How Does a SIMPLE IRA Work?

by Bryan Keythman

An individual retirement arrangement, or IRA, is a type of retirement savings plan that gives you tax advantages on money you save. A savings incentive match plan for employees, or SIMPLE, IRA is one that a business with 100 or fewer employees provides for its employees. If your employer offers a SIMPLE IRA, you can save part of your earnings for retirement, and your employer must contribute some of its own money toward your account.


When you participate in a SIMPLE IRA, your employer sets up an account for you with the financial institution that it uses to administer the IRA, such as a bank or insurance company. In some cases, you may be able to choose the financial institution. The financial institution invests money that you or your employer contribute to your account in stocks, mutual funds or similar investments. You typically determine these investments, and the money you contribute to your SIMPLE IRA is not subject to federal income tax until you withdraw it.

Contributions From Your Salary

You can contribute a percentage of your salary, a set dollar portion of your salary or nothing toward your SIMPLE IRA. For example, you might contribute 2 percent of your monthly pay or $100 of your weekly pay. Your employer deducts your contribution from your salary and deposits it into your account. As of 2012, you may contribute up to $11,500 of your earnings per calendar year. If you are 50 or older, you generally can contribute an additional $2,500 per year.

Employer Contributions

Your employer must contribute toward your SIMPLE IRA in one of two ways. Using a matching contribution, your employer matches your contribution for up to 3 percent of your salary. For example, if you make $100,000 a year and contribute $3,000 annually, your employer would also contribute $3,000 to your account annually. If your employer uses a nonelective contribution, it contributes an amount equal to 2 percent of your salary, regardless of how much you contribute. In this case, you could contribute nothing and would still receive your employer’s nonelective contribution.

Taxes and Withdrawals

When you withdraw money from your SIMPLE IRA, the amount is taxed as part of your regular income. You can withdraw money from your account at any time, but the IRS requires you to pay an additional 10 percent tax if you withdraw before you are 59 1/2 and the withdrawal does not qualify as a hardship withdrawal. This additional tax increases to 25 percent if you withdraw money within two years of starting your SIMPLE IRA. By April 1 of the year after you turn 70 1/2, you must begin to withdraw a certain minimum amount annually.

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