Most Americans can park their retirement savings in a traditional or Roth IRA -- or both. And many Americans can also take advantage of workplace-sponsored retirement programs like 401(k) plans. While self-employed folks are in a different boat, they have some extra options such as the SIMPLE IRA.
The SIMPLE IRA gets its name from the acronym for Savings Incentive Match Plan for Employees. It permits small-business operators and self-employed folks to contribute to retirement savings plans for their workers and themselves through a simplified system. Workers decide whether they want to make salary-reducing contributions, and employers must make matching contributions (up to 3% of the employee's compensation) or nonelective contributions (contributing a fixed 2% of income to every worker, whether they make their own contributions or not). Worker and employer contributions go into a SIMPLE IRA account. Both employee and employer contributions are immediately vested, meaning you don't forfeit any of it should you change jobs.
Nuts and bolts
A SIMPLE IRA involves most of the same rules regarding contributions, distributions, and rollovers as does a traditional IRA. The IRS offers a lot of information on SIMPLE IRAs, but let's review some key things to know.
For 2014 and 2015, contribution limits for the SIMPLE IRA are $12,000 and $12,500, respectively, with catch-up contributions for those 50 or older of $2,500 in 2014 and $3,000 in 2015 also available. That makes it much more powerful than a regular IRA, with its 2015 contribution limit of $5,500 plus a $1,000 catch-up allowance.
Here's another advantage: As with 401(k) plans, a SIMPLE IRA permits dollar-for-dollar employer matching contributions of up to 3% of employee earnings.
Contributions from self-employed folks and small-business employees are deducted from taxable income, reducing taxes due in the year of the contribution. That money can grow on a tax-deferred basis until withdrawn, ideally in retirement, when it will be taxed at the standard income tax rate.
Withdrawals taken before age 59-1/2 will likely result in a 10% early withdrawal penalty (25% if the withdrawal happens within the first two years of participation). As with traditional IRAs and 401(k)s, required minimum distributions must be taken annually beginning at age 70-1/2.
More things to know
Self-employed people can set up and use the SIMPLE IRA to save for retirement, and so can employers that have no more than 100 employees and offer no other retirement plans. Establishing a SIMPLE IRA involves filling out just one or two forms and perhaps a phone call. There are few to no filing requirements for the employer -- the financial institution managing the program takes care of that. As the name suggests, it was designed to be simple to create and administer.
SIMPLE IRAs are often established with well-respected brokerages. Once you have money in a SIMPLE IRA account, you typically can park it in a wide range of investments, such as stocks, bonds, and mutual funds. The options are wider than with many 401(k) plans.
Self-employed people and small businesses have a few more options, such as the Simplified Employee Pension, or SEP, IRA or the Solo 401(k). The SEP has a much higher contribution limit, of $53,000 or 25% of compensation, whichever is lower. The Solo 401(k) has a contribution limit between those of the SIMPLE and SEP, but typically requires more paperwork, and might have more restricted investment options.
The SIMPLE IRA deserves consideration because it can help your retirement savings to grow more effectively. Be smart about your Social Security decisions, too, as they can also make a big difference in your retirement. The report below offers some great strategies.