Several different types of retirement plan - 401(k), defined benefit, and profit-sharing - can be made to suit a prosperous small business or professional practice. But if yours is a really small business such as a home-based, start-up, or sideline business, you may want to consider adopting a Savings Incentive Match Plan for Employees (SIMPLE) IRA.
A SIMPLE IRA is a type of retirement plan specifically designed for small businesses. SIMPLE IRAs are intended to encourage small business employers to offer retirement coverage to their employees, but they work just as well for self-employed persons without employees.
SIMPLE IRAs allow contributions in two steps: first by the employee out of salary, and then by the employer, as a "matching" contribution (which can be less than the employee contribution). When SIMPLE IRAs are used by self-employed persons without employees - as the IRS expressly allows - the self-employed person is contributing both as employee and employer, with both contributions made from self-employment earnings.
To establish a SIMPLE IRA, your business must have no more than 100 employees and cannot have any other retirement plans.
And, here is a quick list of pros and cons:
- Plan is not subject to the discrimination rules that everyday 401(k) plans are.
- Employees are fully vested in all contributions.
- Straightforward benefit formula allows for easy administration.
- Optional participant loans and hardship withdrawals add flexibility for employees.
- No other retirement plans can be maintained.
- Withdrawal and loan flexibility adds administrative burden for the employer.
How Much You Can Put in and Deduct
Those with relatively modest earnings will find that a SIMPLE IRA lets them contribute (invest) and deduct more than other plans. With a SIMPLE IRA, you can put in and deduct some or all of your self-employed business earnings. The limit on this "elective deferral" is $16,500 for 2025 ($16,000 for 2024).
If your earnings exceed that limit, you could make a modest further deductible contribution - specifically, your matching contribution as an employer. Your employer contribution would be 3% of your self-employment earnings, up to a maximum of the elective deferral limit for the year. So employee and employer contributions for 2025 can't be more than the $16,500 maximum employee elective deferral plus a maximum $16,500 for the employer contribution, for a total of $33,000. (For 2024, these contributions can't exceed $16,000 + $16,000, or $32,000.)
Catch up contributions. Owner-employees age 50 or over can make a further deductible "catch up" contribution as as an employee of $3,500 for 2025 (also $3,500 for 2024). Beginning in 2025, if the owner-employee is age 60, 61, 62 or 63 by the end of the tax year, the catch-up contribution limit is higher. For 2025, it's $5,250 for anyone who is one of these ages by the end of 2025.
An owner-employee age 60, 61, 62 or 63 in 2025 with self-employment earnings of $50,000 could contribute and deduct $16,500 as an employee plus an additional $5,250 employee catch up contribution, plus a $1,500 (3% percent of $50,000) employer match, for a total of $23,250.
Low-income owner-employees in SIMPLE IRAs may also be allowed a tax credit up to $2,000 for single filers ($4,000 married filing jointly). This is the Savers Credit, and the credit amount depends on the contribution amount and the employee's adjusted gross income (AGI).
SIMPLE IRAs are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.
If living expenses are covered by your day job (or your spouse's job), then you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE IRA retirement investments.
An individual 401(k) plan, however, could allow you to contribute more, often much more, than SIMPLE IRA. For example, if you are less than 50 years old with $50,000 of self-employment earnings in 2025, you could contribute $16,500 to your SIMPLE IRA plus an additional 3% of $50,000 as an employer contribution, for a total of $18,000. A 401(k) plan would allow a $36,000 contribution. (You could contribute $17,500 to a SIMPLE IRA vs. $35,500 to a 401(k) for 2024.)
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Withdrawal: Easy, but Taxable
There's no legal barrier to withdrawing amounts from your SIMPLE IRA whenever you please. There can be a tax cost, though: Besides regular income tax, the 10% penalty on early withdrawals (generally, withdrawals before age 59 1/2) rises to 25% on withdrawals in the first two years the SIMPLE IRA is in existence.
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A SIMPLE IRA
A SIMPLE IRA really is simpler to set up and operate than most other plans. Contributions go into an IRA that you set up. Those already familiar with IRA rules, investment options, spousal rights, and creditors' rights don't have a lot new to learn.
Requirements for reporting to the IRS and other agencies are negligible, at least if you're setting up the SIMPLE IRA as a self-employed person. Your SIMPLE IRA's trustee or custodian, typically an investment institution, has reporting duties. And the process for figuring the deductible contribution is a bit simpler than with other plans.
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What's Not So Good about SIMPLE IRAs
Other types of retirement plans are often better than the SIMPLE IRA once self-employment earnings become significant. Other not-so-good features include the following:
Other plans for self-employed persons allow a deduction for one year if the contribution is made the following year before the prior year's return is due (generally April 15 or later with extensions). This rule applies to SIMPLE IRAs for the matching contribution you make as an employer. But there's no IRS pronouncement on when the employee's portion of the SIMPLE IRA is due where the only employee is the self-employed person. Those who want to delay contribution would argue that they have as long as it takes to compute self-employment earnings for the tax year (though not beyond the tax return due date, with extensions).
The sooner your money goes in the plan, the longer it's working for you tax-deferred. So delaying your contribution isn't the wisest financial move.
You can't set up the SIMPLE IRA after the year ends and still get a deduction for that year, as is allowed with SEPs. Generally, to make a SIMPLE IRA effective for the year it must be set up by October 1 of that same year. A later date is allowed where the business is started after October 1. In this instance, the SIMPLE IRA must be set up as soon thereafter as administratively feasible.
Then there's a problem if the SIMPLE IRA is intended for a sideline business and you're already in a 401(k) plan in another business or as an employee. In this scenario, the total amount you can put into the SIMPLE IRA and the 401(k) plan combined can't be more than the 401(k) plan limit (including catch-up contributions if applicable).
Here's an example: If you're under age 50 and put $13,500 in your 401(k) in 2025, you can't put more than $10,000 in your SIMPLE IRA for 2025, because the 2025 401(k) contribution limit is $23,500. The same limit applies if you have a SIMPLE IRA while also contributing as an employee to a 403(b) plan.
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How to Get Started in a SIMPLE IRA
SIMPLE IRAs generally are offered by the same financial institutions that offer IRAs and 401(k) plans.
You can expect the institution to give you a plan document (approved by IRS or with approval pending) and an adoption agreement. In the adoption agreement, you will choose an "effective date," which is the beginning date for payments out of salary or business earnings. Remember, that date can't be later than October 1 of the year you adopt the plan, except when a business is formed after October 1.
Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE IRA. You need such an agreement even if you pay yourself business profits rather than salary.
Printed guidance on operating the SIMPLE IRA may also be provided. You will also be establishing a SIMPLE IRA account for yourself as a participant.
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