Are you trying to decipher the differences between retirement savings plans? SIMPLE IRAs (Savings Incentive Match Plans for Employees) and Traditional IRAs (Traditional Individual Retirement Accounts) are two popular investment vehicles that can help you secure a financially stable future.
At first glance, they might seem similar, but each has distinct features that set them apart. Read on to learn more about a SIMPLE IRA vs. a Traditional IRA and how to choose the best one for your golden years.
UNDERSTANDING A SIMPLE IRA
A SIMPLE IRA is a retirement savings plan tailored for small businesses with 100 or fewer employees. It is a way for employees, including the business owner, to make pre-tax contributions towards their retirement.
Typically, employers must match employee contributions dollar-for-dollar up to 3% of the employee's salary. However, this requirement is waived if the employer opts to make nonelective contributions instead.
The maximum amount an employee can contribute to a SIMPLE IRA in 2023 is $15,500 (with an additional “catch-up” of $3,500 for those over 50—if permitted by the company's SIMPLE IRA plan). Early withdrawals (before the age of 59½) are subject to a 10% penalty, and if taken within the first two years of participation, the penalty increases to 25%.
Any small business with 100 or fewer employees can establish a SIMPLE IRA, provided the company has no other retirement plan in place.
UNDERSTANDING A TRADITIONAL IRA
A Traditional IRA is an individual retirement savings account available to anyone with earned income. It allows you to save for retirement on a tax-deferred basis. You contribute pre-tax dollars to a Traditional IRA, which means you don’t pay taxes on the money until you withdraw it in retirement.
The contribution limit for a Traditional IRA in 2023 is $6,500, or $7,500 if you’re 50 or older. Like the SIMPLE IRA, early withdrawals are subject to a 10% penalty, but there’s no increased penalty for withdrawing within the first two years.
To contribute to a Traditional IRA, you must have earned income. Your ability to deduct contributions on your tax return is subject to income limits if a retirement plan at work covers you or your spouse.
There are a few key SIMPLE IRA vs.Traditional IRA differences:
Eligibility—SIMPLE IRAs are designed for small businesses, while Traditional IRAs are available to individuals regardless of employer size.
Contribution Limits—SIMPLE IRAs have higher contribution limits compared to Traditional IRAs.
Employer Matching—SIMPLE IRAs require employer contributions, while the individual solely funds Traditional IRAs.
Early Withdrawal Penalties—SIMPLE IRAs have a steeper penalty for early withdrawals made within the first two years of participation.
CHOOSING BETWEEN SIMPLE AND TRADITIONAL IRAS
It can be challenging to decide which retirement plan to choose. Here’s a short guide to help you make a more informed decision:
WHEN TO CHOOSE A SIMPLE IRA:
- If you’re a small business owner or employed by a small business that offers it.
- When you want to save more than the Traditional IRA limits.
- If you value the employer matching contributions.
WHEN TO CHOOSE A TRADITIONAL IRA:
- If you’re an individual looking for a retirement savings option regardless of your employer.
- When you want more flexibility in investment options.
- If you expect to be in a lower tax bracket during retirement.
CAN YOU HAVE BOTH?
Yes, you can have both a SIMPLE and a Traditional IRA if you meet the eligibility criteria for each. However, be mindful that having both may affect the deductibility of your Traditional IRA contributions depending on your income level and participation in the SIMPLE IRA through your employer.
For example, suppose a SIMPLE IRA covers you at work, and your income exceeds certain thresholds. In that case, the amount you can deduct for contributions to a Traditional IRA might be reduced or eliminated. It's essential to understand the IRS guidelines and consult with a tax professional to maximize the benefits of contributing to both accounts.
STRATEGIZING YOUR RETIREMENT PLAN
Having both a SIMPLE and Traditional IRA can be part of a comprehensive retirement strategy. Here are some factors to take into consideration:
Maximizing Employer Match—If your employer offers a SIMPLE IRA with matching contributions, make sure to contribute enough to take full advantage of this "free money." This is an immediate return on your investment that is hard to beat.
Tax Diversification—While both accounts are tax-deferred, managing how much you contribute to each can be a strategy to diversify your tax liabilities in retirement.
Investment Options—Traditional IRAs often come with a broader range of investment options compared to SIMPLE IRAs. If you are looking to invest in particular stocks, bonds, or mutual funds not available in your SIMPLE IRA, having a Traditional IRA can provide additional opportunities.
Emergency Buffer—Although it's not ideal to use retirement funds for emergencies, Traditional IRAs may offer more flexibility. You might be able to withdraw without penalties for specific cases like first-time home purchases or education expenses.
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.