Find out more about the basic differences between a Roth IRA and a SIMPLE IRA. You’ll learn about the rules for each type of account, who can contribute, and the limits of each plan. Get information to find out whether a Roth IRA or a SIMPLE IRA is a good option for your retirement savings.
What’s the Difference Between a Roth IRA and a SIMPLE IRA?
Roth IRAs and SIMPLE IRAs are both types of individual retirement arrangements, often referred to as individual retirement accounts, or IRAs. Both offer important tax advantages when you invest for your retirement. Because they’re both designed for retirement savings, you may face penalties if you withdraw money from either account early. A Roth IRA is an account you open individually at the brokerage firm of your choice. Contributions are always taxed as they’re made, which means you don’t get to deduct them for tax purposes. However, if you follow certain rules, your money grows untaxed and is 100% yours in retirement. SIMPLE IRA stands for Savings Incentive Match PLan for Employees. You can only contribute to one if you work for a company that offers one. SIMPLE IRAs are generally an option for businesses with 100 or fewer employees that don’t offer another retirement plan. Because a Roth IRA is an account you open as an individual, you’re responsible for funding it. However, with a SIMPLE IRA, your employer will match part of your contributions, using one of the following formulas:
2% non-elective contribution: The employer contributes 2% of the employee’s salary, regardless of how much the employee contributes.3% matching contribution: The employer matches the employee’s contributions dollar-for-dollar, up to 3%. The employer can temporarily reduce its match to 1%. However, it can only do so for two calendar years within a five-year period.
Employers that offer a SIMPLE IRA must allow any worker to participate who earned at least $5,000 during any two years prior to the current calendar year. Likewise, if a worker is expected to earn $5,000 during the calendar year, they must be allowed to contribute. An employer can have less-strict requirements but can’t make the rules more stringent. For example, they could allow someone who only earns $2,000 to participate, but they can’t require that you earn at least $10,000.
Contribution Limits
In 2022, the maximum Roth IRA contribution is $6,000 for people under age 50. Individuals 50 and older can make an additional $1,000 catch-up contribution. Employees younger than 50 can defer up to $14,000 of salary using a SIMPLE IRA. A catch-up contribution of up to $3,000 is allowed for workers 50 and older.
Withdrawal Rules
With a Roth IRA, you’re allowed to access your contributions at any time. However, you’ll pay taxes and a 10% early-withdrawal penalties if you take out your earnings before age 59 ½, or if you haven’t met the five-year rule. If you have a SIMPLE IRA, you aren’t allowed tax-free withdrawals of your contributions at any time because you fund the account with money you haven’t paid taxes on. An extra 10% penalty will apply to withdrawals made before you’re 59 ½. If you withdraw money within the first two years of participation in the plan, the penalty increases to 25%.
Investment Options
You can open a Roth IRA at whatever financial institution you choose. You can invest your money in any stocks, bonds, mutual funds, and exchange-traded funds (ETFs) you want. With a SIMPLE IRA, however, your employer may select the financial institution for your account. Or it may allow you to choose the financial institution. You’re permitted to invest the money in whatever securities the financial institution allows.
A Best-of-Both-Worlds Option
If you’re trying to decide between a Roth IRA versus a SIMPLE IRA, you don’t have to pick one or the other. You can still fund a Roth IRA, even if your employer offers a SIMPLE IRA. A good practice is to take advantage of any employer match first. For example, if your employer matches your contributions up to 3%, aim to contribute 3% so that you’re not passing up free money. If you have extra money to invest, you can invest it in a Roth IRA or contribute extra to your SIMPLE IRA. For many investors, though, funding a Roth IRA once you’ve secured your employer match will make sense. In addition to the ability to withdraw contributions at any time, a Roth IRA has several flexible features. For instance, you can withdraw up to $10,000 for a first-time home purchase or use the money for higher education without penalty in some circumstances. Contributing to both a Roth IRA and SIMPLE IRA can be a smart move if you’re able to do so. By taking advantage of both types of accounts, you’re allowed to invest more money on a tax-advantaged basis. You also get tax diversification, because Roth IRAs are funded with after-tax money, while a SIMPLE IRA is funded with pretax dollars. If you’re not sure what your tax rate will be in retirement, you can get a tax holiday now on your SIMPLE IRA contributions, but you’ll also have tax-free money from your Roth IRA when you retire.
The Bottom Line
As discussed, a Roth IRA and a SIMPLE IRA are two versions of tax-advantaged retirement accounts that can serve different needs for retirement savers. You can open a Roth IRA if you have earned income that doesn’t exceed certain limits, but a SIMPLE IRA is only available if you work for a company with 100 or fewer employees that offers one. You can even set up both kinds of accounts, if you are eligible to do so. Also remember that Roth IRA contributions are made with after-tax dollars, while SIMPLE IRA contributions are always made pretax and will be taxed upon withdrawal.
