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What is a SIMPLE IRA?

A family member of mine will be reviewing what it will take to participate in her employer’s SIMPLE IRA soon. So what do we know about the SIMPLE IRA? The SIMPLE part is Savings Incentive Match Plan for Employees of Small Employers.

The SIMPLE IRA is a retirement plan for small businesses with less than 100 employees who earned $5,000.00 or more during the preceding calendar year. Compared to other retirement plans for small business owners it offers lower start-up and annual costs. They are simpler to operate.

Here are some advantages for the employee:

  • Employees can contribute, on a tax-deferred basis, through convenient payroll deductions.
  • Your employer can choose to match the employee contributions or to contribute a fixed percentage.
  • Employees are 100% vested and are in complete control of their own accounts.
  • Employers can make contributions for employees over the age of 70 1/2 even though the employee can’t if they are over 70 1/2.

The disadvantages include the benefits of a SIMPLE IRA don’t provide an adequate retirement in its self.

Only the following institutions can be designated as trustees of SIMPLE IRA plans:

  • Banks
  • Mutual Funds
  • Insurance companies that issue annuity contracts
  • Other IRS approved institutions

Trustees agree to:

  • Receive and invest contributions, and
  • Provide the employer with a summary description of the plan features each year.

Two models are offered:

  1. Not for use with a designated financial institution, or
  2. Use with a designated financial institution

Number one means the employees are allowed to select the financial institution to receive their contributions. Number two means the initially deposited contributions are with a designated financial institution.

Employee Contributions:

  • You can contribute up to $10,000.00 per year.
  • Employees can change their contribution level once a year during the plan’s election period. However, there can be more election periods during the year.

Employer Contributions (two choices):

  1. A 2% non elective employer contribution equal to 2% of their compensation, regardless of whether they make their own contributions.
  2. A dollar-for-dollar match up to 3% of pay, where the employer matches the employee’s contributions up to 3%.

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SIMPLE IRA Example

Distributions

  • Employees cannot take loans from their SIMPLE IRAs.
  • Contributions and earnings can be withdrawn at anytime as a lump sum or a roll over to an IRA or another employer’s retirement plan.
  • Subject to income tax for the year in which the distributions are received
  • If withdrawn prior to 59 1/2, generally a 10% additional tax applies. If this happens within two years from the beginning of the plan the 10% penalty is increased to 25%.
  • There is a Required Minimum Distribution when the employee reaches 70 1/2.

So there you go. Almost everything you wanted to know about a SIMPLE IRA.

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