What Is a Simple IRA and How Does It Work?
A Simplified Employee Pension (SEP) IRA, commonly referred to as a Simple IRA, is an employer-sponsored retirement plan that allows employees to make tax-deferred contributions to their own individual retirement accounts. It is designed for small businesses and self-employed individuals who want to provide retirement benefits for themselves and their employees.
The employer sets up the Simple IRA plan and makes contributions on behalf of eligible employees. Employees can also make contributions to their own accounts, up to a certain limit each year. Contributions are made with pre-tax dollars, meaning they are not subject to federal income taxes until the money is withdrawn in retirement.
Employers must contribute either a fixed percentage of each employee’s salary or a matching contribution based on the employee’s contributions. The employer’s contribution cannot exceed 3% of the employee’s salary. Employer contributions are tax deductible.
Employees can choose how to invest their contributions, typically through mutual funds, stocks, bonds, or other investments. They can also withdraw funds from their Simple IRA before retirement, but there may be penalties and taxes associated with early withdrawals.
Simple IRAs offer a simple and cost-effective way for employers to provide retirement benefits to their employees. They are easy to set up and maintain, and they provide tax advantages for both employers and employees.