Simple IRA Rules For the Small Business Owner

Individual retirement accounts (IRAs) are a popular method of saving for your golden years.  When you mention IRAs, most people immediately think of either the traditional IRA or Roth IRA which are the two most recognizable types of individual retirement accounts.  What many people may not realize is that there are other types of IRAs that may be available and more appropriate for your situation.  One of these “other” types of IRAs include the SIMPLE IRA which we will discuss in further detail here.

Simple IRA Rules For the Small Business Owner

What is a SIMPLE IRA?

A SIMPLE IRA plan is best described as a close relative of the 401k.  While they share some similarities, they are indeed different types of savings plans for individuals.  The SIMPLE IRA is designed with small business owners and employees in mind.  Where many smaller companies lack the resources to offer retirement plans to their employees, the SIMPLE IRA makes it possible for contributions to be made through salary reductions (for employees), while the employer can provide a matching contribution.

Rules for establishing a SIMPLE IRA.

Employee rules for establishing and participating in a SIMPLE IRA are fairly straight forward.  They include:

  • The company must have less than 100 paid employees that have received at least $5,000 in the prior year.
  • No other retirement plan may be offered such as the 401k or 403b.  Exceptions are allowed if these plans are part of a bargaining workforce union.

Employees do not have a lot of eligibility rules to follow either, they include the following;

  • Employee must have received at least $5,000 in paid compensation at least twice in their working history.
  • Employee must anticipate receiving $5,000 in the current working year.
  • Employees that are covered by a union or collective agreement may be ineligible for participation in a SIMPLE IRA.

Contribution rules.

Just like other IRAs there are contribution rules which must be adhered to by both the employer and employee.  Limits may vary and are similar to that of the 401k.  Employee contributions must be deposited to the SIMPLE IRA by the 30th of the month following the contribution (i.e.  contributions made in May of 2010 must be deposited by June 30, 2010).  Employers contributions do not have to be made monthly, instead they must be deposited by the tax-filing deadline.

Distribution rules.

With any retirement plan it is important to understand the distribution rules to avoid any unnecessary penalties or fees.  The rules for distribution for the SIMPLE IRA are as follows:

  • Two year rule-  Once your employer deposits your first contribution to their SIMPLE IRA, assets in this account must not be moved to another retirement plan.  This rule does not apply to transfers to another SIMPLE IRA.
  • Qualified distributions-  To avoid early distribution penalties, distributions must not be made prior to the age of 59 1/2.  If this occurs, the standard 10% penalty will apply as well as any income taxes owed on the distribution amount.  IF, the two year rule was not followed, the early distribution penalty increases to 25%.  There are exclusions to this penalty which include; un-reimbursed medical expenses, paying medical insurance, disability, qualified higher education expenses, distributions to an IRA beneficiary and to purchase a new home.  It is important to carefully review and understand any exclusions to avoid making an unqualified distribution.

The SIMPLE IRA is an excellent tool to save for retirement for those who qualify.  As with any other retirement or savings plan, it is important to understand the rules and regulations to ensure this is the type of plan that will best meet your financial needs.

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