The Internal Revenue Service drew up the rules for the Savings Incentive Match Plan or SIMPLE IRA to benefit smaller companies that still wish to contribute to their employees' retirement savings. The SIMPLE IRA works like a conventional IRA, except that your employer adds contributions as well. The tax treatment of your own contributions is the same as with a conventional IRA, although the method of accounting for it is somewhat different.
In a SIMPLE IRA, you contribute to a retirement plan by allowing your employer to deduct your contributions automatically from your paycheck. The employer is required to make contributions that match your own, up to 3 percent of your compensation. Alternatively, the employer may make non-elective contributions up to 2 percent of your compensation. The employer is allowed to deduct all its contributions to its employees' SIMPLE plans on its business income tax return.
As of 2012, the IRS limits the amount of your contribution to a SIMPLE IRA to $11,500 a year. If you are age 50 or above, you are also allowed an additional "catch-up" contribution of $2,500. After you reach the minimum retirement age of 59 1/2, you may begin taking withdrawals; the IRS will levy tax on the account earnings. If you withdraw the money before age 59 1/2, you will also pay a 10 percent penalty, unless you are using the money for certain purposes, such as buying a first house or paying medical or educational expenses.
Your contributions to your SIMPLE IRA "pre-tax," meaning that your employer does not withhold any federal income tax on the money before it is deposited into the SIMPLE IRA. The employer does not report the contributions as income on your W-2 form, and you do not report the money as wages or other income on your annual tax return. The IRS makes an exception for business partners and the self-employed, who may deduct their contributions as both employer and employee of a business.
With a traditional IRA, you make contributions as you can throughout the year, and then deduct the amount you contributed on your annual tax return. With a SIMPLE IRA, since the contributions are not reported as income, you may not claim them as a deduction on your tax return -- that would amount to claiming them twice.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.