How a Simple IRA Grows
If you work for a firm with 100 or fewer employees, you may have the opportunity to participate in a Savings Incentive Match Plan for Employees Individual Retirement Account. Your SIMPLE IRA may fluctuate in value over time. However, continuing contributions, wise investment decisions, and tax rules enable your SIMPLE IRA to grow over the long term.
You fund your SIMPLE IRA on a pre-tax basis with a portion of your paycheck. As of 2013, you can deposit the lesser of $12,000 or 100 percent of your salary into a SIMPLE IRA. Your employer can make a matching contribution of up to 3 percent of your annual salary. Alternatively, your employer can make a non-elective contribution to your account. This involves depositing a sum of money equal to up to 2 percent of your annual salary into the account regardless of your own level of contribution.
Your employer creates your SIMPLE IRA on your behalf. Therefore, your employer assumes the responsibility for selecting the investment options. Many SIMPLE IRA plans include mutual funds, in which case your account grows or loses value based on the performance of the selected funds. Some plans include low-risk securities such as certificates of deposit, in which case you receive a set rate of return. Most plans include a number of investment options from which you can choose a fund or product that best serves your needs.
Like most retirement accounts, SIMPLE IRAs grow on a tax-deferred basis. This means neither your contributions nor your employer's are subject to income tax at the time they are made. However, you do have to pay income tax on both your earnings and contributions when you make withdrawals. You also pay a 25 percent tax penalty if you cash in your account within two years and before you reach the age of 59 1/2. The tax-deferred status of a SIMPLE IRA enables your money to grow more quickly. In a taxable account, you would have to pay taxes on an annual basis on your interest earnings and realized capital gains. Within a SIMPLE IRA, such earnings compound without being exposed to taxation at the state or federal level.
Many retirement accounts, including 401(k) plans, are impacted by vesting. In simple terms, vesting is the process through which an employee becomes entitled to an asset or benefit. In a 401(k) plan, it can take between five and seven years for your employer's contributions to become fully vested. If you leave your job within this time frame, you could lose some or all of the money your employer contributed to your 401(k). In contrast, a SIMPLE IRA is 100 percent vested from day one. Though not technically "growth," an immediately vested employer contribution certainly boosts the size of your nest egg.