If you are self-employed you can set up a SIMPLE IRA for yourself and make contributions to the plan even if you don't have employees. You're considered to be self-employed if you are in business for yourself or you are a sole proprietor or partner. Self-employment income can include part-time work. If you receive a Form 1099-MISC for work you performed as an independent contractor, you probably have self-employment income.
You can also set up a 401(k) plan as a SIMPLE plan. However,
there's little advantage to doing so, since you'll have the same lower
contribution limits as a SIMPLE IRA plan, but you'll give up the ease of
administration that makes SIMPLE plans attractive in the first place.
SIMPLE IRA Plans
Looking for a retirement plan for your
employees that's easy and inexpensive to
administer? Well, there may be a simple
answer, the Savings Incentive Match Plan for
Employees of Small Employers, better known
as the SIMPLE IRA plan.
A SIMPLE IRA plan
lets your employees defer up to $13,500 of compensation in
2021 ($16,500 if age 50 or older; unchanged from 2020). You promise
to match employee contributions dollar for
dollar up to 3% of pay, or to make a
"nonelective" contribution for all eligible
employees, whether or not they contribute,
equal to 2% of pay.
(The 3% of pay match may be reduced to as little as 1% in any two of five years. And no more than $290,000 of an employee's pay can be taken into account when determining contributions in
2021, up from $285,000 in 2020.)
How do I set up a SIMPLE IRA plan?
You can adopt a SIMPLE IRA plan for 2021
if you had 100 or fewer employees in 2020
(excluding employees who earned less than
$5,000) and you don't contribute to any other
retirement plan. If your business qualifies,
follow these three simple steps to set up your
SIMPLE IRA plan (you have until October 1 to
set up a new SIMPLE IRA plan for 2021).
Step 1: Adopt a written plan document
You can set up a SIMPLE IRA plan by
completing either a pre-approved document
provided by a financial institution (for example,
a mutual fund company, insurance company, or
bank) or an IRS model document (either Form
5305-SIMPLE or Form 5304-SIMPLE).
Form 5305-SIMPLE lets you specify the
"designated financial institution" that will both
act as your plan's trustee/custodian and initially
receive all plan contributions. Form
5304-SIMPLE, on the other hand, lets each
eligible employee select the financial institution
that will serve as trustee/custodian and receive
all plan contributions.
Step 2: Provide information to your employees
You must provide your eligible employees with
the following information before the beginning
of each election period:
- An explanation of the employees' ability to
make or change salary reduction elections
- Whether you'll make matching contributions
or nonelective contributions for the coming
- A summary description of the plan
- If you use a designated financial institution,
a notice that employees can transfer their
account balances to an IRA provider of their
choice without cost or penalty
The election period is generally the 60-day
period prior to the start of
each calendar year (November 2 to December 31). However, the election
period will be different if you set up a SIMPLE
plan mid-year, or if an employee first becomes
eligible after the 60-day period ends. Forms
5304 and 5305 contain most of the documents you'll
need to comply with these notice requirements.
Step 3: Set up employee accounts
A SIMPLE IRA account must be set up by or for
each eligible employee, and all contributions to
the plan must go into these accounts. In general, you must include all employees who've earned at least $5,000 (from you) during any two preceding years (whether or not consecutive) and who are expected to earn at least $5,000 in the current year.
What are some advantages of a SIMPLE IRA plan?
- SIMPLE IRA plans are not required to follow certain Internal Revenue Code rules that prohibit discrimination in favor of higher-paid workers. Therefore, even if no employees want to contribute, you can establish a plan, contribute on your own behalf, and provide an employer matching contribution.
- You aren't required to file reports with the government — only the financial institution holding the IRAs is required to file reports.
- Once your employees exercise control over the assets in their accounts, you are relieved of any fiduciary responsibility.
- Employer contributions can be flexible.
You can decide each year whether you want to provide a matching contribution or a nonelective contribution.
- The plan requires minimal paperwork.
- Your business can deduct contributions made to a SIMPLE IRA, whether you're making contributions for only yourself, or for yourself and your employees.
The dollars invested are pre-tax dollars and accrue tax deferred. That means that your employees can exclude the contributions from their gross income.
- Income-tax-free rollovers or direct trustee-to-trustee transfers can be made from one SIMPLE IRA to another SIMPLE IRA at any time.
A tax-free rollover from a SIMPLE IRA to a traditional IRA or to another employer plan can be made only after you've participated in the SIMPLE IRA for at least two years. (Caution: You're generally limited to one tax-free, 60-day rollover from one IRA to any other IRA — traditional, Roth, SEP, and SIMPLE — you own in any 12-month period.)
What are some disadvantages?
- You're required to make a contribution every year.
- Your employees are vested immediately. As a result, the SIMPLE IRA might not be a good choice if your goal is to induce employees to remain with your company. Furthermore, immediate vesting can be extremely costly if you have high turnover.
- You're not allowed to maintain any other employer-sponsored retirement plans.
- The annual employee deferral is more than an IRA, but significantly less than a 401(k) plan.
- Withdrawals from a SIMPLE IRA before age 59½ are subject to a 25% early distribution penalty (unless an exception applies) during an employee's first two years of participation, and 10% thereafter, in addition to regular income tax.
What are some key differences between a SIMPLE IRA plan
and a 401(k) plan?
|Number of employees||100 or fewer earning at least $5,000||Any number|
limits||$13,500, $16,500 if 50 or older||$19,500, $26,000 if 50
|Additional employer contributions
allowed?||No||Yes, total contribution (including deferrals) up to
$58,000 or more possible|
|Creditor protection?||Yes, in
bankruptcy; unclear outside bankruptcy||Generally yes, inside and
Early withdrawal penalty||25% during first two years of participation, then 10%||10%|
|Vesting schedule?||No, all contributions 100% vested||Vesting schedule allowed for employer contributions only|
(Dollar limits are for the 2021 plan year.)