How a SIMPLE IRA Works and Who Can Use One

A straightforward IRA is a retirement savings plan for small business owners and their employees

A straightforward IRA (Savings Incentive Match Plan for Employees) is a retirement account that small employers set up for their workers. The employer opens and manages the plan, but each employee owns their own individual account within it. Money goes in through payroll deductions, and the employer contributes a set amount on top — either a match or a non-elective contribution.

The plan gets its name from its structure: it has fewer rules and lower setup costs than a 401(k), making it simpler for small businesses to run. Employees direct their own investments from a menu of options, and they own the money when ready — there is no vesting period. The account stays with the employee even if they leave the job.

Key Takeaways

• A straightforward IRA is set up by an employer, but each employee owns their own account and controls how the money is invested.
• Employers must contribute to the plan each year — either matching what employees put in (up to 3 percent of pay) or giving all employees a flat 2 percent of salary regardless of whether they contribute.
• Employees can contribute up to $16,000 per year in 2023, with an extra $3,500 allowed if they are 50 or older, though these limits change annually.
• Money withdrawn before age 59½ is taxed as income plus a 25 percent penalty during the first two years of the plan, and 10 percent after that.
• A straightforward IRA is only available to employees of businesses with 100 or fewer workers.

Who can set up and use a straightforward IRA

An employer can offer a straightforward IRA if the business has 100 or fewer employees. This includes sole proprietors, partnerships, and corporations. The employer does not have to be profitable — even a business with no net income can set up the plan.

Any employee who earned at least $5,000 in the prior two years must be allowed to participate. An employer can exclude employees who are covered by a union contract or who work fewer than 20 hours per week. Once an employee is in the plan, they stay in unless they leave the job or the employer closes the plan.

How much employees and employers contribute each year

Employees choose how much to contribute from each paycheck, up to an annual limit. For 2023, the limit is $16,000 per year. Employees who are 50 or older can contribute an additional $3,500 (called a catch-up contribution). These limits are set by the IRS and change most years.

The employer must contribute to every participating employee's account. There are two ways to do this: a matching contribution or a non-elective contribution. With a match, the employer contributes up to 3 percent of each employee's salary for every dollar the employee puts in. With a non-elective contribution, the employer gives 2 percent of salary to all employees, whether or not they contribute themselves. The employer chooses which method to use and can change methods from year to year.

An employer can reduce the match to as low as 1 percent in up to two of any five-year period, but must notify employees in advance. The non-elective option stays at 2 percent and cannot be reduced.

Tax treatment of contributions and withdrawals

Employee contributions are made before taxes are withheld from pay, which lowers the employee's taxable income for the year. The employer's contribution is also tax-deductible for the business. Money in the account grows tax-free until withdrawal.

When an employee withdraws money, it is taxed as ordinary income in the year of withdrawal. Withdrawals before age 59½ are subject to a penalty: 25 percent during the first two years the plan is in effect, and 10 percent after that. This is a higher penalty than a traditional IRA (which is 10 percent at any time), making early withdrawal more costly. Withdrawals after age 59½ have no penalty, though income tax still applies.

Required minimum distributions (RMDs) begin at age 73. The account holder must withdraw a set amount each year based on their age and account balance, calculated using IRS tables.

straightforward IRA versus other retirement plans

A straightforward IRA differs from a traditional IRA in who sets it up and how much can be contributed. A traditional IRA is opened by an individual, not an employer, and has a much lower contribution limit ($7,000 in 2023, or $8,000 if 50 or older). A straightforward IRA is employer-sponsored and allows higher contributions because the employer adds money on top.

Compared to a 401(k), a straightforward IRA has lower administrative costs and fewer compliance rules. A 401(k) allows higher contributions (up to $23,000 in 2023) and can include loan provisions, but requires more paperwork and annual testing to may support the plan does not unfairly benefit highly paid employees. A straightforward IRA does not have these testing requirements, which is why it appeals to small employers.

A SEP IRA (Simplified Employee Pension) is another option for small business owners. It allows much higher contributions — up to 25 percent of net self-employment income for a sole proprietor — but the employer must contribute the same percentage for all employees who earn over $650 per year. A straightforward IRA gives the employer more flexibility in contribution amounts.

How a straightforward IRA is set up and managed

The employer chooses a financial institution — a bank, brokerage, or insurance company — to hold the plan. The employer completes a plan document (often a template provided by the financial institution) and gives each employee a summary describing the plan rules, contribution limits, and investment options.

The employer must make contributions on time. Employee contributions are deducted from paychecks and sent to the financial institution, usually monthly. The employer's contribution must be deposited by the tax filing important date (including extensions) for that year.

Each employee receives an annual statement showing their account balance, contributions made, and investment performance. The employer files Form 5498-straightforward with the IRS each year to report contributions.

When a straightforward IRA ends or an employee leaves

If an employer closes the plan, employees keep their accounts and can roll the money into another IRA or retirement plan without penalty. The employer must notify employees at least 30 days before closing.

When an employee leaves the job, they own all the money in their account and can leave it there, roll it to an IRA at another financial institution, or roll it to a new employer's plan if that plan accepts rollovers. There is no waiting period — the money is theirs when ready.

If an employee withdraws money before age 59½ within the first two years of the plan's existence, the 25 percent penalty applies. After two years, the penalty drops to 10 percent. This early withdrawal penalty is separate from income tax, which applies to all withdrawals.

Frequently Asked Questions

Can a self-employed person with no employees set up a straightforward IRA?

Yes. A sole proprietor with no employees can open a straightforward IRA. The owner contributes as both the employee and the employer. The self-employed person can contribute up to the annual limit as an employee, plus a non-elective employer contribution of 2 percent of net self-employment income (after adjusting for self-employment tax).

What happens if I withdraw money from my straightforward IRA before age 59½?

The withdrawal is taxed as ordinary income, and a penalty applies. If you withdraw within the first two years of the plan, the penalty is 25 percent of the amount withdrawn. After two years, the penalty is 10 percent. Some exceptions exist for disability, medical expenses, and first-time home purchases, but these are narrow and require documentation.

Can I have a straightforward IRA and a 401(k) at the same time?

No. If you are covered by a straightforward IRA at work, you cannot contribute to a 401(k) in the same year. However, you can have a traditional or Roth IRA in addition to a straightforward IRA, though contributions to all accounts combined are subject to limits.

What if my employer stops matching contributions?

Your employer can reduce the match to as low as 1 percent in up to two of any five-year period, but must tell you in writing before the plan year begins. If your employer switches to a non-elective 2 percent contribution instead, you still receive that 2 percent whether or not you contribute yourself.

Can I roll a straightforward IRA into a Roth IRA?

Yes, but with restrictions. You cannot roll a straightforward IRA into a Roth IRA during the first two years the straightforward IRA is in effect. After two years, you can roll it over, but the amount rolled is taxed as income in the year of the rollover. You will owe income tax on the full amount converted.