Are You Putting Too Much Money in a SIMPLE Retirement Plan?

There are many options for retirement savings plans, but SIMPLE IRAs are a popular choice for small businesses and employees. Although they have some advantages, a SIMPLE retirement plan has limitations that may hurt your retirement savings in the long run.

Are you putting too much money into a SIMPLE plan?

Let’s find out.

What is a SIMPLE IRA?

A SIMPLE IRA is exactly what it sounds like – a simple retirement savings plan that’s easy to manage. You and your employer contribute tax-deferred money into the account, and it gets invested similarly to a traditional IRA. Taxes are deferred until you withdraw the money during retirement. 

SIMPLE stands for:

  • Savings
  • Incentive
  • Match
  • Plan for
  • Employers

This type of IRA is employer-sponsored, so it’s offered to employees through a business. SIMPLE IRAs are designed specifically for small businesses with no more than 100 employees.

Employers that offer a SIMPLE IRA must make contributions every year. Contributions can be either:

  • 2% non-elective for each employee
  • A matching contribution of up to 3% of compensation

Employee contribution is elective, and all SIMPLE IRA funds belong to the employee. With nonelective contributions, the employer must still make contributions to every employee’s account even if they choose not to make contributions themselves.

In 2022, employees can contribute up to $14,000. Those who are over 50 can make additional catch-up contributions of up to $3,000.

SIMPLE IRAs are appealing because they’re easy to set up, but they aren’t always the right option for everyone. When it comes to retirement savings, it’s important to carefully weigh the benefits and drawbacks of your options so that you can find one that meets your needs. 

The Advantages of a SIMPLE Retirement Plan

SIMPLE IRAs do have their advantages. For starters, they offer an easily accessible way to save for retirement. Other benefits include:

Easy Setup

SIMPLE IRAs are straightforward for business owners to set up and require minimal paperwork compared to other types of accounts. Depending on the provider, you may even be able to set everything up online.

Here’s how it works:

  • Use Form 5305-SIMPLE if you want to choose the financial institution where the IRAs will be held, or use Form 5304-SIMPLE if you want your employees to choose.
  • Provide employees with information about the plan.
  • File the proper paperwork for eligible employees to create their SIMPLE IRAs

For employees, the process is even easier. Just ask your employer for the right forms, and fill them out. 

Easy setup is one of the primary advantages of SIMPLE IRAs and part of the reason why it’s such a popular option for both small businesses and individuals.

Low Maintenance Costs

With some retirement plans, there are fees to open and maintain accounts. With SIMPLE IRAs, the upfront and managing costs are typically lower. In fact, most providers don’t even charge a setup fee. Annual maintenance costs are negligible ($15-$25 per participating employee). 

Lower maintenance and startup costs make SIMPLE IRAs an attractive option for small businesses. 

Contributions are Tax Deductible

Employers can claim tax deductions on their matching contributions to SIMPLE IRAs for employees. For employees, the contributions are not reported as income on W-2s because your contributions are pre-tax.

Employer Matches Contributions

For employees, a SIMPLE IRA has the advantage of employers being required to make contributions. Your employer can either:

  • Match your contributions up to 3%
  • Make non-elective contributions of 2% of your compensation (if you earn less than $285,000/year)

With the non-elective option, employers make contributions regardless of whether you contribute to the account.

This may be great as an employee and not so great as the business owner. 

Fewer Eligibility Requirements

SIMPLE IRAs have relatively simple and straightforward eligibility requirements. Most workers will qualify. To be eligible, you must:

  • Make at least $5,000 from your employer in any of the last two calendar years (they don’t need to be consecutive).
  • Expect to make at least $5,000 with your employer in the current year.

Of course, your employer must also offer a SIMPLE IRA option. 

Overall, SIMPLE IRAs really are simple to set up and maintain. But easy isn’t always the best option.

The Drawbacks of a SIMPLE IRA

If you have no retirement savings plan, a SIMPLE IRA can certainly be better than having no retirement savings plan. However, there are some drawbacks to these plans that you should consider:

No Roth Options

Roth options are not available, which has consequences for tax planning. Since these IRAs are non-Roth accounts, you’ll:

  • Make pre-tax contributions
  • Pay taxes when withdrawals are made

SIMPLE IRA accounts are pre-tax contributions. You may be lucky and taxes will drop when you begin taking withdrawals, but if they don’t, you’ll have a larger tax burden. Additionally, you can take out $10,000 to use as a down payment on your first home, but you’ll pay taxes on this amount, drastically reducing it in the process.

Contribution Limits are Lower Than Other Retirement Options

A SIMPLE IRA’s contribution limits are $14,000 plus, workers over 50 can contribute an additional $3,000 to their accounts in catch-up contributions. Unfortunately, these limits are much lower than some other retirement options. 

For example, with a 401(k), individuals can contribute $20,500 in 2022 and catch-up contributions of up to $6,500 can be added to this amount.

There are Better Options for Self-Employed Individuals

If you’re self-employed, there are options other than a SIMPLE IRA, such as a a solo 401(k) or SEP IRA, that you should evaluate. Of course, you need to consider all factors, but a:

  • Solo 401(k) can be borrowed against, have simplified administrative costs, and higher contribution limits of up to $61,000 in 2022.
  • SEP IRAs allow you to contribute up to 25% of the employee’s salary, or up to $61,000. You can also opt to adjust contributions if cash flow is low for one quarter or year.

A SIMPLE IRA is often better than nothing, but there are also often better options available that are tax-advantageous or allow for higher contributions to be made.

Final Thoughts

If you’re putting too much money into a SIMPLE retirement plan, it may cause you a higher tax burden in the future. It’s always best to consider your options and find a retirement plan that can help you lower taxes, earn higher returns, and meet your financial goals for the retirement lifestyle you want to live.

To learn more about how KPN Enterprises can help you with evaluating what retirement accounts are best for you or to schedule a call, contact us here