How a Simple IRA Grows

by Andrew Gellert, Demand Media
    SIMPLE IRA plans function as retirement plants, similar to 401(k) plans or IRA funds.

    SIMPLE IRA plans function as retirement plants, similar to 401(k) plans or IRA funds.

    A SIMPLE IRA, or Savings Incentive Match Plan for Employees Individual Retirement Account, is a type of retirement plan available to certain small businesses. A SIMPLE IRA has characteristic contribution limits and structures that allow it to grow through contributions by the employees and the employer, as well as through investment.

    Background and Eligibility

    The goal of the SIMPLE IRA format is to provide a simple retirement plan for small businesses -- those with fewer than 100 employees -- that do not yet have such a plan in place. The plan is easy to implement, requiring only a written agreement from the employees using a form available from the Internal Revenue Service. The employer opens SIMPLE IRA accounts for each employee with a financial institution. The employee then chooses among the investments offered by the firm operating the SIMPLE IRA accounts.

    Contributions and Limits

    Part of setting up the SIMPLE IRA plan is determining what form the mandatory employer contributions will take. The employer can either make a contribution of 2 percent of each employee's salary, regardless of the employee's contribution; or the employer can make a contribution of up to 3 percent of the employee's salary, matching the employee's contribution. An employee can contribute a portion of her salary to her account, as long as the contributions are under predetermined limits. For 2012, the individual annual limit was $11,500.

    Growth through Investment

    Like a normal IRA account, a SIMPLE IRA grows through contributions as well as investments in financial products. Employees are free to choose among the investment vehicles offered by the authorized operator of the SIMPLE IRA plan. Depending on the investments' performance, the money placed into the account will grow over the years that the account is active. Employees have total ownership of the accounts, so if they leave their jobs, they take the accounts with them.

    Growth through Contributions

    An employee's SIMPLE IRA account will also grow according to both the level of his contribution and the level of the employer's contribution. Obviously, the more an employee and employer contribute to the plan, the better its chance of growing. According to the IRS, if an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the salary reduction contributions that an employee can make to all the plans he participates in is limited to 17,500 in 2013. If permitted by the SIMPLE IRA plan, the IRS says, participants who are age 50 or older at the end of the calendar year can also make catch-up contributions. The catch-up contribution limit for SIMPLE IRA plans is $2,500 for 2013.

    About the Author

    Andrew Gellert is a graduate student who has written science, business, finance and economics articles for four years. He was also the editor of his own section of his college's newspaper, "The Cowl," and has published in his undergraduate economics department's newsletter.

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