Part 1: SIMPLE IRAs The government has afforded several tax-advantaged options for business owners to save for retirement. The purpose of this series is to educate doctors,including small business owners, about the most commonly-used plans for Independent Contractor (“IC”) income. (As your practice volume grows and you age, you may eventually supplement your 401k with a Defined Contribution plan, but the purpose of this series is for basic plans.) Choosing which type to use can vary from year to year, depending upon timing and other goals. In this 3-part series, we will examine the advantages and disadvantages of each.

What is a SIMPLE IRA and when should I use one?

A SIMPLE IRA is a blended business-personal retirement account. The business aspect allows the owner of the business to govern participation and gives the owner of the business a deduction for employer contributions to the plan. The personal aspect means that employees are immediately vested in their accounts, which are in their names. This means employees own 100% of the balance of their SIMPLE accounts, including employer contributions, at the inception of participation.

Eligible participants can contribute the lesser of earned income or up to $13,500 ($16,500 if age 50+), pre-tax, to personal retirement account. The business owner matches up to 3% of employee contributions. No paperwork filings are required by the IRS and the SIMPLE account is low maintenance and inexpensive to manage.

Because a SIMPLE is an employer account, employees who participate can contribute the maximum annual amount allowed to their personal IRA accounts in addition to full SIMPLE contributions. This means an employee under age 50 can contribute $13,500 + $6,000, or $19,500 annually to an IRA account (2020). If this sounds familiar, it’s the same amount as the allowable employee contribution you can make to a 401k!

What you need to know:

• You must set up a SIMPLE plan no later than 60 days before the end of the year for which it is to be in effect. In other words, you must open your SIMPLE account with your custodian by 11/2/20 to make contributions for the year 2020.
• Any distributions from a SIMPLE account in the first 2 years of its existence, unless to another SIMPLE account, will be subject to a 25% early withdrawal penalty, even if you are age 59 ½. This means even rollovers to another employer’s 401k would be penalized.
• Employees are immediately 100% vested. Withdrawals before age 59 ½ will be assessed a 10% penalty unless you qualify for one of these exceptions. Rollovers to qualified retirement accounts are not taxed or penalized unless within the first two years.
• Employees are eligible to participate if they have:
  • Received at least $5,000 in compensation during any 2 years preceding the current calendar year and are
  • Reasonably expected to receive at least $5,000 during the current calendar year.
• There is no Roth option for SIMPLE’s.
• Because a SIMPLE is a pre-tax IRA, a balance in your account at the end of the year will cause some or all of a back-door Roth IRA conversion to be taxed.*

When to use a SIMPLE:

• If you are not making back-door Roth IRA conversions*
• If you have high employee turnover and/or only limited part-time help
• If you have employees and want a low-maintenance, low-cost retirement plan
• If you won’t contribute over $13,500/$16,500 annually to a retirement plan

SIMPLE IRAs are most often used by young practice owners who are still paying off school loans and can’t afford to set aside much for retirement but want to provide an inexpensive benefit for employees. In Part 2 of this series, we’ll take a look at the advantages and disadvantages of SEP IRAs.

*What if you have a backdoor Roth IRA?

It is possible to have both a SIMPLE and a backdoor Roth, but your options are more limited. After the 2-year mark, you need to either convert the SIMPLE funds prior to 12/31 every other year while making 2 yrs of backdoor Roth conversions in January of the following year or pay pro-rata tax. Of course, if you happen to have a leftover solo-k from some 1099 work, you can always roll over your SIMPLE to that account q2 yrs. Or, you can pay pro-rata tax, which, to me, can work out pretty well for you.

The Pro-Rata Rule for Backdoor Roth IRAs

Part 2: What is a SEP IRA and when should I use one?

Part 3: What is a 401k and when should I use one?