Many people find retirement planning complicated, and with all of the different types of retirement plans available to both workers and business owners, choosing your best option can be a big challenge. In considering all of the trade-offs of different retirement-plan options, many small businesses, and even some slightly larger employers, help to foster their workers' retirement prospects by giving them the opportunity to use what's known as a SIMPLE IRA. Let's take a closer look at the SIMPLE IRA and whether it lives up to its moniker.
What is a SIMPLE IRA?
In the time-honored tradition of legislative acronyms, Congress came up with the name "SIMPLE" by taking the first one or two letters of each word in the IRA's longer name, the Savings Incentive Match Plan for Employees. Lawmakers designed SIMPLE IRAs to have fewer upfront administrative hassles in creating the retirement plan and making it available to workers.
Like any retirement plan, the SIMPLE IRA gives employees an opportunity to set some of their own earnings aside for retirement. It also provides for employer matching of those contributions up to a certain set amount.
Who can establish a SIMPLE IRA?
SIMPLE IRAs are a common choice for self-employed individuals looking to increase the amount they can set aside for retirement. But the IRS allows small businesses with up to 100 employees to use SIMPLE IRAs as their chosen option for retirement savings.
SIMPLE IRAs are only allowed if an employer has no other retirement plan in place. So if your employer has a 401(k) plan or similar option in place already, adding on a SIMPLE IRA isn't allowed.
How much can employees contribute to a SIMPLE IRA?
Each year, the IRS announces a limit on the amount workers can save in a SIMPLE IRA. For 2014, that amount is $12,000. Moreover, if you're age 50 or older and your employer's particular SIMPLE IRA allows for catch-up contributions, you can add another $2,500, for a total of $14,500.
Note that those amounts are more than double what you can save in a typical IRA. With limits of just $5,500 for those younger than 50 and $6,500 for those 50 or older, typical IRAs don't meet the needs of many small-business owners and their employees, and SIMPLE IRAs therefore add a powerful boost to their ability to save for retirement.
What does the employer have to contribute on a worker's behalf?
One of the best characteristics of the SIMPLE IRA for small-business employees is that an employer must provide either profit-sharing or matching contributions on their behalf. Employers can choose either to match up to 3% of employee contributions dollar for dollar or to give 2% profit-sharing contributions regardless of whether employees make their own contributions.
Under limited circumstances, an employer can temporarily reduce matching contributions to as little as 1%. But that lower match can only last for two years in any five-year period.
How and when can an employer set up a SIMPLE IRA?
Employers are responsible for setting up a SIMPLE IRA, so workers can't do so on their own. The process, though, is relatively simple, with the IRS providing prototype documents that allow a single IRS form to get things rolling.
Once the plan is established, most financial institutions offer SIMPLE IRA services, making investments available to plan participants. In general, a wide range of investment choices are available, including stocks, mutual funds, exchange-traded funds, and similar securities, but depending on which financial institution the employer chooses, there may be limits to which investments are available.
The SIMPLE IRA does a good job of living up to its name, providing attractive benefits without many of the complications that more sophisticated retirement plans entail. SIMPLE IRAs don't let you set aside quite as much money as some options available for self-employed workers and small businesses, but for many, the added simplicity is more than worth the trade-off.
Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.