SIMPLE IRAs (individual retirement arrangements) are tax-advantaged traditional IRAs for business owners and employees that accept tax-deductible contributions. In contrast, Roth IRAs offer tax advantages during your retirement years, when you can withdraw the funds with no tax penalty.
You may be wondering if you can contribute to a SIMPLE Roth IRA, but they don’t exist. Instead, to take advantage of a Roth IRA account’s benefits, you can convert a SIMPLE IRA to a Roth IRA.
Learn the difference between these two types of IRAs, the pros and cons of each, and how conversion works.
Key Takeaways
- SIMPLE IRAs are traditional IRAs and can’t be Roth IRAs.
- Contributions to SIMPLE IRAs are not taxable in the year of the contribution, but they are taxable in the year they are withdrawn.
- You make Roth IRA contributions with after-tax money, so no tax is due on withdrawals.
- You can convert a SIMPLE IRA to a Roth IRA after a two-year waiting period, but you can’t convert a Roth IRA to a SIMPLE IRA.
SIMPLE IRAs Do Not Have a Roth Option
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement plan that allows business owners and employees to contribute to traditional IRAs. It’s designed for smaller employers with 100 or fewer employees who each received $5,000 or more from their employer during the year.
You can’t include a Roth IRA option in an employee plan, because SIMPLE IRAs are funded with earnings that have been deducted from your income, while Roth IRAs are funded with after-tax funds.
Note
You can have a SIMPLE IRA account with an employer and also have an individual Roth IRA. Your contributions to the SIMPLE IRA plan don’t affect how much you can contribute to the Roth IRA.
SIMPLE IRAs vs. After-Tax Retirement Plans
The IRS has several options for after-tax retirement plans, for both individuals directly or through an employer’s retirement plan. A traditional IRA is any IRA that isn’t a Roth or a SIMPLE IRA.
Traditional IRAs are individual retirement arrangements in which an individual’s contributions are tax-deductible. Contributions to SIMPLE IRAs and other after-tax retirement plans are tax-deductible, but are taxed when funds are withdrawn.
SIMPLE IRA Contributions and Distributions
Participating employees with a SIMPLE IRA plan contribute to the plan each year and their employer generally must match dollar-for-dollar up to 3% of their compensation or make a 2% non-elective contribution for each eligible employee.
For example, say an employee whose annual pay is $50,000 contributes 5% of their salary ($2,500) to the SIMPLE IRA one year. The employer matches up to 3% ($1,500), making the employee’s total contribution $4,000 for that year. The other option is for the employer to contribute 2% of compensation for all eligible employees, even if the employee doesn’t contribute.
Employee contributions to SIMPLE IRAs are limited to a maximum each year. For 2022, the maximum employees can contribute is $14,000, but employees age 50 or over can contribute an additional $3,000.
Note
Don’t confuse a SIMPLE IRA with a SEP-IRA, which is an individual IRA account with a Simplified Employee Pension Plan (SEP) for small business owners and employees.
Roth Accounts Are After-Tax Retirement Plans
A Roth 401(k) is similar to what you might envision a SIMPLE Roth IRA to be in that it is an employer-sponsored retirement plan in which you can contribute after-tax dollars for tax-free withdrawals in your retirement years. Employers can make matching contributions.
This account works the same as a Roth IRA, with after-tax contributions. There’s no tax on withdrawals of earnings if they are made at least five years after the first contribution and after age 59½.
Note
A Roth IRA is a retirement account for individuals that allows you to contribute after-tax amounts to a Roth account, up to a limit every year. The individual can then withdraw money, including earnings, from the account any time after age 59½ with no taxation or penalties.
You can withdraw your original Roth 401(k) or Roth IRA contributions with no penalties or taxation at any time, but there are penalties for early withdrawal of any earnings you made on your investments. Some exceptions for withdrawing earnings before your retirement age include withdrawing from a Roth IRA if you are using the funds to buy your first home.
Changing a SIMPLE IRA to a Roth IRA
A rollover is a way to transfer money from some types of retirement accounts to others. To avoid tax issues, you must deposit the payment from one retirement account to another within 60 days or have a financial institution do the transfer. You can make only one rollover transaction of any type each year.
Other IRS rollover rules include:
- You can rollover a traditional IRA to a Roth IRA (called a conversion). You must include the Roth amount in your taxable income for the year.
- You can convert a SIMPLE IRA to a non-SIMPLE IRA tax-free, but you must participate in the SIMPLE plan for two years first.
- You can’t rollover amounts from a Roth IRA to an employer retirement plan, including a SIMPLE IRA or a Roth 401(k). Roth IRAs can only be rolled over to another Roth IRA.
Frequently Asked Questions (FAQs)
How much can an employer contribute to a SIMPLE IRA?
Employee contributions to a SIMPLE IRA are limited each year. For 2022, an employee’s contributions to a SIMPLE IRA can’t be more than $14,000, but individuals age 50 and older can contribute an additional “catch-up” amount of $3,000 through 2022. An employer can contribute to employee SIMPLE IRAs by matching up to 3% of an individual employee’s contribution or give all employees 2% of their compensation each year.
What’s the difference between a SIMPLE IRA and a traditional IRA?
A SIMPLE IRA is a type of employer retirement plan for small businesses, with accounts held by eligible employees and both employees and the employer making contributions. A traditional IRA, on the other hand, is owned by an individual, not as part of an employer retirement plan. Contributions to both of these types of IRAs are tax-deductible, up to a maximum each year and with tax due on withdrawal.
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