SIMPLE IRA: Definition, Rules, & Contribution Limits

A SIMPLE IRA is a tax-advantaged retirement plan for small businesses and solopreneurs. It’s easy to set up and affordable but it comes with lower contribution limits.

SIMPLE IRA definition

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A SIMPLE IRA is an easy-to-manage, low-cost retirement plan for small businesses and self-employed workers, offering tax-deferred savings with both employee and employer contributions.

While it’s more affordable than a 401(k), it comes with lower contribution limits and mandatory distributions starting at age 73.

If you work for yourself and want a better return on your savings, this article will help you understand SIMPLE IRAs.

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What is a SIMPLE IRA?

SIMPLE IRA definition

A SIMPLE IRA – short for Savings Incentive Match Plan for Employees – is a retirement savings plan for small businesses with less than 100 employees and self-employed workers.

Like a 401(k), both employees and employers can contribute to a SIMPLE IRA. Compared to other types of retirement savings accounts, SIMPLE IRAs are cost-effective for small businesses and require less paperwork to set up.

How does a SIMPLE IRA plan work?

A SIMPLE IRA is like a combination of an employer-sponsored 401(k) and a self-managed IRA. During the election period, employees determine how much they would like to contribute to their savings plan.

Their contribution is automatically deducted from their paycheck using pre-tax dollars, helping workers reduce their taxable income.

After a SIMPLE IRA is set up, employers have to give their employees 60 days’ notice to determine whether or not they want to participate in the plan.

Employers are required to let their employees know what the employer plans to contribute to the plan and the dates of the election period. 

Employers have two contribution options:

  • 2% non-elective contribution of the employee’s compensation
  • Matching contribution up to 3% of an employee’s contribution

Let’s say you’ve started your own consulting practice. You set up a SIMPLE IRA to start saving for retirement. Under the plan, you can individually contribute up to $16,000 and the business can contribute 2% of your compensation.

If you pay yourself an $80,000 salary, that’s an additional $1,600 you can save for retirement.

Unlike an employer-sponsored 401(k), a SIMPLE IRA gives you control over what you invest in. You can choose a low-cost ETF like the Vanguard S&P 500 ETF to reduce your overhead while increasing your long-term returns.

SIMPLE IRA Contribution Limits

SIMPLE IRAs aren’t as well-known as traditional IRAs, but if you are self-employed or want to offer a retirement option for your employees, they are a good, low-cost alternative.

Just like other retirement plans, there are annual contribution limits. For 2025, employees can contribute up to $16,000 annually.

Employees aged 50 or older can make an extra catch-up contribution of $3,500 for a maximum contribution of $19,500. 

If you participate in another employer’s retirement savings plan, the total employee contribution you can make across all accounts is $23,000.

SIMPLE IRA Employee 2025 Contribution Limits

Contribution TypeContribution Limit
Small business employee or self-employed worker (younger than 50 years old)$16,000
Small business employee or self-employed worker (50 years old or older)$19,500
Combined limit for employees participating in another employer-sponsored plan$23,000

There is a separate contribution limit for employers. They can either match an employee’s contribution up to 3% of their salary or contribute 2% for all eligible employees.

Nonelective contributions are capped at a maximum salary of $345,000.

SIMPLE IRA Employer 2025 Contribution Limits

Contribution TypeContribution Limit
Compensation match3%
Non-elective contribution2%

Contributions have to be made by the tax deadline. For employers that is usually April 15. For sole proprietors who want to make contributions to a SIMPLE IRA, the IRS advises them to do so by January 30.

What are the SIMPLE IRA rules?

To be eligible to open a SIMPLE IRA, a small business must employ 100 workers or less. Individuals who work for themselves are also eligible.

For individuals to be able to contribute, they must first work for a company that offers a SIMPLE IRA. If they do, they have to have earned at least $5,000 in compensation during any two previous calendar years.

They must also be expecting to earn at least $5,000 in the current year.

Like other retirement savings plans, there are rules governing how employees can take disbursements. SIMPLE IRAs are tax-deferred plans.

Contributions are made with pre-tax dollars. When you begin taking disbursements, withdrawals are subject to income tax.

Anyone who makes a withdrawal before age 59 ½ will pay a 10% penalty.

If you decide you need to tap into your funds within the first two years of participating in a SIMPLE IRA, you will be hit with a 25% tax.

SIMPLE IRAs come with required minimum distributions. On April 1 of the year following the calendar year, you reach age 73, you will be obligated to make withdrawals from your SIMPLE IRA.

After that, you’ll be required to take a disbursement every year by December 31. 

The actual distribution amount varies based on the value of your SIMPLE IRA and your life expectancy. The IRS uses the Uniform Lifetime Table to determine the specific amount you’ll be required to take.

Benefits & Disadvantages

There are some benefits to opening a SIMPLE IRA, especially for employers who want to offer the option to their staff or solopreneurs who want to capitalize on tax-deferred savings.

Before opening an account, here are some things you should take into consideration.

Benefits

  • Low cost. Compared to 401(k)s, there’s a much lower operating cost for both employers and self-employed workers.
  • Tax benefits. Workers who make contributions can reduce their taxable income while employers can receive a tax deduction for making contributions on behalf of their employees.
  • Flexible investment choices. Employees have more options to invest in, not just pre-picked plans provided in typical employer-sponsored 401(k)s. This gives employees the ability to manage their own asset allocation and diversify their holdings according to their personal risk tolerance.
  • Ability to contribute to other accounts. Workers who participate in a SIMPLE IRA can also contribute to other employer-sponsored plans. Just be mindful of the total contribution limit across all accounts.

Disadvantages

  • Limited savings potential. While a SIMPLE IRA is a good option, it isn’t the best option. Other retirement savings plans offer business owners the opportunity to save even more.
  • Waiting period. There is a two-year waiting period before funds can be rolled over into a traditional IRA. Nonqualified rollovers are subjected to a 25% penalty.
  • Required minimum distributions. Once you hit age 73 you’ll have to begin taking distributions from your SIMPLE IRA regardless of whether or not you want to.
  • No loan option. You won’t be able to take out a loan like you can with a 401(k). If you need to tap into your funds early, you’ll be hit with a 10% early withdrawal penalty.
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SIMPLE IRA vs. 401(k)

A 401(k) is arguably the most well-known retirement savings option but it isn’t the best option especially for employers.

A SIMPLE IRA is easier to set up and easier to maintain but comes with lower contribution limits.

CriteriaSIMPLE IRA401(k)
Tax StatusTax-deferredTax-deferred
Who Can Contribute?Employee and employerEmployee and employer
Contribution Limit$16,000 (individual) + $3,500 (catch-up)$23,000 (under 50) or $30,500 (older than 50)

SEP IRA vs. SIMPLE IRA

Similar to a SIMPLE IRA, a SEP IRA is ideal for small businesses and self-employed workers. While workers can’t contribute to a SEP IRA, it does come with the potential for employers to contribute slightly more.

CriteriaSEP IRASIMPLE IRA(k)
Tax StatusTax-deferredTax-deferred
Who Can Contribute?Employer onlyEmployee and employer
Contribution Limit25% of an employee’s salary up to $69,000$16,000 (individual) + $3,500 (catch-up)

SIMPLE IRA vs. Roth IRA

A Roth IRA offers different benefits that traditional savings plans do not. Using post-tax dollars, a Roth IRA allows you to grow your savings tax-free.

For many investors, a Roth IRA is a supplemental savings plan, in addition to an employer-sponsored plan.

CriteriaSIMPLE IRARoth IRA
Tax StatusTax-deferredTax-free
Who Can Contribute?Employee and employerEmployee only
Contribution Limit$16,000 (individual) + $3,500 (catch-up)$7,000 (under 50) or $8,000 (older than 50)

According to the 2022 SECURE Act 2.0, employees with a SIMPLE IRA can designate their funds to go to a Roth account.

*This hasn’t been fully implemented and not all employers offer this option.

SIMPLE IRA vs. Traditional IRA

CriteriaSIMPLE IRATraditional IRA
Tax StatusTax-deferredTax-deferred
Who Can Contribute?Employee and employerEmployee only
Contribution Limit$16,000 (individual) + $3,500 (catch-up)$7,000 (under 50) or $8,000 (older than 50)

How to Set Up a SIMPLE IRA Plan

To set up a SIMPLE IRA, talk to your employer to see if it is an option. If it is, each employee has to complete IRS Form 5305-SA to set up an account.

For self-employed workers, verify you are eligible to open an account. Work with a brokerage firm like Vanguard or Fidelity to get started.

Fill out IRS Form 5305-SIMPLE to designate your brokerage as the custodian of your plan.

After the necessary paperwork is complete and your account is opened, you can begin funding your account. Like other self-managed IRAs, you can use the funds deposited into your account to invest in stocks, bonds, ETFs, and if eligible, crypto or gold.

Is a SIMPLE IRA right for you?

A SIMPLE IRA is a tax-advantaged retirement savings plan that is best for sole proprietors or small businesses. If you work for yourself, this plan allows you to make contributions that reduce your taxable income while receiving a contribution from your business.

While a SIMPLE IRA is easier to administer, it isn’t the best option for everyone. It comes with lower contribution limits than traditional 401(k)s, additional penalties, and required minimum distributions. 

Before opening an account, evaluate your personal financial situation or talk to a professional financial advisor. Determine whether or not the tax benefits and contribution limits make sense for you and if they don’t, find a different plan that better aligns with your goals.

FAQs

What is the 2-year rule for a SIMPLE IRA?

You must wait two years before rolling over a SIMPLE IRA into a different plan – like a traditional IRA. If you don’t you’ll be hit with a 25% penalty.

What should I do with my SIMPLE IRA after I leave my job?

If you leave your job you can leave your SIMPLE IRA with the financial institution that manages your account or roll it over to another SIMPLE IRA without penalty.

You can also wait two years when the account is eligible to be rolled over to a different type of account, like a Roth IRA.

How much can an employer contribute to a SIMPLE IRA?

Employers can either match an employee’s contribution up to 3% of their compensation or make a nonelective 2% contribution for all employees.

How are SIMPLE IRAs taxed?

SIMPLE IRAs are tax-deferred and are taxed as ordinary income when you begin taking distributions. If you take a withdrawal before age 59 ½ your withdrawal will incur an additional 10% penalty.

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