A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement savings plan designed for small businesses and their employees. It allows both the employer and employee to contribute to the employee’s retirement account while keeping setup and maintenance costs low. It’s a practical option for small employers who want to offer a retirement benefit without the complexity of a 401k.

In this post, we’ll cover who’s eligible for a SIMPLE IRA, how it works in retirement, the two-year rule, tax implications, potential downsides, and 2025 contribution limits, along with how it differs from a traditional IRA.

Who Is Eligible for a SIMPLE IRA?

A SIMPLE IRA is meant for small businesses with 100 or fewer employees who earned at least $5,000 in the previous year. To qualify:

• Employees must have earned at least $5,000 in any two prior years and be expected to earn at least that amount in the current year.
• Employers must make either:
  • A dollar-for-dollar match of employee contributions up to 3% of compensation, or
  • A non-elective contribution of 2% of compensation for all eligible employees, even if they don’t contribute.

Because it’s straightforward and low-cost, a SIMPLE IRA is often used by small employers who want to encourage retirement savings without extensive fees and maintenance.

How Does a SIMPLE IRA Work When You Retire?

Throughout your career, contributions grow tax-deferred, meaning you don’t pay taxes on the money or investment earnings until you withdraw them. When you retire:

• You can roll over your SIMPLE IRA into a traditional IRA (after meeting the two-year rule).
• Withdrawals are taxed as ordinary income.
• If you withdraw before age 59½, you’ll likely owe a 10% penalty — or 25% if you’re still within the plan’s two-year rule.
• Required Minimum Distributions (RMDs) begin at age 73 (unless future IRS rules change).

In short, your SIMPLE IRA functions like other traditional retirement accounts — helping you grow savings now while deferring taxes until later.

What Is the 2-Year Rule for a SIMPLE IRA?

The two-year rule is one of the most important features of a SIMPLE IRA. It means:

• You cannot roll over money from your SIMPLE IRA into another retirement account (like a traditional IRA or 401k) until you’ve participated in the plan for at least two years.
• If you take money out before that two-year period and before age 59½, you’ll face a 25% early withdrawal penalty — higher than the usual 10%.
• After the two years, you can roll over funds or take withdrawals under standard IRA rules.

This rule protects the plan’s integrity and encourages participants to save for long-term retirement goals.

Do I Have to Pay Taxes on My SIMPLE IRA?

Yes. SIMPLE IRAs are tax-deferred, not tax-free. Here’s what that means:

• Contributions are pre-tax, reducing your taxable income during working years.
• Earnings grow tax-deferred until withdrawal.
• When you take distributions in retirement, they’re taxed as ordinary income.
• Withdrawals before age 59½ may be subject to taxes and penalties.

The advantage is that you lower your taxes now, but you’ll need to plan for taxable income in retirement.

Is a SIMPLE IRA a Traditional IRA?

A SIMPLE IRA shares many similarities with a traditional IRA, but they’re not the same. Both accounts offer pre-tax growth and taxable withdrawals, but they differ in structure and purpose.

• A traditional IRA is opened by an individual, while a SIMPLE IRA is an employer-sponsored plan.
• Contribution limits are higher for SIMPLE IRAs because employers can also contribute.
• SIMPLE IRAs have mandatory employer contributions (either matching or nonelective), while traditional IRAs do not.
• SIMPLE IRAs are subject to the two-year rule; traditional IRAs are not.

Basically, a SIMPLE IRA is a type of traditional IRA designed specifically for small-business employers and their employees.

What Are the Downsides of a SIMPLE IRA?

While SIMPLE IRAs offer many benefits, there are a few drawbacks to keep in mind:

• Lower contribution limits than 401ks, which can limit total savings potential.
• Limited investment options, depending on the financial institution.
• The two-year rule restricts early rollovers and increases early withdrawal penalties.
• Required employer contributions can be a financial strain for very small businesses.
• No Roth option in most plans, meaning all contributions are pre-tax.

Despite these downsides, the simplicity and low cost make it a strong choice for small employers and employees looking for an easy retirement plan.

SIMPLE IRA Contribution Limits for 2025

For 2025, the IRS has announced updated contribution limits for SIMPLE IRAs:

• Employee contribution limit: $16,500
• Catch-up contribution (age 50+): $3,500, for a total of $20,000
• Special catch-up (ages 60–63): Up to $5,250, allowing contributions as high as $21,750
• Employer match: Up to 3% of compensation, or a 2% nonelective contribution for all eligible employees

These limits make the SIMPLE IRA an attractive way to save more than you could with a traditional IRA while keeping participation requirements simple.

Final Thoughts on SIMPLE IRAs

A SIMPLE IRA is an excellent retirement savings option for small business owners and employees alike. It offers tax-deferred growth, employer contributions, and easy setup — all without the complex rules and costs of a 401k. However, it’s important to understand the two-year rule, the tax treatment of withdrawals, and how contribution limits fit into your broader retirement plan.

If you’re eligible for a SIMPLE IRA, take full advantage of employer matching and stay consistent with your contributions. A well-managed SIMPLE IRA can play a key role in building long-term financial security.

Want to learn more about SIMPLE IRAs? Contact Zynergy Retirement today.