The SIMPLE IRA (Section 408(p))

How it works

A SIMPLE IRA is a salary-deferral retirement plan built for small employers under Section 408(p). Employees defer part of their pay before federal income tax into individual IRAs, which reduces their current taxable wages, and the employer has to contribute on top of that. The employer side is not discretionary. It is either a dollar-for-dollar match on what an employee defers, on the first 3 percent of that employee's compensation, or a flat 2 percent nonelective contribution for every eligible employee whether or not that employee defers anything at all.

SIMPLE stands for Savings Incentive Match Plan for Employees. The tax mechanism is plain: the employer contribution is a deductible business expense, and a traditional employee deferral escapes federal income tax until it comes back out at withdrawal. That is the default and still the common case, but it is no longer the only one: since SECURE 2.0 Section 601, a SIMPLE may allow an employee to designate deferrals as Roth, and a Roth SIMPLE deferral is included in income when made.

What sets it apart is the administrative side. There is no Form 5500 to file, no ADP or ACP nondiscrimination testing to run, and no third-party administrator required, and the IRS supplies the entire plan document as a two-page model form. Measured by what it costs to operate, it is the cheapest employer-sponsored plan available to a business that has rank-and-file employees who have to be covered.

The trade-off runs in three directions, and each one has a section below. The deferral limit sits well below what a 401(k) allows. The employer contribution is mandatory in every year the plan runs. And a withdrawal in the first two years of participation carries a 25 percent additional tax rather than the usual 10 percent.

For an owner with no employees, the first of those usually settles it: in an owner-only situation a Solo 401(k) or a SEP-IRA almost always allows a larger contribution than a SIMPLE does. I compare that pair directly in my article on the Solo 401(k) and the SEP-IRA, and the Solo 401(k)'s own mechanics are in the Solo 401(k) strategy. The SIMPLE earns its place once there are staff who have to be covered.

What SECURE 2.0 changed about the deferral limit

The deferral limit is not one number, and since SECURE 2.0 it depends on headcount. Section 408(p)(2)(E), as amended by section 117 of the SECURE 2.0 Act of 2022, added a higher deferral limit set at 110 percent of the 2024 base amount. What it does not do is hand that limit to every employer on the same terms.

• 25 or fewer employees. The higher limit applies automatically, with no additional employer cost required.
• 26 to 100 employees. The higher limit applies only if the employer buys up, by either increasing the match to 4 percent of compensation or increasing the nonelective contribution to 3 percent of compensation. An employer in this range that stays at the standard 3 percent match or 2 percent nonelective keeps the standard, lower deferral limit.

That is a live planning question rather than a technicality, because the deferral limit a given employee may use for the year depends on which tier the employer sits in and which election it made.

What this is worth in Florida

Nothing at the state level, and I would rather say so plainly. Florida has no individual income tax and does not tax pass-through income at the personal level, so deferring wages into a SIMPLE defers no Florida tax, because there was none to defer. The whole benefit for a Florida employer and a Florida employee is federal, sitting in the federal bracket and the payroll arithmetic rather than in any state result. There is also no Florida filing tied to the plan.

Who this applies to

Several separate tests decide this, and they get run together by accident because more than one turns on the same $5,000 figure while measuring something different.

• The employer's size. Any employer, including a sole proprietor or a single-member LLC, that had no more than 100 employees who received at least $5,000 in compensation in the preceding calendar year. This one counts heads and looks back exactly one year.
• The grace period after growth. An employer that grows past 100 employees does not lose SIMPLE-eligible status the moment it happens. It keeps that status for the two calendar years following the last year it satisfied the 100-employee test.
• The exclusive-plan rule. The employer generally cannot maintain any other qualified plan to which contributions are made or benefits accrue for the same calendar year. This is the single biggest disqualifier in practice: a business already running a 401(k) or a SEP for the year cannot also run a SIMPLE.
• Which employees have to be let in. Any employee who earned at least $5,000 in compensation in any two prior years, and who is reasonably expected to earn at least $5,000 in the current year, has to be allowed to participate. An employer may set thresholds lower than that, letting more people in, but may not set them higher to keep people out.

A solo owner with no employees does qualify, and can occupy both sides of the arrangement. It is rarely the right answer there, because for an owner-only business a Solo 401(k) or a SEP-IRA almost always allows two to three times the contribution room.

What it requires

Everything below is a condition of the arrangement being a SIMPLE at all, not a best practice layered on top.

The employer contribution, in every year the plan runs

The employer picks one of two formulas for the year and has to fund it.

• The 3 percent match. Dollar for dollar on what an employee actually defers, on the first 3 percent of that employee's compensation. An employee who defers nothing receives nothing under this formula.
• The 2 percent nonelective contribution. Two percent of compensation for every eligible employee earning at least $5,000, regardless of whether that employee defers. Compensation for this formula is capped at the annual compensation limit, which the IRS adjusts each year.

There is one release valve and it is narrow. The 3 percent match may be reduced to a figure not lower than 1 percent, for no more than two years out of any five-year period, with advance notice to employees. Skipping the employer contribution altogether is not among the choices, and doing it disqualifies the plan.

The calendar the plan runs on

A SIMPLE is bound to the calendar year more tightly than most plans, and four dates carry that weight.

• The effective date. A new plan has to be effective on a date between January 1 and October 1 of the year, unless the business came into existence after October 1. An employer that already maintained a SIMPLE in the prior year does not get the October 1 grace; its plan is expected to already be in place.
• The notice and the election window. Each eligible employee receives an annual notice covering the deferral election, the match or nonelective choice for the year, and the summary description, before the 60-day election period. The standard election period runs November 2 through December 31 for the following year, a window that satisfies that 60-day minimum. A newly established plan runs its window around the plan's effective date instead.
• Deferral deposits. Withheld employee deferrals go in as soon as the amounts can reasonably be segregated. The outer limit is 30 days after the end of the month in which the amounts would otherwise have been paid in cash, and that outer limit is a ceiling rather than a target.
• The employer contribution. Due by the due date of the employer's federal income tax return for the year, including extensions, and deducted on the business return.

Once the plan is effective it generally runs the full calendar year, and contributions cannot simply be stopped partway through. There is one statutory exit. Section 408(p)(11), added by SECURE 2.0 and effective for plan years beginning after 2023, lets an employer terminate a SIMPLE mid-year provided it establishes a safe harbor 401(k) to replace it as of the day after the termination date, with the two deferral limits prorated by days for that year. Outside that replace-with-a-safe-harbor case, the plan runs to December 31.

What you need to document

None of this is filed with the IRS. A SIMPLE has no Form 5500 and no annual report, so what the employer retains is what there is to show.

The signed plan document

Form 5304-SIMPLE, under which each employee picks their own financial institution, or Form 5305-SIMPLE, under which the employer designates a single one. A prototype document from the custodian is also acceptable. Nothing is filed; the employer retains it.

The annual employee notice, and evidence of the election window

The notice given to each eligible employee for the year, and evidence that the 60-day election period was actually made available rather than merely assumed.

The contribution-formula election for each year

Which formula was elected, the 3 percent match or the 2 percent nonelective, in writing, year by year. Where the match was reduced below 3 percent, the file also has to carry the running count of reduction years inside the relevant five-year period, since the allowance is two years out of any five.

Which SECURE 2.0 tier applies, and any buy-up election

Whether the plan sat in the 25-or-fewer tier or the 26-to-100 tier for the year, and for the latter, whether the employer elected the 4 percent match or the 3 percent nonelective to unlock the higher deferral limit. The limit a given employee may use depends on it.

Proof of timely deposits

Records showing when withheld deferrals were actually deposited, set against the dates they were withheld from pay.

Where it goes wrong

This is not an aggressive position and it is not a reportable transaction. It is a mainstream statutory plan, and the risk attached to it is operational compliance rather than anything resembling a listed-transaction posture. What goes wrong here goes wrong quietly, inside the plan's paperwork and calendar.

• Running a second plan in the same year. This is the most common error. Funding a 401(k) or a SEP for the same year a SIMPLE is running violates the exclusive-plan rule and voids the SIMPLE. What has to be established before adopting one is that no other plan received contributions for that year. The Section 408(p)(11) replacement described above is the one carve-out from this, and it is narrow: the successor has to be a safe harbor 401(k) taking effect the day after the SIMPLE ends.
• Terminating in the middle of the year without meeting the one exception. A SIMPLE runs the full calendar year once effective, unless the employer uses the Section 408(p)(11) route and replaces it with a safe harbor 401(k) effective the day after termination. Moving to a plan that is not a safe harbor 401(k) still means waiting until the following January 1, with the November 2 to December 31 notice given for that year.
• Missing the October 1 establishment deadline. That kills the plan for the year, with the single exception of a business that did not exist before October 1.
• Depositing employee deferrals late. Late deposits carry prohibited transaction and fiduciary breach exposure. Waiting out the 30-day outer limit is not safe when the money could have been segregated sooner.
• Skipping the mandatory employer contribution. The match or the nonelective is not optional in any year the plan runs, and skipping it disqualifies the plan.

The two-year rule, which is the one clients feel

A distribution taken within two years of the employee's first SIMPLE contribution carries a 25 percent additional tax under Section 72(t)(6), rather than the 10 percent that applies to an early distribution once that period has passed.

The part that causes real damage is what Section 408(d)(3)(G) does to rollovers inside the same window. A rollover out of the SIMPLE into a non-SIMPLE IRA or into a 401(k) during those two years is generally itself a taxable distribution, and it carries the same 25 percent, which makes a transfer from one SIMPLE into another SIMPLE the ordinary penalty-free move in that period. There is a statutory exception, and it matters because it is the case a business changing plans actually lands in: Section 72(t)(6)(B) switches the 25 percent off where the employer terminated the SIMPLE and established a 401(k) or 403(b), and the money rolls into that plan. Section 408(d)(3)(G) is itself conditioned on the 25 percent applying, so it does not bite there either.

The clock is measured from the employee's own first SIMPLE contribution, so it is not a single plan-level date that everyone shares. This is worth raising with a client before anyone moves money, because once the transfer has happened there is nothing left to unwind.

A situation where this comes up

The fact pattern where a SIMPLE is genuinely the right answer has a specific shape: an owner with staff.

An owner-managed business with a handful of rank-and-file employees wants retirement saving for the owner, does not want a third-party administrator or an annual filing, and cannot exclude the staff from whatever it adopts. A Solo 401(k) cannot exclude those employees. What the SIMPLE offers instead is a low and predictable mandatory employer cost, a 3 percent match paid only to the people who actually defer, or a 2 percent nonelective across the board, against no Form 5500 and no nondiscrimination testing. The owner gives up real contribution room to get that, and the plan is chosen because of the staff rather than in spite of them.

The version that goes wrong is the business that already has something else running. Someone funded a SEP for the year, or a 401(k) is still technically in place, and a SIMPLE gets adopted alongside it. The exclusive-plan rule voids the SIMPLE, and by the time it surfaces, deferrals have already been withheld from employee pay across a full year.

The other version I watch for is an owner who assumes the decision can be revisited in June. A SIMPLE mostly does not work that way. Once it is effective it runs to December 31 and the employer contribution is owed for that whole year, with one exception worth knowing: the Section 408(p)(11) mid-year termination, available only where a safe harbor 401(k) replaces the plan the day after it ends. Absent that, the earliest exit is the following January 1.