Saving for retirement can be challenging, but there are many different types of tax-favored accounts you can use to make it easier. Those who are self-employed or who run small businesses can set up what's known as a SIMPLE IRA to give themselves and any workers they have access to a broad-based retirement savings plan, and both employers and employees can get tax benefits from it. Technically, employee contributions to a SIMPLE IRA aren't deductible, but as you'll see below, the net effect is basically the same as if they were deductible.
What a SIMPLE IRA is
The federal government loves acronyms, and here, SIMPLE stands for Savings Incentive Match PLan for Employees. The benefit of the SIMPLE IRA is that it's, well, simple. In comparison to a 401(k) or other more sophisticated alternatives, the SIMPLE IRA is a good way to capture most of the benefits available from a retirement plan without the added cost and administrative hassle of more complicated retirement plans.
Employees are allowed to contribute up to $12,500 to a SIMPLE IRA in 2016. Those who are 50 or older can contribute an additional $3,000 if they choose. In addition, employers have a couple of choices about how they match what employees put into a SIMPLE IRA. They can choose to contribute 2% of each employee's compensation, regardless of whether employees participate by making contributions of their own. Alternatively, they can match employees' contributions up to 3% of compensation, with smaller matches applying if employees don't elect to set aside at least that much.
Why workers can't deduct SIMPLE IRA contributions
Many taxpayers get confused about how to treat SIMPLE IRA contributions. Line 28 on Form 1040 talks specifically about self-employed SIMPLE IRA plans as a deduction, appearing just a few lines above the regular IRA deduction. But that line is only for the employer contribution for a self-employed person.
What many find surprising is that there's no place to deduct SIMPLE IRA contributions. However, there's a very good reason for that: the money you divert from your paycheck to a SIMPLE IRA never appears in your taxable income in the first place. Specifically, the W-2 you get from your employer should not include your SIMPLE IRA contributions as taxable income. As a result, contributions do reduce your taxable income, but not in a way that's evident on your tax return.
Whether you're self-employed, own your own business, or are fortunate enough to work for someone who has set a plan up, SIMPLE IRAs are a great way to save for retirement. By letting you reduce your taxable income, contributing to a SIMPLE IRA can cut your tax bill and help you save more for retirement at the same time.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!
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.