Differences Between a Traditional IRA & a SIMPLE IRA

by Mark Kennan

    Traditional individual retirement accounts and savings incentive match plans for employees' IRAs both offer tax-deferred retirement savings. They also both share the same requirements for investment options and early withdrawal penalty exceptions. However, besides the fact that SIMPLE IRAs are set up by employers for their employees while traditional IRAs are opened on your own behalf, the Internal Revenue Service rules contain several other important differences.

    Eligibility

    To contribute to a traditional IRA, you just need to have earned income during the year and be less than 70 1/2 years old at the end of the year. To contribute to a SIMPLE IRAs, you must meet the eligibility requirements set by your employer. These requirements cannot exceed requiring that you earn at least $5,000 in compensation in any two prior years and are expected to earn at least $5,000 for the current year. For example, your employer could allow you to participate if you were only expected to make $2,000, but couldn’t exclude you if you weren’t expected to make $10,000. If you’re self-employed, you can set up a SIMPLE IRA for yourself.

    Contribution Limits

    Traditional IRAs have a lower contribution limit than SIMPLE IRAs. As of 2012, you could contribute up to $5,000 per year ($6,000 if age 50 or older) to a traditional IRA as long as you had at least that much earned income. The maximum contribution for a SIMPLE IRA was $11,500 ($14,000 if age 50 or older) or your salary for the year. However, these amounts are adjusted for inflation, and the IRS reports the new limits in each annual version of IRS Publication 590.

    Employers Matching Contributions

    Employers cannot match the contributions that you make to your traditional IRA. With a SIMPLE IRA, your employer must make a contribution, using either the elective method or the non-elective method. Under the elective method, your employer must match your contribution dollar for dollar up to 3 percent of your salary. Under the non-elective method, the employer must make a contribution equal to 2 percent of your salary regardless of how much you contribute.

    Early Distribution Penalties

    If you take a distribution from your traditional IRA before turning 59 1/2, you pay a 10 percent tax penalty in addition to regular income tax on the entire amount of your withdrawal. The same penalty usually applies to distributions from a SIMPLE IRA. However, if you take an early distribution within two years of opening your SIMPLE IRA, you must pay a 25 percent penalty instead of a 10 percent penalty. For example, if you take a $4,000 early distribution within two years of opening your SIMPLE IRA, not only do you have to pay income taxes, you also have to pay a $1,000 early withdrawal penalty.

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    About the Author

    Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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