SIMPLE IRA

A SIMPLE IRA is an employer-sponsored retirement plan built on individual retirement accounts, under which employees may elect salary reduction contributions and the employer must contribute on their behalf. SIMPLE is an acronym, and the model documents spell it out as "Savings Incentive Match Plan for Employees of Small Employers." Two other names are worth knowing because official sources use them. The tax code calls the underlying account a "simple retirement account" and the plan itself a "qualified salary reduction arrangement," so a reader who meets those phrases in a statute or a plan document is looking at the same thing. Eligibility to sponsor one is limited to employers with no more than 100 employees who received at least $5,000 of compensation in the preceding year, with a two-year grace period once a growing employer crosses the line.

The employer contribution is the defining feature. Every year the employer must choose one of two formulas and tell employees which before the election period opens. The first is a dollar-for-dollar matching contribution up to 3% of compensation, paid only to employees who defer. The second is a nonelective contribution of 2% of compensation for every eligible employee, paid whether they defer or not. The match percentage can be reduced to as low as 1%, but not in more than 2 years out of any 5-year period, and employees must be notified in advance. There is no year in which an employer can simply skip the contribution, which is the sharpest contrast with a SEP IRA.

Four deferral figures, and the pair you use is set by the employer. SECURE 2.0 created a parallel higher limit for smaller employers on top of the standard one. The standard deferral limit is $17,000 with an age-50 catch-up of $4,000. The higher limit is $18,100 with an age-50 catch-up of $3,850. Two conditions gate it, and consumer summaries almost always give only the second. First, the employer must not have established or maintained a qualified plan, a 403(a) annuity plan, or a 403(b) plan for substantially the same employees during the 3 taxable years before it first maintained the SIMPLE. An employer that already ran a 401(k) and switched cannot use the higher limit at all. Second, among employers that clear that test, the higher limit applies automatically to those with 25 or fewer qualifying employees, and by election to those with 26 to 100, where making the election also raises the required employer contribution, from 2% to 3% for the nonelective and from 3% to 4% for the match. Read the two catch-up figures again, because the higher-limit plan's catch-up is the smaller of the two. That is not a transcription error; the two amounts sit in different statutory provisions and are adjusted separately. For participants who reach age 60, 61, 62, or 63 during the year, a larger catch-up of $5,250 replaces the age-50 amount rather than adding to it.

Deferrals are not ring-fenced from the rest of a person's plan contributions. Publication 560 states that salary reduction contributions under a SIMPLE IRA plan count toward the overall annual limit on elective deferrals, $24,500. Somebody who defers into a 401(k) at one job and a SIMPLE IRA at another has one shared ceiling across both, which is a common and expensive surprise.

The two-year 25% additional tax has no parallel elsewhere. Section 72(t)(6)(A) replaces "10 percent" with "25 percent" for any amount received from a SIMPLE retirement account during the two-year period beginning on the date the individual first participated in the employer's arrangement. The clock runs from first participation, not from the date of each contribution, and moving the money does not escape it. Inside the two years a SIMPLE IRA can be rolled over tax-free only into another SIMPLE IRA, so an attempted rollover to a traditional or Roth IRA is not a rollover at all: it is a distribution, taxed as income, charged the 25%, and liable to become an excess contribution in the receiving account. SECURE 2.0 added one narrow relief: the 25% rate does not apply where an employer terminates its SIMPLE and establishes a 401(k) or 403(b), and the money moves there as a rollover.

Timing, coverage, and vesting. A SIMPLE IRA plan can be established effective on any date from January 1 through October 1 of a year, unless the employer is brand new, in which case it may be set up as soon as administratively feasible. An employee is eligible if they received at least $5,000 in compensation during any 2 preceding years and are reasonably expected to receive at least $5,000 in the current year, and an employer may loosen those conditions but not tighten them. The employee election period is generally the 60 days before January 1, running from November 2 to December 31, and a plan may offer longer or additional windows. Contributions are nonforfeitable from the moment they are made, so there is no vesting schedule. Roth SIMPLE IRAs have been permitted since 2023, but the documentation has not caught up: the IRS model forms 5304-SIMPLE and 5305-SIMPLE were last revised in 2012 and contain no Roth provisions, and the IRS's own SIMPLE plan page still carries the pre-2023 line that a SIMPLE IRA cannot be a Roth IRA. A Roth election also has to be made by the employee before the contribution; an employer cannot default anyone into one.

The exclusive-plan rule. A SIMPLE IRA plan must generally be the only retirement plan to which the employer contributes, or under which benefits accrue, for service in any year the SIMPLE is effective. There is an exception for a separate plan covering collectively bargained employees. An employer that wants a profit-sharing contribution on top of employee deferrals has to look at a 401(k) instead.

The employer adopts a plan document, notifies employees of the contribution formula and their right to make or change a salary reduction election, and a SIMPLE IRA is opened for each eligible employee. Employees elect a percentage of pay during the election window. Salary reduction amounts are withheld from each paycheck and deposited; employer matching or nonelective contributions are due by the employer's tax filing deadline including extensions. There is no annual Form 5500 to file.

A hypothetical example under the 3% match. Aisha earns $60,000 and elects to defer 6% of her pay, which is $3,600. Because the match is dollar-for-dollar only up to 3% of compensation, her employer contributes $1,800, not $3,600, so $5,400 goes into her account for the year. Had the employer chosen the 2% nonelective formula instead, she would have received $1,200 regardless of what she deferred, and so would every other eligible employee, including those who deferred nothing.

A second hypothetical showing the two-year rule. Aisha first participated in March 2026 and withdraws $10,000 in November 2027, at age 41. The withdrawal is ordinary income, and because it falls inside the two-year window the additional tax is 25% rather than 10%, so $2,500 rather than $1,000. Waiting until after March 2028 would have cut the additional tax by $1,500.

Pros

• Very light administration. No annual filing, no nondiscrimination testing, and a short model document.
• Employees can defer their own pay, which a SEP IRA does not allow, and the employer contribution is guaranteed rather than discretionary.
• Employer cost is capped and predictable, at 3% of pay for those who defer or 2% of total eligible pay.
• Contributions vest immediately, so nothing is lost when someone leaves.
• Roth SIMPLE IRAs have been available since 2023 where the documents provide for them.

Cons

• The employer contribution is mandatory every year, including years when the business is losing money.
• Deferral limits are meaningfully lower than a 401(k)'s, so it caps out sooner for a high-earning owner.
• The 25% additional tax in the first two years is a real trap for a new participant who needs the money.
• It must generally be the employer's only plan, so no profit-sharing contribution can be layered on top.
• No plan loans, and the balances aggregate with traditional IRAs under the pro-rata rule.