The Pros and Cons of a SIMPLE IRA

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A SIMPLE IRA is what I like to call a ‘fall between’ plan.

It has some of the characteristics of a SEP IRA and some of the characteristics of a 401(k); because of the SIMPLE IRA rules, it kind of ‘falls in between’ the two different plans.

When an employer has less than 100 employees and wants an alternative to a 401(k) plan that is simple and less expensive to install, a SIMPLE is worth looking into. Under a SIMPLE plan, both qualified employees and employers can make contributions to traditional IRA’s set up in their name(s).

If you’re a self employed individual you can also have a SIMPLE IRA, but as I told Blogger X (in my email to him) it probably makes more sense to have a SEP or Solo 401(k), because the amount you can contribute to a SIMPLE is capped at a far lower level ($10,500 for 2008) then either of the other plans mentioned.

If you are anticipating growth in your business and want to eventually put away as much as you can, then the SEP and Solo 401(k) allow you more flexibility then the SIMPLE.

Pros of a SIMPLE (Savings Incentive Match Plan for Employees) IRA

• Easy to install - much like the SEP IRA, all the documents you need to open up a SIMPLE will be on file at most banks or financial institutions.
• Benefits are totally portable (100%)
• Unlike the SEP IRA, employees can defer a portion of their salaries into the plan - which is a pre-tax contribution.
• Employers can also make contributions into the accounts of each employee, hence the name Savings Incentive Match Plan. For example, an employer may decide to match 3% of an employees contribution dollar for dollar or make a non-elective contribution for each eligible employee - up to 2% of pay.
• If an employee makes a contribution and an employer matches that contribution, the employee is 100% vested immediately, there is no vesting period like you find in many company sponsored 401(k) plans.

Cons of a SIMPLE IRA

• If you’re an employee (or the sole proprietor employer), you are limited on the salary deferral contribution amount you can make ($10,500 for 2008). However, employees aged 50 or older can make “catch up” contributions ($2,500 for 2008).
• If an employer adopts a SIMPLE IRA plan, it cannot maintain another qualified retirement plan, SEP, TDA or government plan (other than a 457 plan).
• An employer may initially setup a SIMPLE IRA plan as late as October 1st of the year when the contributions will be made.
• Even if an eligible employee does not make a contribution to his (or her) SIMPLE IRA, under a ‘non elective’ contribution formula, that employee must still receive an employer contribution up to 2% of his or her salary. (This could be looked at as both a Pro and (or) a Con).

In Conclusion

If you’re self employed a SEP or Solo 401(k) will allow you to sock away more pre-tax dollars, especially if you expect your income to grow in coming years.

If you have employees (that have received at least $5,000 in compensation during any 2 preceding years and the same is expected this year) and want to offer them the ability to defer portions of their salary, without the complications of setting up a qualified 401(k) plan, then a SIMPLE IRA may be a viable option.

Tags: SIMPLE IRA