SIMPLE IRA Withdrawal
Employees can withdraw funds from the SIMPLE IRA before retirement age, but not without serious consequences. The IRS considers SIMPLE IRA withdrawals as income to the account holder, so the funds will be subject to regular income tax.
In addition to regular income tax – as with a traditional IRA – the IRS imposes a 10% penalty on early withdrawals from the SIMPLE IRA before the age of 59 and a half. If the employee makes such withdrawals during the first two years of participation in the SIMPLE IRA plan, the penalty tax increases to 25%.
There are some exceptions to this tax penalty, the most common of which may be unreimbursed medical expenses that exceed 10% of the individual’s adjusted gross income.
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Sources:
Internal Revenue Service. “SIMPLE IRA Plan.”
Internal Revenue Service. “Retirement Plans FAQs Regarding SIMPLE IRA Plans.”
Internal Revenue Service. “Retirement Plans for Self-Employed People.”
Internal Revenue Service. “Retirement Topics – SIMPLE IRA Contribution Limits.”
IRS. “SIMPLE IRA Withdrawal and Transfer Rules.”
Source: https://www.thebalancemoney.com/simple-ira-plans-for-small-business-owners-and-employees-358015
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