What is a SIMPLE IRA or 401(k) Retirement Plan?

Use your business or self-employment income to boost your retirement nest egg.

Laura Adams, MBA
4-minute read
Episode #234


One of the advantages of being self-employed is that you get additional perks from the Internal Revenue Service to help you save for retirement. Setting up a retirement plan for your business allows you to put aside more money, gives you additional tax deductions, and may help you attract and keep valuable employees.

One of the retirement plans available for a small business is called a SIMPLE plan. No matter if you run a business with employees or are self-employed and work by yourself full or part-time, I’ll tell you what you need to know about using a SIMPLE to grow a healthy retirement nest egg.

What is a SIMPLE Retirement Plan?

SIMPLE is an acronym that stands for savings incentive match plan for employees—but it’s also meant to be a simplified retirement plan with relatively low costs. You can set up a SIMPLE IRA or a SIMPLE 401(k)—check out the links below to learn more about their differences and how to set one up.

Either is ideal as a starter plan for small to medium-size companies or for the self-employed because they come with few administrative hassles, fees, and restrictions. As long as you don’t maintain another type of workplace retirement account, like a conventional 401(k) or a SEP-IRA, and you have fewer than 100 employees, you can set up a SIMPLE for your business.

Who Can Contribute to a SIMPLE Retirement Plan?

A SIMPLE is ideal as a starter plan for small to medium-size companies or for the self-employed because it comes with few administrative hassles, fees, and restrictions.

The requirements for contributing to a SIMPLE are pretty straightforward. Employees and self-employed individuals must generally have earned at least $5,000 during any of the 2 prior years. Additionally, you must expect to earn at least $5,000 during the current year in which you make SIMPLE contributions.

How Are SIMPLE Contributions Made?

A SIMPLE allows an employer to reduce an employee’s paycheck by a certain percentage or flat amount and contribute it to the account. For 2011, you can contribute a maximum of $11,500 or $14,000 if you’re age 50 or older. Contributions are made on a pre-tax basis, so they’re excluded from gross income and are not subject to federal income tax withholding.

You’re always 100% vested in (or have full ownership of) all the contributions you and an employer make to a SIMPLE—and you can stop making contributions at any time during the year. You typically get to choose how to invest your money from a menu of options that are available from the financial institution that manages the SIMPLE and holds your funds.

What Are SIMPLE Matching Contributions?

One of the defining features of a SIMPLE is that the employer must contribute to their workers’ accounts each year as either matching funds or as nonelective contributions. Here’s how the matching option works: The employer must match what the employee contributes on a dollar-for-dollar basis up to 3% of their compensation.

For example: If you earn $50,000 and contribute 10% or $5,000 to a SIMPLE, your employer would match 3% of your compensation by depositing an additional $1,500 ($50,000 x 3%) into your account, bringing your total contribution for the year up to $6,500. But if an employee doesn’t contribute any money, they lose out on getting additional matching funds.

What Are SIMPLE Nonelective Contributions?

The second SIMPLE option for an employer is to make nonelective contributions to their employees’ accounts. Nonelective means that the employer has to pay up regardless of whether the employee contributes any of their own money. The employer is required to give the employee 2% of their compensation up to $4,900 each year.

For instance, if you make $50,000, the employer would be obligated to kick in 2% or $1,000 ($50,000 x 2%), regardless of the amount you contributed. Again, the employer gets to choose between these 2 options—they never have to fork over both matching and nonelective contributions.

How to Take Distributions from a SIMPLE?

Distributions from a SIMPLE are subject to typical IRA and 401(k) rules. You must begin taking required minimum distributions after age 70½ and early withdrawals taken before age 59½ are generally subject to income tax plus a 10% penalty.

The early withdrawal penalty is actually increased to 25% if funds are withdrawn before you’ve participated in a SIMPLE for 2 years. After this 2-year time limit, you can also make tax-free rollovers from a SIMPLE IRA or a SIMPLE 401(k) into a traditional IRA if you decide to call it quits with your business or job. 

Can You Contribute to a SIMPLE and An IRA?

It’s important to remember that using a SIMPLE for your business (or contributing to one as an employee) never affects the amount you can put in a traditional or Roth IRA. For 2011 you can still contribute $5,000 or $6,000 if you’re age 50 or older. If you’re a business owner who maxed out your IRA and still have more money to invest, take a hard look at using a retirement plan for your business. A SIMPLE could be the ticket to saving more now, so you have much more income to enjoy during retirement. 

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Get More Money Girl!

There’s a huge archive of past articles and podcasts if you type in what you want to learn about in the search bar at the top of the page. Here are all the many places you can connect with me, learn more about personal finance, and ask your money question:

More Resources:
Publication 4222, 401(k) Plans for Small Business
Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)
Publication 4334, SIMPLE IRA Plans for Small Businesses
FAQs regarding SIMPLE IRA Plans
To set up a SIMPLE IRA: complete Form 5304 or Form 5305
To set up a SIMPLE 401(k): contact a bank or mutual fund company for help getting started

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlersbook is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.