Many smaller businesses now offer Simple IRAs to their employees. These retirement plans deliver many of the same benefits as a 401(k) plan as well as similar tax advantages to a Traditional IRA.
Does your employer offer a Simple IRA as part of your benefits? Are you wondering whether it’s a better option than a Traditional IRA? You’ve come to the right place! Keep reading as we break down the differences between Simple and Traditional IRAs so you can get a better idea of which might be best for you.
WHAT IS A SIMPLE IRA?
A SIMPLE (Savings Incentive Match Plan for Employees) IRA is a retirement savings plan tailored to the needs of smaller businesses with 100 employees or less. It offers a way for employees to make pre-tax contributions towards their retirement and have these matched by their employer, who can take a tax deduction for these payments.
Like a 401(k) plan, employers can match contributions you make to your Simple IRA plan. In this case, employers have an option to match your contributions dollar-for-dollar for up to 3% of your salary, or to contribute a flat rate of 2% of the employee’s salary, even if the employee doesn’t contribute.
As with other tax-advantaged retirement accounts, there’s a limit to how much you can contribute annually to a Simple IRA plan. In 2024 that number is $16,000 and in 2025 it will be $16,500. In each case, workers over the age of 50 can contribute an additional $3,500 in “catch-up” payments.
And, as with Traditional IRAs, there is a 10% penalty (plus taxes due) if money is withdrawn from the account before age 59½. That penalty rises to 25% if money is withdrawn within the first two years of participation in the plan.
You’re also limited in how you can invest the money in your IRA to whatever investments your employer chooses.
WHAT IS A TRADITIONAL IRA?
Traditional IRAs are private retirement accounts that can be opened by anyone who receives earned income. There are no contributions by your employer. You can contribute pre-tax dollars on a tax-deferred basis, which means you don’t pay taxes on the money until you withdraw it in retirement.
You can begin withdrawing distributions from your IRA when you reach age 59½, and there is a 10% penalty (in addition to taxes due) if you choose to withdraw money earlier.
Contribution limits to a Traditional IRA are limited to $7,000 in 2024 and 2025, or $8,000 if you are 50 or older. This is significantly lower than what you can contribute to a Simple IRA plan. In addition, your ability to deduct contributions to your IRA is subject to income limits if you or your spouse are covered by a tax-advantaged retirement plan at work.
Unlike Simple IRAs, Traditional IRAs are also available as a Roth IRA option. This type of IRA allows you to pay tax upfront on your contributions so that withdrawals after age 59½ are tax-free. This can be to your advantage if you are in a higher tax bracket at that age than you were at the time of contribution.
Also unlike Simple IRAs, you’re free to invest money in a 401(k) in a variety of options of your choice from money market accounts or share certificates to stocks and bonds. Investors in Simple IRAs can only choose from options offered by the plan provider.
The following table summarizes the main differences between Simple and Traditional IRAs.
Simple vs. Traditional IRAs |
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Simple IRA | Traditional IRA | |
Eligibility | Employees of small businesses (100 employees or fewer) | Anyone with earned income, regardless of employer size |
Contribution Limits (2024) | $16,000 ($19,500 with catch-up for 50+) | $7,000 ($8,000 with catch-up for 50+) |
Employer Contributions | Required (dollar-for-dollar match up to 3% of salary or 2% flat rate) | Not applicable (funded solely by the individual) |
Tax Benefits | Pre-tax contributions, employer deductions | Pre-tax contributions (tax-deferred), subject to deductibility limits |
Early Withdrawal Penalty | 25% within the first two years, 10% thereafter before age 59½ | 10% before age 59½, with some exceptions |
Investment Options | Limited by employer’s plan offerings | A broad range of options (stocks, bonds, mutual funds, etc.) |
Roth Option | Not available | Available (pay tax upfront, tax-free withdrawals in retirement) |
PROS AND CONS OF SIMPLE IRAs
Let’s consider some of the specific advantages and disadvantages offered by Simple IRAs.
PROS
Major advantages of Simple IRAs include:
- Easy and affordable for employers to set up and manage
- Tax-deferred retirement savings for employees
- Tax-deductible contributions for employers
- Higher contribution limits than Traditional IRAs
- Catch-up contributions for employees over 50
CONS
Potential disadvantages of Simple IRAs include:
- Lower employee contribution limits than 401(k) accounts
- Higher withdrawal penalty (25%) for the first two years
- Investment options are limited to what the employer’s plan provider offers
- No “Roth” option for making after-tax contributions
- Required Minimum Distributions (RMDs) after age 73
PROS AND CONS OF TRADITIONAL IRAs
Now, by contrast, let’s examine some of the advantages and disadvantages of Traditional IRAs.
PROS
Major advantages of Traditional IRAs include:
- Easy to set up – does not require help from an employer
- Tax-deferred retirement savings for investors
- Catch-up contributions for investors over 50
- Wide choice of investment options for funds
- “Roth IRA” option for after-tax contributions
CONS
Potential disadvantages of Traditional IRAs include:
- Lower contribution limits than Simple IRAs and company 401(k)s
- 10% early withdrawal penalty to access your money before age 59½
- Deductible contributions may be limited or eliminated based on your income level if you or your spouse are covered by a workplace retirement plan
- Withdrawals are taxed as ordinary income, which means you might pay more tax if you are in a higher tax bracket than when you contributed
- Required Minimum Distributions (RMDs) after age 73 (Roth IRAs are exempt)
CHOOSING BETWEEN SIMPLE AND TRADITIONAL IRAS
It can be challenging to decide which retirement plan is right for you. A lot depends on your current and expected income levels, other retirement savings options, and your long-term retirement savings goals.
That said, choosing a matched retirement plan like a Simple IRA is almost always a good thing, even if you have other retirement savings options. This is because you can make higher contributions to a Simple IRA, and your employer’s matching contributions are essentially free money available to you.
A Simple IRA also makes sense when:
- You don’t want too many options for how your savings are invested.
- You expect to be in a lower tax bracket when you make withdrawals.
- You want to make larger, matched catch-up contributions over the age of 50.
On the other hand, choosing a Traditional IRA plan over a Simple IRA may make sense in some cases if you do not want your contributions to a Simple IRA plan to limit by income what you can contribute to your Traditional IRA.
Choosing to go the Traditional IRA route might also make sense if:
- You are not eligible for either a Simple IRA or a 401(k).
- You want to set up a Roth IRA for post-tax contributions or to avoid RMDs after age 73.
- You want more investment options for your IRA funds.
YOU CAN HAVE IT BOTH WAYS
Can you contribute to a Simple IRA and a Traditional IRA? Yes! These accounts can complement each other. You can benefit from higher annual contributions and employer matches with your Simple IRA while also contributing to your own Traditional IRA.
The only time this would not be advisable would be if your income is high enough to limit your IRA contributions because you are also contributing to a Simple IRA. You should consult an expert tax advisor if you believe this might be the case.
FREQUENTLY ASKED QUESTIONS
Here are some answers to frequently asked questions about Simple and Traditional IRAs.
CAN YOU CONVERT A SIMPLE IRA TO A TRADITIONAL IRA?
Yes, you can convert a Simple IRA to a Traditional IRA, but you must wait at least two years after starting the Simple IRA to do so.
CAN YOU MAX OUT TRADITIONAL AND SIMPLE IRAs?
Yes, but it does depend on you and your spouse’s incomes. You can contribute to both a Traditional IRA and a Simple IRA in the same year, but there are income limits for deducting contributions to the Traditional IRA if you're also participating in a Simple IRA.
ARE SIMPLE IRAS MOST SIMILAR TO 401(K) PLANS?
Yes, Simple IRAs are most similar to 401(k) plans, as they both allow employee contributions and employer matching, but Simple IRAs are designed for smaller businesses with fewer than 100 employees, while 401(k) also allow even higher deductible annual contributions.
CAN I CONTRIBUTE BEYOND WHAT IS DEDUCTIBLE TO AN IRA?
Yes, you can contribute funds beyond the deductible limit to either a Simple or Traditional IRA, but these contributions will count as after-tax income.
DO SIMPLE IRAS HAVE INVESTMENT OPTIONS?
Yes, Simple IRAs do offer some investment options, typically including mutual funds, stocks, and bonds, but these depend on the financial institution managing the account.
WHICH IRA IS RIGHT FOR YOU?
When deciding between a Simple IRA and a Traditional IRA, it's crucial to look at your unique financial situation, retirement goals, and tax implications. The key is to start saving early and consistently, irrespective of the retirement vehicle.
At Wasatch Peaks Credit Union, we offer several highly attractive IRAs that can help secure your financial future. Click below to learn more about the value you’ll get from opening a Traditional IRA with us.