Tax Consequences of a SIMPLE IRA

Tax Consequences of a SIMPLE IRA
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Savings Incentive Match Plans for Employees, or SIMPLE, IRAs are subject to the same investment rules as traditional IRAs, according to the Internal Revenue Service. A SIMPLE IRA is an IRA-based retirement plan that enables employers to more easily contribute to their employees' retirement account, as well as their own retirement accounts. Tax rules governing SIMPLE IRA plans detail what size of businesses can establish a SIMPLE IRA as well as how such a plan affects employees.


A business with under 100 employees that each earn at least $5,000 per calendar year can establish a SIMPLE IRA program. The IRS requires the business to file Form 5305-SIMPLE or Form 5304-SIMPLE to establish a SIMPLE IRA program. Form 5305-SIMPLE mandates contributions made to the SIMPLE IRA be kept in a prescribed account; Form 5304-SIMPLE allows the employees to choose the account from which to draw funds contributed to the SIMPLE IRA. A business that establishes a SIMPLE IRA must form either a trust account or a custodial account for each employee.


When an employee contributes to a SIMPLE IRA program, she can claim a deduction on her income tax filings that corresponds with her filing status and modified adjusted gross income level. These contributions are considered a voluntary salary reduction, according to the IRS, and come from income earned through wages, tips and salary before taxes. Contributions to a SIMPLE IRA can be elective or non-elective. Your employer must match your elective contributions to the SIMPLE IRA, though non-elective contributions from an employer can be in any amount. The IRS limits SIMPLE IRA contributions to $11,500 as of publication.


Distributions from a SIMPLE IRA are the payments the account-holder collects when she stops making contributions to the account. Distributions from a SIMPLE IRA are taxable as usual income according to the IRS, though early distributions -- those collected before the predetermined collection time -- may be subject to an early distribution penalty. The additional tax on early distributions is 25 percent for the first two years you participate in an employer's SIMPLE IRA program; after two years, the additional tax is 10 percent. However, the IRS does not consider rollover distributions or trustee-to-trustee distributions as taxable.


SIMPLE IRAs must be established between January 1 and October 1. After the initial SIMPLE IRA program has been established, new accounts can only be made effective on January 1. No employee is exempt from participating in his employer's SIMPLE IRA plan, though he can elect to not make contributions to the account. Though the employee would accrue no matching contributions to the account, he would receive and report an employer nonelective contribution for the year. Employees of tax-exempt and charitable organizations are eligible to participate in SIMPLE IRA programs, though an employer can decide to exclude employees who are part of a collective bargaining agreement or who are resident aliens.