This article updated on Jan. 13, 2016.
A SIMPLE IRA is designed for small business owners to provide tax-advantaged retirement benefits for their employees, as well as for self-employed individuals to save for their own retirement. Although the structure of this type of retirement plan is quite simple (as the name implies), the contribution limits can get a little confusing -- especially for self-employed individuals. (For more information on IRAs, there's a whole Fool section that can help you figure out which one is right for you, and how best to use it.)
Here are the current SIMPLE IRA contribution limits, and how to figure out what you can contribute.
Contribution limits for employees
A SIMPLE IRA has some attributes of a traditional IRA, and some of typical employer-sponsored retirement plans like 401(k)s. The accounts themselves are treated like a traditional IRA -- contributions are made on a pre-tax basis and can be used to invest in any stocks, bonds, or funds the account holder chooses. However, as in a 401(k), contributions are split into two distinct categories: employee salary reduction and employer contributions.
Employees are allowed to contribute up to $12,500 in the form of salary reductions to their SIMPLE IRA in 2015 and 2016, but contributions may not exceed their compensation. In other words, if you earn $8,000 from your employer, then that's the maximum you can contribute -- which makes sense, since you obviously can't defer more than 100% of your salary.
If you're 50 or older, you're allowed an additional catch-up contribution of up to $3,000 on top of the $12,500 limit. Salary reduction contributions are made on a "percentage of compensation" basis, and employers aren't allowed to place any restrictions on employee contributions, other than enforcing the limits.
It's also worth mentioning that if the employees participate in any other employer-sponsored retirement plans, such as a 401(k) from a second job, then the total of all salary reduction contributions is capped at $18,000, or $24,000 for those over 50.
Employer contributions and overall maximums
Employers have to contribute to the SIMPLE IRA of every employee who meets certain requirements, such as a minimum of $5,000 in compensation in any two previous years, and they have two choices.
The employer can choose to match employee contributions dollar-for-dollar up to a maximum of 3% of the employee's salary. Or, the employer could choose to make nonelective contributions, contributing 2% of each employee's salary into their SIMPLE IRA regardless of whether or not the employee chooses to contribute. The nonelective contribution amount is based on up to $265,000 in employee compensation, while the matching contributions are only limited by how much the employee chooses to contribute.
So, the absolute maximum annual contribution to a SIMPLE IRA would be $31,000, but this would require a specific combination of factors. The employee would need to be over 50 in order to take advantage of catch-up contributions and would need to earn more than $516,667 in order to max out both salary reductions and employer matching contributions (3% of this amount is $15,500). And the employer would need to have chosen the matching option, not the nonelective contribution option. The actual maximum is much less than this for most employees.
Calculating the limits for self-employed SIMPLE IRA participants
If you're a sole proprietor (i.e., if you file a Schedule C with your taxes), then you are considered both the employer and employee for SIMPLE IRA contribution purposes. So let's take a look at an example of how this works.
Let's say you report $100,000 in business income on your Schedule C, and you're less than 50 years old. You're allowed to contribute $12,500 as a "salary reduction," plus another 3% of your income ($3,000) as a "matching contribution." So, in this case, your maximum annual contribution would be $15,500.
For another example, let's consider a 45-year-old owner of a highly profitable business whose Schedule C income is $1,000,000. The salary reduction maximum of $12,500 still applies, but since 3% of his or her income is more than the maximum salary reduction, the employer portion of the contribution is limited to $12,500. So, in this case the business owner is allowed to contribute up to $25,000 to their SIMPLE IRA.
It is rather "simple"
As long as you understand how SIMPLE IRA employee and employer contributions work, the contribution limits are rather easy to understand. A SIMPLE IRA has several advantages, such as low start-up and maintenance expenses, easy administration, and thousands of investment possibilities, so if you're looking for a new retirement plan, a SIMPLE IRA could be worth a look.