Taxable Rules for a SIMPLE IRA

by Cindy Quarters

The term “SIMPLE” stands for Simple Incentive Match Plan for Employees. A SIMPLE Individual Retirement Account (SIMPLE IRA) is a retirement-savings plan that is available only to small businesses that have less than 100 qualified employees. There are tax benefits to using such a plan and tax consequences to withdrawing funds. Once in a SIMPLE IRA, money grows tax-free until it is withdrawn.

Employee Participation

When an employee opts to participate in a SIMPLE IRA plan, money is deducted from her paycheck each pay period for deposit into her IRA account. She can choose to contribute any amount the plan allows, but the employer is only required to match funds up to a specified limit. Funds placed in a SIMPLE IRA are considered to be salary-reduction funds and are deducted from the amount of an employee’s pay before taxes are calculated, thus reducing the employee’s tax liability. As of 2011, the employee may not contribute more than $11,500 to a SIMPLE IRA.

Employer Matching

With a SIMPLE IRA, the employer contributes money to an employee’s retirement account by matching the amount of the employee contribution, up to 3% of the employee’s salary. An additional 2% can be added to this amount if the employer chooses to do so. Matching funds must be available to all eligible employees, generally those making more than $5,000 per year as of 2011. Since these contributions are considered to be a business expense, money placed into a SIMPLE IRA reduces the employer’s tax liability.

Regular Withdrawals

An employee can begin to receive money from his SIMPLE IRA account any time after he reaches the age of 59 ½. At that time, the employee will be responsible for paying taxes on the amount of the withdrawal. Since money is not usually taken from an IRA until the account owner has retired, the person’s tax bracket is normally lower than it was when the contributions were made, resulting in significantly less tax liability.

Early Withdrawals

A person with a SIMPLE IRA can take money out before she turns 59 ½, but this may have significant tax consequences. Unless the money is used for an approved purpose, such as paying medical bills or as a down payment on a first home, any money taken out of the account will be taxed at the account owner’s regular tax rate for the year in which the money was withdrawn. In addition, a 10% tax penalty is assessed on the amount of the withdrawal. If the money is taken from the account less than two years after the account was opened, the tax penalty is raised to 25%. Rollovers to other types of retirement accounts are often allowed without the participant incurring any tax penalty.

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