Simple individual retirement accounts are designed for small businesses with 100 or fewer eligible employees. This includes sole proprietorships, corporations, partnerships, government entities and tax exempt organizations. Through a salary reduction agreement, you authorize your employer to deduct a certain amount from your wages to go toward your IRA account. Your contributions are made with pretax money, which means they are not subject to specific withholding taxes.
Your contributions are not subject to federal income tax withholding. Therefore, when your employer deducts your contributions from your gross wages, you do not pay federal income tax on the amount. The state may treat Simple IRAs differently than federal law for state income tax purposes. You may consult the state revenue agency to determine whether state income tax must come out of your Simple IRA contributions.
Your employer must take Social Security and Medicare taxes -- also called Federal Insurance Contributions Act taxes -- from your contributions. As of 2013, you pay 6.2 percent of your gross wages for Social Security tax and 1.45 percent for Medicare tax. When calculating your FICA taxes, your employer includes your IRA contributions in your total wages for the pay period. Then it multiplies your wages by the required percentages. As of 2013, Social Security tax has an annual wage limit of $113,700 and Medicare generally has none. However, if you earn more than $200,000 for the year, the excess amount is subject to an additional Medicare tax of 0.9 percent.
If your employer chooses to match your Simple IRA contributions, it may do so on a dollar-for-dollar basis up to 3 percent of your wages. Instead of matching your contributions, your employer can choose to make non-elective contributions of 2 percent of your wages. During the plan election period, your employer must inform you of which contribution method it will use that year. Whereas your contributions are subject to FICA withholding, your employer’s match or non-elective contributions are not.
Limit and Withdrawal
As of 2013, you may contribute up to $12,000 annually to your Simple IRA plan. If you are 50 or older and the plan allows it, you may contribute a catch-up amount of $2,500. When you withdraw your money from the plan, you must pay federal, and if applicable, state income tax on your contributions and earnings. Generally, if you withdraw from the plan before age 59 1/2, you might have to pay an additional 10 percent in federal income tax; however, there are some exceptions to this rule. In addition, the Internal Revenue Service has a two-year policy that applies to Simple IRA early distributions. If your early distribution happens during two years after the date you started to participate in the plan, the additional tax of 10 percent is increased to 25 percent.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.