The Tax Differences for SIMPLE IRA & 403(b)

Is a SIMPLE IRA the same as traditional IRA? In some ways, it is. But it may be best to understand SIMPLE IRAs and how it compares to other types of retirement accounts to avoid confusion.

A SIMPLE IRA is a traditional IRA to which both the taxpayer and the taxpayer's employer contribute. SIMPLE stands for "Savings Incentive Match Plan for Employees" and is generally subject to the same rules as a traditional IRA. Typically, the taxpayer will contribute a set percentage of wages to the IRA, and the employer will match that amount up to ​3 percent​.

A 403(b) plan is a retirement plan offered only to certain types of taxpayers, including public school employees, ministers and employees of certain tax exempt organizations. A 403(b) plan may or may not include employer matching.

These two types of retirement accounts differ in three main ways: contributions, distributions (withdrawals) and rollover rules. Understanding the differences between a SIMPLE IRA vs. 4o3(b) can help you make smart decisions for your financial future.

According to the IRS rules for simple IRA contributions, the SIMPLE IRA contribution limits are capped at ​$13,500​ for the tax year 2021 (​$16,500​ for taxpayers aged at least 50 years). These contributions are made pre-tax, which means that the percentage that comes out of your paycheck reduces the amount of income you are taxed on. This means that when the employee receives distributions from the IRA, those distributions are taxable income.

For example, if a taxpayer makes $50,000 per year and elects to contribute 5 percent of that salary to a SIMPLE IRA, the taxpayer will contribute $2,500 that year, or 5 percent of the gross salary before taxes. Doing so will reduce the taxpayer's taxable income for that year by $2,500, thus reducing the tax to be paid for that year. However, when the taxpayer retires and receives distributions from the IRA, taxes must be paid on the distributions.

A 403(b) plan has a higher contribution cap of ​$19,500​ for the 2021 tax year for employee contributions and a catch up limit of ​$6,500​. And the total of the employee's contribution and the employer's contribution cannot exceed ​$58,000​.

Contributions to a 403(b) plan are also taken pre-tax unless the plan is a Roth 403(b) plan, in which case the contributions are taken post-tax, and distributions are not taxable. That is, if the taxpayer makes $50,000 per year, a 10 percent contribution to a Roth 403(b) would not be $5,000, because it would be deducted after taxes.

So, if the taxpayer's annual take-home pay turns out to be $37,500 after taxes, the annual Roth contribution will be only $3,750, and any distributions at retirement will not be taxed.

To reiterate, both SIMPLE IRAs and 403(b) plans are funded by pre-tax income. This means that when distributions are made at retirement, the distributions are taxed, since the money was not taxed when actually earned.

A holder of a SIMPLE IRA may withdraw money from the IRA at any time; however, if funds are withdrawn before the employee reaches the age of ​59 1/2​, a ​10 percent penalty​ is assessed on the distribution in addition to the income tax. That penalty is increased to ​25 percent​ if the employee has had the IRA for less than two years.

403(b) plans also assess a ​10 percent early-distribution penalty​, but that penalty will not be assessed if the distributions are made after a taxpayer loses a job, dies, becomes disabled or is a qualified reservist. If the taxpayer suffers from financial hardship and needs distributions, there is no penalty on the amounts distributed from the taxpayer's own contributions.

If the 403(b) plan is a Roth 403(b), which means the contributions were made post-tax, the distribution will not be taxed. Both plans require the employee to begin receiving distributions at the age of ​72​.

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A SIMPLE IRA can generally be rolled over into any other type of retirement plan, depending upon the terms and conditions of that particular IRA. A 403(b) may need to be rolled over to an IRA or other type of retirement fund if the employee changes jobs and no longer works for a public school, a church or a qualified tax-exempt organization. Your SIMPLE IRA retirement plan flexibility can help ensure that you craft a long-term future that is stable and secure.

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