Last Updated on November 14, 2023 by Ben
What is a Simple IRA vs. Traditional IRA? What are the differences between these two types of retirement accounts? What is the difference in contribution limits, and when can you withdraw funds without penalty? What are some other considerations for an individual to make in choosing one over the other? These questions will be answered today.
A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a retirement savings plan designed to help small-business owners and their employees save for retirement. A retirement plan is a way for small businesses with less than 100 employees to help their employees. Employees who earn at least $5,000 a year can use this plan.
A SIMPLE IRA is like a traditional IRA. In a SIMPLE IRA, people can make tax-deferred contributions to their account so that it grows over time. When you retire, you start to withdraw money. When that happens, you need to give some of the money back in taxes.
A SIMPLE IRA is one where both the employer and the employee put money into an account. Employers have to give money when you work. They either match your contribution up to 3% of your salary or give you a flat 2%. No matter what they decide, you must save some of the money for yourself too. If you match an employee’s money, they must put in some first.
The yearly limit for SIMPLE IRA contributions is $13,500. Plus, if you are over 50 years old, you can make an additional $3,000 a year.
A SIMPLE IRA is a savings plan for retirement. It is for people who work at small businesses with less than 100 employees. This plan stands for “Savings Incentive Match Plan for Employees” and “Individual Retirement Account.” If employers want to, they can make a plan where the company gives 2% of the employee’s salary. If an employer wants to make a plan that matches an employee’s contribution, they can do so up to 3% of their salary.
In 2021, employees can contribute a maximum of $13,500. This is increased to account for inflation. Older people who are over 50 can also make another contribution of up to $3,000, and then the total that they can have in their retirement fund is up to $16,500.
One of the important parts of a new law called the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 is that employers who sign up to offer 401(k) or SIMPLE IRA plans will get a tax credit.
You can open a traditional IRA and put money in it to save for your retirement. The company does not help you with this. You can open an IRA if you have worked and earned some money in the past year. And you must be younger than 70 ½ years old at the end of the year.
A traditional IRA allows individuals to put money in before taxes. Investments can grow tax-deferred, and when you don’t have to pay any taxes until the person who got the money from the IRA withdraws it. Individuals can gross up to a certain amount of money in a year. They can give it all to the government, or not.
You might not be able to make money from your IRA if you are making too much money in a year. If you have a traditional IRA, the amount of money you can take out for each year might depend on your income and other things. Retirement savers may save money in their IRA. They might do this through a broker, or they can use a Robo-advisor.
Differences Between SIMPLE IRAs and Traditional IRAs
Eligibility to Contribute
You need to have earned income like money you get from work. If you are less than 70 1/2 years old at the end of the year, you can contribute to a traditional IRA. Earned income is like money you get from work.
To give to a SIMPLE IRA, you must meet the eligibility requirements set by your employer. These requirements cannot exceed requiring that you earn at least $5,000 in compensation for any two years and are expected to earn at least $5,000 this year.
You might be able to participate in your employer’s plan if you make $2,000 per year. But your employer can’t exclude you from the plan if you earn more than $10,000 a year. If you don’t have a job, you can open an IRA. The IRS says that SIMPLE IRAs are good for small employers who do not offer any other retirement savings plan to their employees.
Annual Contribution Limits
Traditional IRAs have lower contribution limits than SIMPLE IRAs. As of the tax year 2019, you can only contribute up to $6,000 per year ($7,000 if age 50 or older) to a traditional IRA if you had at least $6,000 in earnings. The maximum amount you can put into a SIMPLE IRA is $13,000 or your yearly salary, whichever is smaller.
Employers Matching Contributions
Employers cannot match the money that you put into a traditional IRA because it is not from your workplace. A SIMPLE IRA is different. Your employer must give money to you in this retirement plan. They can use either of the two ways to do this: elective or non-elective. Under the elective plan, your employer has to match your contribution up to 3% of your salary. Under the non-elective plan, they have to make a contribution of 2% of what they earn, no matter how much they contribute.
Early Distribution Penalties
You will pay more money if you take money from your IRA that is before you are 59 1/2 years old. If you are under 59 1/2, the tax penalty is 10%, and regular income tax is on the whole amount. The same rule usually applies to distributions from a SIMPLE IRA. But if you take an early distribution within two years of opening your SIMPLE IRA, you must pay a 25% penalty instead of the normal 10%.
For example, if you take a $4,000 early distribution of your SIMPLE IRA within two years of opening it, you have to pay the income taxes and pay a $1,000 early withdrawal penalty.
SIMPLE IRA Advantages
SIMPLE IRAs do not need to have a non-discrimination and top-heavy test. When someone makes money, they can take it with them when they leave. This is good because the employer’s matching contributions belong to the employee. Additionally, some tax credits may be available for both employees and employers.
You can put up to $12,500 per year in a SIMPLE IRA. If you are 50 or older, you can put in an extra $3,000. This means that you can have up to $15,500 per year if you are 50 or older.
Another difference between a SIMPLE IRA account and a traditional IRA account is that an employer can choose to match the contributions of their employees. This means that you might get more money every month. Employers can either match their employees’ contributions up to 3% of their salaries or contribute a fixed amount of 2% regardless of whether they contribute.
Traditional IRA Advantages
IRAs are a good way to save money. The tax deduction for contributions and the tax-deferred investment compounding are the main benefits. You can invest in stocks, bonds, and mutual funds with an IRA.
IRAs are a good way to save for retirement. You save money before taxes, and then it grows in the account. This helps you not have to pay taxes on your money when you retire, which is very helpful.
When you retire, your income tax goes up. But when you take money out of an IRA, your taxes don’t go up. They stay the same because you already paid those taxes in the past.
A contribution limit is when you can put money in. It’s $6,000 for those under age 50 and $7,000 for those over age 50. You have to take money out of the account if you’re over 72.
Traditional IRAs and SIMPLE IRAs are different. With a traditional IRA, it is possible to take money out of the IRA penalty-free, even if you don’t have any money in there. With a SIMPLE IRA, you will get a much bigger tax bill if you take money out without having anything in your bank account. The SIMPLE IRA is a plan that lets you save money. You will lose 25% of the money if you take it out within two years of joining, even if you qualify for an exception.
Which Retirement Plan Should You Choose?
If you are self-employed or run your own business, opening a SIMPLE IRA is a good idea. This can help you save for retirement. You can put in more money than other IRAs, which will help you pay less in taxes now. Another important thing about the SIMPLE IRA is that you can contribute as both an employee and employer if you are self-employed.
There are two different types of IRAs. A traditional IRA is a kind of retirement account that offers tax breaks. SIMPLE IRAs are another kind, and they offer tax breaks too. No matter what option you pick, the earlier you start saving money, the more money you will have when it is time to retire.
Can I Have Both a SIMPLE IRA and a Traditional IRA?
Yes, it is viable for an individual to have both a SIMPLE IRA through their employer and a traditional IRA on their own—though they may not deduct all of their traditional IRA contributions. The IRS sets the maximum amount of deductions per calendar year.
Single people with an AGI (adjusted gross income) of more than $66,000 are only allowed to take a partial deduction. People with an AGI above $76,000 won’t be able to take any deduction at all. In today’s market, it is hard to discover the right buyer for your home. It can be tough to find someone with enough money and who also wants your home. But you do not need to give up. Make sure that you list your house at a competitive price with other homes in the area with prices from $300K.
As you can see, there are pros and cons to both options. No matter which option you ultimately choose, it’s important to remember that the earlier you start contributing to your account each year—regardless of what type of IRA plan it is—the greater. Your chances will be for accumulating a sizable savings balance in time for retirement.