How Does a Simple IRA Work?

Jason Stolz CLTC, CRPC

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a type of employer-sponsored retirement plan designed for small businesses with 100 or fewer employees. It combines the tax advantages of a traditional IRA with the employer-matching features of a 401(k), offering an easy and affordable way for employers to help their workers save for retirement.

Understanding how a SIMPLE IRA works—including contribution limits, tax benefits, and rollover options—can help you decide whether it’s the right fit for your business or personal retirement plan. Many individuals eventually use their Simple IRA to create guaranteed income during retirement.

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SIMPLE IRA Basics: Contributions, Eligibility, and Taxes

Eligibility: Employers with 100 or fewer employees earning at least $5,000 can establish a SIMPLE IRA plan.
Contributions: Employees can defer up to $16,000 in 2025 ($19,500 if age 50+). Employers must either match up to 3% of compensation or make a 2% nonelective contribution for all eligible employees.
Tax benefits: Contributions are tax-deductible for employers and reduce taxable income for employees. Growth is tax-deferred until withdrawn.
Withdrawals: Distributions before age 59½ are subject to income tax and a 10% penalty—or 25% if within two years of plan participation.

SIMPLE IRA vs. SEP IRA vs. 401(k): Key Differences

Each retirement plan type offers unique advantages. The table below compares the SIMPLE IRA to other popular options for small business owners and self-employed individuals:

Feature	SIMPLE IRA	SEP IRA	401(k)
Eligibility	Employers ≤100 employees	Any size business	Any employer
Employee Contributions	Up to $16,000 (2025)	Not allowed	Up to $23,000 (2025)
Employer Contributions	2% nonelective or 3% match	Up to 25% of pay	Optional match or profit share
Administration	Simple and low-cost	Minimal paperwork	More complex
Early Withdrawal Penalty	25% (first 2 years), then 10%	10%	10%
Rollover Options	To IRA or annuity after 2 years	Flexible	Flexible

Estimate Your SIMPLE IRA Income

Rolling Over a SIMPLE IRA to an Annuity

After two years of participation, SIMPLE IRAs become eligible for tax-free rollovers to another qualified account—like an IRA or a fixed or fixed indexed annuity. A direct rollover ensures your funds move custodian-to-custodian without triggering taxes or penalties.

Tax-deferred growth: Rollover maintains your tax benefits while offering more investment flexibility.
Guaranteed income: Converting a portion to an annuity can secure a predictable lifetime income stream.
Principal protection: Fixed and indexed annuities protect your balance from market downturns.
Legacy options: Income and death benefit riders can ensure continued protection for beneficiaries.

Compare SIMPLE IRA Rollover Options

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Frequently Asked Questions: SIMPLE IRAs

Who can set up a SIMPLE IRA?

Employers with 100 or fewer employees who earned at least $5,000 in the prior year can sponsor a SIMPLE IRA plan. Employees generally become eligible if they earned $5,000 in any two preceding years and expect to earn $5,000 in the current year.

How do employer contributions work?

Employers must either match employee salary deferrals dollar-for-dollar up to 3% of compensation, or make a 2% nonelective contribution for every eligible employee—whether or not the employee defers.

What are the employee contribution limits?

Employees can defer up to the current SIMPLE IRA annual limit, with an additional catch-up contribution available for those age 50 or older. (Your plan materials list the current-year limits.)

When do the 25% and 10% early withdrawal penalties apply?

Withdrawals before age 59½ are generally subject to a 10% penalty. If the distribution occurs within the first two years of participating in a SIMPLE IRA, the penalty increases to 25%.

Can I roll a SIMPLE IRA into another account?

Yes. After two years of participation, you can typically complete a direct rollover to an IRA or qualified annuity without current taxation.

Are Roth SIMPLE IRA options available?

Some plans may offer Roth deferrals. Traditional contributions reduce current taxable income; Roth deferrals use after-tax dollars and may allow tax-free qualified withdrawals later.

How do SIMPLE IRAs compare with SEP IRAs or 401(k)s?

A SIMPLE IRA is easier and less costly to administer than most 401(k)s and allows employee deferrals (unlike a SEP IRA), but it has lower contribution limits than many 401(k) plans. See the comparison table on this page for a quick overview.

Can a SIMPLE IRA fund guaranteed retirement income?

Yes—many savers roll a portion to an annuity at retirement to convert savings into guaranteed income for life while maintaining beneficiary protections.