Important SIMPLE IRA Rules for the Small Business Owner

SIMPLE IRA rules are designed to make this retirement plan option relatively low cost and low hassle for small business owners. There are rules governing eligibility, contributions, tax benefits and withdrawals. All of the rules are fairly straight forward, allowing any business with one or more employees to provide retirement assistance.


The business in question must have between 1 and 100 employees. Not all employees are eligible, but those earning at least $5,000 in compensation during any two years preceding the current calendar year must be given the option of choosing the plan. The company must not offer any other form of retirement plan, such as 401k or another IRA option. Finally, the company must complete its eligibility by filling out RS Form 5304-SIMPLE or IRS Form 5305-SIMPLE annually. This is the single form required each year, making the SIMPLE plan truly simple.


With a SIMPLE IRA, the contribution burden falls largely on the individual employee. The employer must make a contribution match annually, however, regardless of the financial status of the company in a given year. The employer can choose one of two contributions options: first, it can match employee contributions up to 3 percent of the employee's salary or the contribution limit; or, it can contribute 2 percent straight, non matching, meaning all individuals will receive the benefit. An employee will carry the biggest contribution burden if he or she chooses to participate. An employee can have the contribution held from a paycheck up to the maximum annual limit. That limit for 2011 is $10,500; the limit increases after age 50. Possible catch up contributions for previous years may also increase the limit by up to $2,500 plus cost of living increases.

Tax Benefits

SIMPLE IRA contributions are tax deductible for both the employer and the employee. Technically, the contributions are made in pretax dollars. This means the total amount contributed can be deducted from annual income. While the money is in the retirement account, it will be permitted to grow tax free. The types of investments available through a SIMPLE IRA are restricted, but in general the accounts may invest in stocks and bonds. Once an employee reaches the minimum retirement age of 59-1/2, he or she can begin taking withdrawals. The withdrawals will be taxed at the time they are taken as part of the individual's income.


An employee cannot take withdrawals from a SIMPLE IRA before minimum retirement age. If he or she does so, an additional 10 percent penalty is charged on top of the owed taxes. There are few exceptions to this rule, but an employee may withdraw the funds early to pay for secondary education for him or herself or a dependent. The funds may also be used as the down payment on a first home without incurring the penalty. Once the individual reaches 59-1/2, withdrawals are optional. At 70-1/2, withdrawals become mandatory. At this point, the retiree will have to take minimum withdrawals on an annual basis or face penalties for excess accumulation.

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