Getting Started with A SIMPLE IRA: A Beginner's Guide to Retirement Planning
Retirement planning is essential to financial planning. As an employer, you can profoundly impact your employee's retirement savings and have some tax perks. A great place to start is with a retirement savings plan. There are many retirement savings plan options available to employers. One option is a Savings Incentive Match Plan for Employees or SIMPLE IRA. This blog post will explore what a SIMPLE IRA is, how it works, and its benefits and drawbacks.
What is a SIMPLE IRA?
Despite the long name, as the acronym implies, these plans are simple. They are simple to start and manage, and their design and eligibility options also are simple.
A SIMPLE IRA is a retirement savings plan that small businesses with 100 or fewer employees can offer. An individual retirement account (IRA) allows employers and employees to contribute to the plan. The SIMPLE IRA is designed to be straightforward, with fewer administrative requirements than other retirement plans.
Many financial institutions, such as fund companies, have the tools to set up a SIMPLE IRA. These providers often require a small fee to start and maintain one of these retirement plans. However, one of the potential drawbacks to this is that fund companies sometimes only supply their funds. For example, suppose XYZ company provides a low-cost SIMPLE IRA platform. In that case, they may only have XYZ funds to choose from, which can impact a participant's ability to diversify if some of the funds from that company are mediocre.
SIMPLE IRAs require the use of Form 5304-SIMPLE or 5305-SIMPLE. Form 5304-SIMPLE permits participants to select a financial institution of their choice, while Form 5305-SIMPLE requires all to participate in an institution of your choice. These forms walk you through many rules as you check the boxes and fill in the blanks.
How Does a SIMPLE IRA Work?
Eligibility
Employees who earned at least $5,000 in any of the last two years or expect to make that amount this coming year would be eligible. In addition, employers can be less restrictive if they want. For example, an employer can exclude employees covered by a union agreement or nonresident alien employees who do not have "U.S. Wages, Salaries, or other personal services compensation from the employer?"
Contributions
Under a SIMPLE IRA, the employer and the employee can contribute to the plan. However, unlike the flexibility of a 401k, a SIMPLE IRA gives the employer two choices when it comes to matching.
Contribute 2% to all retirement accounts regardless of whether or not the employee also contributes.
Match employee contributions up to 3%.
The contributions to a SIMPLE IRA are tax-deductible for the employer and tax-deferred for the employee until retirement. After that, the funds in the account grow tax-free until withdrawn, and withdrawals after 59 1/2 are taxed as regular income.
Timing
A SIMPLE IRA could be set up on January 1 through October 1 of that year if you have not had another employer plan that year. However, remember that the retirement plan must run through the year. Therefore, if you are considering moving from a SIMPLE IRA to a 401(k), you won't be able to make this change mid-year.
Setup
Having a professional help you set up a SIMPLE IRA makes sense.
Advantages of a SIMPLE IRA
One of the significant advantages of a SIMPLE IRA is its simplicity. The plan is easy to set up and maintain, with fewer administrative requirements than other retirement plans. Additionally, both the employer and the employee can contribute to the plan, which helps maximize retirement savings. For example, some of the testing and filing requirements of a 401(k) are not required in a SIMPLE IRA.
Another advantage of a SIMPLE IRA is its flexibility. Employees can contribute as much or as little as they want, up to the annual contribution limit. Additionally, employees can invest their contributions in various investment options, such as mutual funds, stocks, and bonds. As noted above, investment choices may be limited depending on your platform.
Another benefit of the SIMPLE IRA is its portability. If an employee leaves the company, they can roll over their SIMPLE IRA into another retirement plan, such as a traditional IRA or a 401(k). This portability feature allows employees to maintain their retirement savings and avoid tax penalties.
Disadvantages of a SIMPLE IRA
One of the disadvantages of a SIMPLE IRA is its contribution limits. The maximum contribution limit is lower than 401(k) plan limits. Additionally, the catch-up contribution limit is also lower than other plans.
Another disadvantage of a SIMPLE IRA is the early withdrawal penalty. If an employee withdraws funds from the account before the age of 59 1/2, they will be subject to a 10% penalty in addition to regular income taxes. This penalty can significantly reduce the value of retirement savings and discourage employees from making early withdrawals. In addition, if funds are withdrawn within two years from when a participant first participates, there is a 25% tax penalty.
Unlike 401(k) plans, SIMPLE IRAs cannot add a vesting schedule to employer contributions. In other words, once an employee is eligible and receives a match, they keep 100% of the employer contribution when they leave the company. There is no vesting regardless of how long an employee has been with the company.
Execute Agreement
There are two ways to execute a SIMPLe IRA. First, you must set up one of two types of documents.
Form 5305-SIMPLE: If the SIMPLE IRA contributions will go to an employer-designated financial institution.
Form 5304-SIMPLE: If the participant is to select the financial institution that will be receiving their SIMPLE IRA contributions.
Conclusion
Talk to a professional to make sure you understand all your options. If you are looking for guidance in choosing a retirement plan, we would love to help. Though CUI Wealth Management is based in Salt Lake City, Utah, we serve clients in many states. Please see the website footer for a complete list of states we serve.