Differences Between a Traditional IRA & a SIMPLE IRA

by Keith Evans

Individuals saving for retirement have several financial options, and many choose to open tax-advantaged individual retirement arrangements, or IRAs, to hold at least some of their savings. Although many investors may have some familiarity with traditional IRAs, another form of retirement account known as the Savings Incentive Match Plan for Employees, or SIMPLE IRA, may offer more attractive investment options for some small-business employees -- if their employers opt to offer the plan.

Opening

Individuals can set up traditional IRAs on their own initiative. Banks and other financial institutions typically offer IRA services, but investors can also open traditional IRAs with stockbrokers, mutual funds and even insurance companies. Although individuals can open a traditional IRA at almost any participating institution, an employer must open a SIMPLE IRA on the employee’s behalf. SIMPLE plans were created specifically for small businesses who might not have the resources to administer more complicated 401(k)-style retirement plans. Consequently, any employer who establishes a SIMPLE IRA must have no more than 100 employees during the calendar year during which it establishes the account.

Contributions

In a traditional IRA structure, investors can make contributions on their own schedule. In a SIMPLE IRA, by contrast, employees rely on the employer to make periodic contributions to the IRA. Employees cannot directly contribute to the retirement account themselves; instead, employees who wish to make their own contributions to a SIMPLE account must do so through employer payroll deductions.

Tax Benefits

To encourage people to save for retirement, the IRS allows individuals to take tax deductions on up to $5,000 per year for IRA contributions as of 2012, and some individuals who are over 50 may take tax deductions on contributions of up to $6,000 per year. Employees who contribute to SIMPLE IRA accounts can defer taxation on up to $11,500 per year as of 2012, including both the employee’s payroll-deducted contributions and the amount that the employer contributes on the employee’s behalf. In addition, employers can claim a tax credit of up to $500 per year for each SIMPLE IRA account they maintain.

Eligibility

Any individual who received taxable compensation during a tax year can open and maintain a traditional IRA as long as he has not yet reached the age of 70 1/2. To hold a SIMPLE IRA, by contrast, individuals must work for a small business that employs no more than 100 employees. The IRS requires that employers who sponsor SIMPLE IRA accounts must allow participation from any employee who made at least $5,000 in either of the prior two tax years, and who is expected to make at least $5,000 in the present year.

Considerations

Because both traditional and SIMPLE IRA accounts defer taxation, account holders who withdraw from the accounts after reaching retirement age must pay taxes on the funds at their normal tax rate. Account holders who terminate or otherwise withdraw from the accounts prior to reaching retirement age may face an additional penalty for early withdrawal. Employees who hold a SIMPLE IRA account need not become vested in the accounts before making withdrawals.

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