What Is a SIMPLE IRA and How Does It Work?

Written by |

A SIMPLE IRA is a type of retirement plan available to small businesses with 100 or fewer employees.

Because of its lower contribution limits and restrictive rules, money expert Clark Howard isn’t too fond of SIMPLE IRA plans.

In this article, I’ll explain how a SIMPLE IRA compares to a solo 401(k) and a SEP IRA. I’ll also explain what Clark doesn’t like about SIMPLE IRAs.

Table of Contents


A SIMPLE IRA is a retirement plan for small businesses with 100 or fewer employees.

SIMPLE IRA stands for “Savings Incentive Match Plan for Employees Individual Retirement Account.” That’s a mouthful. But it’s in the same family as SEP IRAs and solo 401(k)s.

If you’re self-employed, a SIMPLE IRA probably doesn’t make sense for you. The contribution limits are considerably lower and the rules are more restrictive than those of a SEP IRA or a solo 401(k). There may be a narrow use case where it makes sense for someone who’s self-employed, and I’ll discuss that later in this article.

“The SIMPLE IRA: Nobody does the SIMPLE any more. And the reason is it’s a lie! There’s nothing simple about a SIMPLE,” Clark says.

“The paperwork is brutal. It’s straight-jacketed with a lot of inflexible rules. I never, ever recommend a SIMPLE to anybody. So in my opinion, which could be wrong, I think it really is a choice between the SEP and the solo 401(k).”

Rules & LimitsSIMPLE IRA Version
Eligibility• $5,000+ compensation for 2+ years
• Expect $5,000+ compensation in 2021
Employee Contribution Limit$13,500*
Catch-Up Contribution Limit$3,000 (50 and older)
Employer Contributions• Non-elective (2% of salary)

• Dollar-for-dollar match (up to 3% of salary)
TaxesPre-tax contributions only (owe taxes upon withdrawal)

*You can make up to $19,500 in total tax-deductible contributions each year. This limit allows you to contribute to multiple 401(k) accounts.

How Does a SIMPLE IRA Work?

If you own a company that employs 100 or fewer people, you’re allowed to open a SIMPLE IRA.

One of the few attractive features of a SIMPLE IRA is that there are minimal paperwork requirements. Outside of working with your financial institution to put together an initial (but basic) document for your SIMPLE IRA plan, you’ll need to provide annual disclosure statements to your employees. But there’s no annual IRS filing requirement for the business.

You’re allowed to choose the financial institution that will hold the SIMPLE IRA of every employee. To do that, you’ll establish the plans via Form 5305-SIMPLE. But you can also let your employees pick where they want to hold their own SIMPLE IRAs. To do that, you’ll establish the plans via Form 5304-SIMPLE.


Most financial institutions have IRS-approved SIMPLE IRA templates. So depending on the financial institution with which you do business, you may not need to fill out either of those forms.

Your business can also get a tax credit of up to $500 for adding automatic enrollment to your SIMPLE IRA plan.

To qualify for a SIMPLE IRA plan, the IRS mandates that an employee must have earned at least $5,000 from the business in at least two previous years (which don’t have to be consecutive). An employee also must “reasonably expect to receive” at least $5,000 in income from the company in a given year to be eligible to participate in the plan that year.

In order to open an account, employees need to fill out SIMPLE IRA adoption agreements. Once enrolled, an employee can contribute up to the $13,500 limit ($16,500 for 50 and older). Note that all SIMPLE IRAs are traditional plans; there is no Roth available.


Similar to solo 401(k) plans, major brokerages offer inexpensive, easy SIMPLE IRA options.

For example, Vanguard’s SIMPLE IRA option charges $25 per year for each fund to which you invest within your plan. So if you invest in four funds, you’ll be charged $100 per year. Vanguard waives that fee once you’ve invested at least $50,000.

At that investment level ($50,000+), Vanguard also includes Personal Advisor Services, which includes the ability to invest via a digital (or “robo”) advisor while getting advice and guidance from a team of human financial advisors.

Clark likes Vanguard due to its low-cost model. He’s also a fan of Fidelity and Schwab.

SIMPLE IRA Contribution Limits for 2021

Type Of ContributionSIMPLE IRA Contribution Limit
Employee Contribution$13,500*
Catch-Up Contribution$3,000 (50 and older)
Employer Non-Elective Contributions2% of salary
Employer Match Contributions100% match on 3% of salary^

*You can make up to $19,500 in total tax-deductible contributions each year. This limit allows you to contribute to multiple 401(k) accounts.

^Can reduce to as little as 1% of every eligible employees’ salary in any two out of five years; maximum eligible compensation is $290,000 for 2021.


If you offer a SIMPLE IRA plan to your employees, your company must contribute each year. But you can choose between a 2% non-elective contribution and a 3% dollar-for-dollar match.

You must decide the option you’re going to offer and notify your employees during the election period. Employers are required to have an annual election period of 60 days from Nov. 2 to Dec. 31, but companies can choose to offer multiple election periods.

If you’re an employee and your company offers you a SIMPLE IRA, you’re limited to making $13,500 of contributions in 2021. For those 50 and older, you can make an additional $3,000 in catch-up contributions.

However, you can still make up to $6,000 in tax-deductible contributions to a traditional or Roth IRA (plus an additional $1,000 if you’re 50 or older).

SIMPLE IRA Withdrawal Rules and Early Withdrawal Penalty

There are a few exceptions, but in most cases, the IRS will slap you with a 10% early withdrawal penalty if you reach into your retirement account and withdraw before you turn 59½.

And it’s worse if you withdraw less than two years after opening your account. The penalty for violating the SIMPLE IRA two-year waiting period? A 25% IRS tax.

That’s in addition to federal and possibly state income tax — not to mention the opportunity cost of the tax-deferred growth on your investments. So if you withdraw $100,000 from your SIMPLE IRA prior to the end of your two-year waiting period, you’ll owe $25,000 in early withdrawal penalties before you even get the bill for your income tax on the $100,000.

The two-year waiting period holds true no matter your age. You’re also not allowed to roll over your funds to another retirement account (other than a different SIMPLE IRA) until two years after you’ve opened your account.

The typical 10% early withdrawal penalty prior to 59½ still applies to a SIMPLE IRA even after you’ve waited out the two years.

Remember that SIMPLE IRA plans don’t offer you a chance to make Roth contributions. So all of your contributions (up to your maximum deductible limit) will reduce your tax bill. But you’ll owe taxes on your contributions, your employer’s contributions and your investment earnings when you withdraw the money in retirement.


Required Minimum Distributions (RMDs) start at 72 years old per IRS rules. In other words, you have to start taking money out of your SIMPLE IRA after you turn 72 even if you’re still working. The only workaround is to convert your funds to a Roth IRA, but then you’ll immediately owe taxes on every dollar.

How To Open a SIMPLE IRA

If you decide to offer a SIMPLE IRA plan to your employees, you’ll follow these three steps to get started:

  1. Determine whether you’ll give your employees the option to choose their financial institution(s). Most major financial institutions have an IRS-approved model. Otherwise, you’ll need to fill out some extra paperwork to start the plan. The form will be different if you allow each employee to choose their custodians, or the companies through which they invest.
  2. Provide plan information to every eligible employee. During the election period, you need to inform eligible employees which employer contribution option you’ll use for that year.
  3. Set up SIMPLE IRA accounts for each eligible employee. As you know, IRA stands for “Individual Retirement Account.” So as the employer, you’ll need to set up each account individually. That could mean as many as 100 different forms.

Advantages of a SIMPLE IRA

Here are some of the benefits of SIMPLE IRA plans:

  • Easier and less expensive than a 401(k). If you own a small business and you have employees, a SIMPLE IRA may be the only retirement plan you can afford to offer. It’s certainly less costly, less time consuming and requires less compliance knowledge than a traditional workplace 401(k).
  • Tax deductible. The contributions you make as a business owner reduce your tax bill for the year. You can get an additional tax credit just by auto-enrolling your employees in the plan.
  • Mandatory employer contributions. This is one thing that sets a SIMPLE IRA apart from a SEP IRA or a solo 401(k). If you’re an eligible employee and your company offers a SIMPLE IRA, it must offer employer contributions.
  • Low eligibility requirements. As an employee, it’s easy to qualify. All you need is at least two years where you’ve made $5,000+ from a company and the expectation that you’ll make at least $5,000 this year.
  • Allows contributions to other IRAs. Contributions to a SIMPLE IRA don’t exclude you from making contributions to your own traditional or Roth IRA.
  • More investment options than a 401(k). In general, IRAs give you more control and selection in terms of investment options. That’s true in this case as well.

Disadvantages of a SIMPLE IRA

Here are some of the drawbacks of SIMPLE IRA plans:

  • Lower contribution limits. SIMPLE IRAs are at the bottom of the barrel in terms of individual contribution limits allowed for workplace retirement plans. So it’s not the best plan if you’re looking to max out your retirement contributions.
  • No Roth option. Clark is a huge proponent of Roth retirement accounts. He expects federal income tax rates to increase over time due to federal budget deficits. SIMPLE IRA plans don’t offer Roth options.
  • Huge penalty for withdrawing within first two years. Even if you meet the IRS age condition ( at least 59½ years old), if you withdraw from your SIMPLE IRA less than two years after opening it, you’ll owe the IRS a whopping 25% penalty. On top of that, you’ll also owe federal income tax on the full amount you withdraw.
  • Rollovers restricted. You’ll have to wait at least two years before transferring your balance to anything other than another SIMPLE IRA.
  • Limit to employer contributions. Companies that offer these plans must give the same percentage contribution to each qualifying employee. But the most that an employer will contribute is 3% of your salary through a dollar-for-dollar match (which requires you to also contribute at least 3% of your salary). Compare that to 20%+ with the other common options for the self-employed or small business owners.

SIMPLE IRA vs. Solo 401(k) vs. SEP IRA

Employee Contribution Limits$13,500 ($3,000 in catch-up contributions)$19,500 ($6,500 in catch-up contributions)Not allowed
Employer Contribution LimitsNon-elective (2%) or dollar-for-dollar (1 to 3%)20% of net income or 25% of gross income*20% of net income or 25% of gross income*
Employer Eligibility100 or fewer employeesCan't have a qualified employee; must earn self-employment incomeMust earn self-employment income
Employee Eligiblility• $5,000+ income in 2+ years

• Expect $5,000+ this year
• At least one year

• At least 1,000 hours per year
• At least 21 years old

• At least 3 years of service within 5-year period (service year = $600+ in income)
Unique Rules25% early withdrawal penalty in first two yearsAllows for Roth contributions and almost unlimited investment optionsMust contribute same percentage to every qualifying employee

*Or $58,000 in total contributions, whichever is less.

Clark professes a strong distaste for SIMPLE IRA plans, especially when self-employed individuals have a solo 401(k) or SEP IRA plan as options.

Those plans include higher contribution limits and fewer restrictions.

Here’s when each of these options is best:

  • Solo 401(k): A great option if you don’t have any qualifying employees  and you’re trying to set aside as much money as possible for retirement. In some cases, you’ll have the option to contribute to a solo Roth 401(k), and you’ll enjoy the most investing options of any retirement plan. A solo 401(k) gives you the ability to contribute as an employer and as an employee simultaneously.
  • SEP IRA: Wonderful if you want less administrative hassle than with a solo 401(k) and/or you have at least one qualifying employee but don’t want to operate a full-fledged 401(k).
  • SIMPLE IRA: Good for a more narrow use case. You probably need to check both these boxes: First, you’re ineligible for a solo 401(k) because you have one or more employees. And second, a SEP IRA is prohibitively expensive for you because you must give every qualified employee the same contribution percentage. If you want to offer everyone in your company some sort of retirement plan while spending less than you would on a 401(k), a SIMPLE IRA is the “better than nothing” option.

Final Thoughts

Given the available retirement plan options, business owners and employers are unlikely to be happiest with a SIMPLE IRA.

It’s easy to see why Clark feels so strongly about them. But if you fit into the narrow use case I’ve described here, it’s understandable why you’d at least consider a SIMPLE IRA plan.


Still, if you’re able to do so, Clark would like you to set aside as much money as you can for retirement each year. That means a retirement plan with higher contribution limits than a SIMPLE IRA.

More Clark.com Content You May Like:

The Latest From The Podcast