Understanding How SIMPLE IRAs Work

Updated: Oct. 6, 2020, 2:41 p.m.

A SIMPLE IRA is a retirement savings plan for employers with 100 or fewer employees. While SIMPLE IRAs are, as the name implies, pretty simple, the name is actually an acronym standing for Savings Incentive Match PLan for Employees. Offering one might be a cost-effective way for small business owners to give their employees a retirement savings plan without the expenses or potential limitations of a 401(k).

How a SIMPLE IRA Works

At its core, a SIMPLE IRA is just like a traditional IRA. It mostly follows the same rules as a traditional IRA regarding investments, distributions, and rollovers.

However, SIMPLE IRA contributions work a lot like 401(k) contributions. There are two components to funding the SIMPLE IRA: elective salary deferrals made by the employee and nonelective contributions made by the employer.

The employer contribution can take one of two forms: a flat percentage of an employee’s salary, or a dollar-for-dollar match of the employee’s elective contribution up to a certain percentage of an employee’s salary.

So a SIMPLE IRA can offer employees benefits like those of a 401(k), but in the nice low-cost package of an IRA. 401(k) plans can be costly and time-consuming to establish and administrate, while SIMPLE IRAs are relatively painless.

Pros and Cons of a SIMPLE IRA


  • Lower costs to establish and operate compared to a 401(k) plan.
  • More investment choices than most 401(k) plans: 401(k) accounts are typically limited to just a few mutual funds and ETFs. SIMPLE IRA accounts usually let owners buy and sell any security or financial instrument they choose, with just a few limitations on risky stock options trades.
  • Employer contributions vest immediately: This is an advantage for the account holder, but the employer loses a strong incentive that can keep employees around for the long term.


  • Lower contribution limits compared to a 401(k): Both the employee elective salary deferral and the maximum employer matching contribution percentage are lower than in a 401(k) plan.
  • No Roth option: Elective deferrals are always tax deferred and pooled with employer contributions.
  • Extra penalty for rollovers and withdrawals within two years of establishing the account: You’ll pay an extra 15% penalty (on top of the standard 10% penalty) for withdrawals made within two years of establishing the SIMPLE IRA. That 25% penalty also applies to rollovers to non-SIMPLE IRA accounts within two years.
  • May interfere with a backdoor Roth IRA strategy: Funds held in a SIMPLE IRA are subject to the IRA aggregation rule, which could affect tax planning for people reliant on the backdoor Roth IRA.

Related Retirement Plans

SIMPLE IRA Rules and Contribution Limits

As mentioned, there are two types of SIMPLE IRA contributions: elective employee contributions and nonelective employer contributions.

Employee contributions are limited (in 2020) to 100% of salary or $13,500, whichever is less. Contributions are deducted directly from an employee’s payroll and aren’t subject to income tax. They are, however, still subject to FICA and unemployment tax.

Employers have two options for their contributions:

  • A flat 2% of employee compensation up to the annual limit of $285,000 for 2020.
  • Matching contributions on 3% of the employee’s salary. (The match rate can be temporarily reduced under certain circumstances.)

Employee SIMPLE IRA contributions do not preclude contributions to other workplace retirement plans an employee may have. However, total contributions to all workplace retirement plans cannot exceed the maximum limit for any one plan in which an employee participates. So if you have both a SIMPLE IRA and a 401(k) available to you, you cannot contribute more than $19,500 combined (for 2020) to both plans.

Contributing to a SIMPLE IRA doesn’t prevent employees from opening their own IRAs and contributing. For those who rely on a backdoor Roth IRA, however, the SIMPLE IRA account may cause problems, as the funds are subject to the IRA aggregation rule.

How to Establish a SIMPLE IRA

Employers can adopt a SIMPLE IRA plan by adopting one of the IRS’ model plans or by simply using the prototype plan available at their brokerage of choice. Then the employer must provide each eligible employee regarding the plan details and where contributions will be deposited. Finally, the employer sets up a SIMPLE IRA account for each employee and fills out form 5305-S or 5305-SA, depending on how the accounts are established (as a trust or custodial account). Most online brokerages will handle those details.

The deadline for establishing a SIMPLE IRA is October 1. If you’re a new employer established after October 1, you can still set up a SIMPLE IRA “as soon as administratively feasible.”