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Why a SIMPLE-IRA Could Be Your Best Retirement Plan Alternative

Updated: Mar 28, 2023


Michael Moffa, AIF®, AWMA®, CEPA®, CRPC®

Chairman | Private Wealth Advisor




A SIMPLE-IRA could be your best retirement plan option if your business generates only a modest amount of annual income.


You must have your SIMPLE-IRA set up by October 1, 2022, to permit a deductible contribution for your 2022 tax year.


Here’s what you need to know about the often-underappreciated SIMPLE-IRA small business retirement plan alternative.


SIMPLE-IRA Basics


For the one-person operation that generates only a modest amount of annual income, the SIMPLE-IRA is often the best tax-favored retirement plan choice.


Self-employed individuals can set up SIMPLE-IRAs. So can one-employee corporations and other employers with up to 100 workers. For this purpose, only employees who earned at least

$5,000 during the previous year are counted.


Deductible Contributions


For 2022, you can contribute up to the lesser of


  • 100 percent of self-employment income or corporate salary, or

  • $14,000.


This is considered to be an elective deferral contribution made to your SIMPLE-IRA account by you as a self-employed individual or by you as an employee of your own corporation.


Then the employer makes a matching contribution equal to the lesser of (1) 3 percent of your self-employment income or salary, or (2) the amount of your elective deferral contribution.


When you run your business as a sole proprietorship or as a single-member LLC treated as a sole proprietorship for tax purposes, you make the employer matching contribution, as well as the elective deferral contribution, on your own behalf.


When you are employed by your own C or S corporation, the company makes the employer matching contribution to your account. The elective deferral contribution is withheld from your salary.1



SIMPLE-IRA Contribution Advantage Illustrated


The following examples quantify the SIMPLE-IRA deductible contribution advantage for a business that generates modest annual income.


Example 1: Corporate Business


You are employed by your own C or S corporation (the results are the same either way). You receive a $30,000 salary for the year. You contribute the maximum $14,000 to your SIMPLE- IRA as an elective deferral contribution. That reduces your taxable salary from $30,000 to

$16,000 for federal income tax purposes.


You then direct your corporation to make a matching deductible employer contribution of

$900 (3 percent x $30,000). So, the elective deferral and employer contributions add up to a total of $14,900 of tax-saving deductions. Nice!


In contrast, if you had a simplified employee pension (SEP) arrangement or a profit-sharing plan, the maximum deductible contribution to your account would be only $7,500 (25 percent x your $30,000 salary).


Example 2: Sole Proprietorship


You run your shop as a sole proprietorship or as a single-member LLC treated as a sole proprietorship for tax purposes. You have $30,000 of net self-employment income for the year. You contribute the maximum $14,000 to your SIMPLE-IRA and claim a $14,000 deduction on your Form 1040.


You then make a matching employer contribution of $900 (3 percent x $30,000) and deduct another $900 on your Form 1040. The combined tax-saving deductible contributions add up to

$14,900.


In contrast, the maximum deductible contribution would be only $6,000 (20 percent x

$30,000) with a self-employed SEP or a defined contribution Keogh plan.


Extra Catch-Up Contributions If You Are Age 50 or Older


If you are age 50 or older as of December 31, 2022, you can make an additional catch-up

elective deferral contribution of up to $3,000 for 2022.2


So, if you are age 50 or older at year-end, the maximum 2022 elective deferral contribution, including the extra catch-up contribution, is $17,000 ($14,000 + $3,000).


Example 3: Catch-Up Contributions


You earn $30,000 of self-employment income or salary from your corporation and are age 50 or older as of year-end. You can contribute up to $17,900 to your SIMPLE-IRA ($14,000 regular elective deferral contribution + $3,000 extra catch-up contribution + $900 employer matching contribution).


In contrast, the maximum deductible pay-in to a self-employed SEP or defined contribution Keogh plan would be only $6,000 (20 percent x $30,000). The maximum deductible contribution to a corporate SEP or profit-sharing plan would be only $7,500 (25 percent x

$30,000).


SIMPLE-IRA Pros


When your business produces only a modest amount of annual income, the SIMPLE-IRA arrangement can permit much healthier annual deductible contributions to your account, as the preceding examples illustrate.


Also, SIMPLE-IRA elective deferral contributions are completely discretionary. If you decide not to make an elective deferral contribution for the year, you need not make any employer matching contribution either. So, you can limit contributions to very minimal amounts, or even nothing at all, in years when cash is tight. Flexibility is good!


Finally, with a SIMPLE-IRA, there is no requirement to file any annual reports with the federal government.3 Yay!


SIMPLE-IRA Cons


The SIMPLE-IRA is not the best choice if your business produces healthy annual self- employment income or a healthy annual corporate salary for you. In that scenario, other types of plans, such as a SEP, solo 401(k) plan, or defined benefit pension plan, can permit larger annual deductible contributions to your account.


You must establish your SIMPLE-IRA by no later than October 1 of the year for which the initial deductible contribution will be made.4 For example, you must set up your SIMPLE-IRA by October 1, 2022, to make a deductible contribution for the 2022 tax year.


Note. The SECURE Act modification that allows qualified plans to set themselves up retroactively for the prior year does not apply to the SIMPLE-IRA.


Employees


With a SIMPLE-IRA plan, you may have to make employer matching contributions for other employees (beyond just yourself as the owner), and those contributions are immediately 100 percent vested.

Specifically, all employees who earned $5,000 or more during any two previous years (whether or not consecutive) and who are reasonably expected to earn at least $5,000 in the current year must be allowed to participate in the SIMPLE-IRA plan.5


But if you don’t have any employees who meet that description, you can establish a SIMPLE- IRA that benefits only you.


Finally, you cannot borrow from a SIMPLE-IRA account. In contrast, you can borrow against other types of retirement plan accounts (assuming the plan document so permits), except for SEPs.6 SIMPLE-IRAs and SEP accounts are considered IRAs, and borrowing from an IRA is a tax-law no-no.


Can You Also Contribute to a Traditional or Roth IRA If You Have a SIMPLE-IRA?


Yes, but the SIMPLE-IRA is considered an employer-sponsored retirement plan, so the privilege of making deductible contributions to a traditional IRA is subject to the usual income limitations that apply to participants in employer-sponsored retirement plans.


How to Set Up a SIMPLE-IRA


Most major brokerage firms will set up SIMPLE-IRAs for minimal or no fees. As stated earlier, you must set up a SIMPLE-IRA plan by October 1 of the year in question to accept deductible contributions for that year.


Takeaways


When your business generates a modest amount of self-employment income or salary from your corporation and there are no other employees who must be covered, the SIMPLE-IRA is probably the best retirement plan choice, because it offers the opportunity to make bigger annual deductible contributions.


The bigger contribution is even bigger if you are age 50 or older, because you can then make additional elective deferral catch-up contributions.



Keep this in mind: SIMPLE-IRAs are simple, and simple is good!



1 IRC Section 408(p) 2018.

2 IRC Section 414(v)(2)(B)(ii).

3 IRC Section 408(l)(2) 2018.

4 IRC Section 408(p)(6)(C) 2018.

5 IRC Sections 408(p)(3) 2018; 408(p)(4) 2018.

6 IRC Sections 408(e) 2018; 4975(c)(1)(B); 4975(d)(1); 4975(f)(6).


Sourced with the help of The Bradford Tax Institute

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