I remember when I first realized a SIMPLE IRA was not just a simple (meaning regular old traditional) IRA. Once I began to learn more about them, I still had trouble understanding why anyone would ever want one. The truth is if you are like most doctors you are either an employee, an independent contractor, or a partner in a partnership. But if you own a practice and have several employees, then a SIMPLE IRA might be worth considering.
The Downsides
There are lots of downsides with a SIMPLE IRA. Let’s take a look at them one by one.
Lower contribution limits- Instead of being able to put in $17.5K (like a 401K), a SIMPLE IRA only allows an employee to contribute $12K. The catch-up contribution for those over 50 is only $2500, instead of $5500 with the other types of retirement accounts.
Low matching limits- You can only match up to 3% of the employee’s first $250K in compensation. So the maximum you could get into the account each year would be $12K + $7.5K= $19.5K. That’s much less than the $51K total you can get into a 401K, profit-sharing plan, SEP-IRA, or solo 401K.
Inflexible, Required Match- If you have employees, you have to give them that same 3% match. There are a few ways you can make it less than that, like a 2% set contribution instead of a match, or you can actually decrease the match as low as 1%, but only for 2 out of 5 years.
The Upsides
There are a few upsides to a SIMPLE IRA, although I feel they rarely outweigh the significant downsides.
No Discrimination Testing- A 401K has to be discrimination tested each year. That means that the average “highly compensated employee” (HCE- anyone making $115K or more or who owns 5% or more of the company cannot contribute more than 2% more than the average “non-HCEs.” Sometimes this keeps the HCEs from being able to max out the account. For example, consider a dentist with a 401K who employs two hygienists, an assistant and a clerk. If he doesn’t get the employees to make big contributions, he might not be able to contribute more in the 401K than to a SIMPLE IRA.
Easier and Cheaper to Administer- Most employers will need to hire a company to run their 401K. A SIMPLE IRA, on the other hand, can easily be done yourself for nearly nothing. At Vanguard the employer pays nothing, but the employees pay $25 per fund per year.
So Who Should Use A SIMPLE IRA?
The ideal person to use is a relatively low paid business owner with just a few employees who WANTS to offer his employees a retirement plan. If you’re highly paid (and want to save more than say $15K a year in a pre-tax manner), a SIMPLE IRA is less than ideal, but perhaps better than other options for you. If you would prefer NOT to pay any extra toward your employee’s retirement, you might consider a non-qualified plan (no up-front tax deduction) or a cash balance/defined benefit plan.
Another major downside a new client of mine just hit – Once you start the year with a SIMPLE IRA, you cannot stop it during the year. At the same time you cannot contribute to another qualified retirement account (e.g. 401(k) or SEP-IRA). My client is stuck with a plan that doesn’t fit his needs because his previous Advisor didn’t explain all of the downside risks at the time he set it up.
Every retirement plan has a downside to it. SIMPLE IRAs just have more than their fair share. Anyone choosing a new plan should understand the cons of whatever plan he/she chooses.
Also, there is the downside of simple iras counting in the prorata irs calculations for roth conversions of nondeductible iras.
Hi WCI:
I have been following your website for a while, this will be the first (somewhat) lengthy comment:
Current salary is ~150 K with 5% increase each year, I am an employee with W2, My employer is somewhat reluctant to do the work and put in a retirement plan for me(partly because a 401k costs money to maintain, partly because he is lazy XD), and this is going to be my 3rd year working, I do have Roth/back door Roth, and moonlight jobs that pays cash, but I still want to look for ways to shelter regular income from tax.
so I’ve thought about the few scenarios I have:
1. Continue the same way right now, with just backdoor Roth
2. Continue to be on W2 and ask my employer to do a SIMPLE IRA for me,+Backdoor Roth
3. Continue to be on W2, try to convince my boss to do 401 K for me+ Backdoor Roth
4. Switch from W2 to 1099 (which my boss is willing to do), and either do a SEP IRA or solo 401k, +backdoor Roth, do you think the extra tax sheltering power of these two outweigh the extra tax that I pay as 1099 if I cannot find enough to do tax write off?
(I am ok with putting away 25% of my income, no student loans, already have down payment saved, and moonlight cash job is more than enough to sustain monthly expenses)
5. any other scenario you could think of that can maximize tax sheltering?
Thank you so much for your time, any feedback is greatly appreciated !!
Since he’s willing to make you an IC, why not have him pay you a little extra- enough to cover the cost of your benefits and both halves of the SS tax. It’s all the same amount of money to him. Then you can do an individual 401(k).
few more questions:
1. I just got off the phone with vanguard small business department, they told me you can still do a SEP IRA even when you are on W2?? is this true? (directly deduct 25% of salary and contribute to SEP account, and hence salary on W2 would be much lower)
2. for solo 401 k, you would have to start your own one person company and be paid company to company right ? you cannot just be a IC with 1099 ? (or is it that you have the 1099 and start your own one person company in order to do the solo 401 k?)
not sure if I’m reading things correctly, thanks for your time !
1. No. Not unless you have self-employment income also from somewhere. An employer can use a SEP-IRA as their retirement plan also for their employees. Perhaps that’s what he was referring to. But if your employer isn’t doing a SEP-IRA for you, you can’t do one on your own as an employee.
2. An IC is a one person company. So yes, you can do an individual 401(k) with 1099 income.
what I meant was if my employer can open a SEP IRA for me while paying me on W 2 (not I open one for myself) and I guess the answer is yes..? if this is the case, then I would rather do this than switch to 1099 and do solo 401k, because the amount of work going into it (also I think if all of my income is on 1099, the mortgage lender sees this as less desirable than W2 when it comes to buying a house..?) thanks for the fast response~
The downside of that SEP-IRA is you can’t do backdoor Roth IRAs.
you mean you can NEVER do back door Roth forever once you have SEP IRA?
my plan is to be on W2 for few more years, and after I buy a house/apt, switch to 1099 and have solo 401k
It depends on what you mean by “do backdoor Roth IRA.” Do you understand the pro-rata issue? The point of a backdoor Roth IRA is to contribute to a Roth IRA without having to pay any additional taxes on the previously taxed money or on any of your tax-deferred money. In order to do that, you have to convert a non-deductible traditional IRA to a Roth IRA. But if you have a tax-deferred traditional, SEP, or SIMPLE IRA all conversions are pro-rata and don’t really accomplish what you probably want to do.
Thanks for this post, I’m a long-time reader, first time post! My wife and I are freshly minted attendings, so this site and your book are integral in our decision making.
What do you think of this scenario:
In early Jan 2015 I made a $5,500 contribution and conversion via backdoor Roth for my wife. She also became eligible to contribute to her SIMPLE IRA in Jan 2015, which we started contributing to as well. At the time I was not aware I would not get the benefits of the backdoor Roth with a SIMPLE contribution.
Do you recommend reconverting the Roth to Traditional IRA? Should I just bite the bullet on taxes this year and leave it in the Roth?
Tough question. I guess I probably would recharacterize it. I might still make the contribution each year, but wait until something can be done with the SIMPLE before doing the conversion. Hopefully you can do that within a few years.
Thanks for the reply.
Just to clarify, do you mean continue contributing $5,500 into the Traditional IRA each year, then after 2 years of contributing to the SIMPLE, transfer it to another IRA or another type of account so that I can take advantage of the backdoor Roth (presumably I’d have $11k in the traditional Roth and $12.5 x2 + match in SIMPLE).
Thanks, I know this is a strange situation and Fidelity doesn’t have a good answer either–I had to tell THEM I wasn’t able to take advantage of the backdoor Roth with a SIMPLE!
Eventually she may change to a job with a 401(k) and you can roll the SIMPLE in there, and then convert the non-deductible traditional IRA, paying taxes only on the gains.
Hello everyone,
I recently took an associate position and they have a Simple IRA plan for employees. The employer will match up to 3%. Any plan is better than no plan, but I have a few concerns.
1. The route the employer has taken is through a broker who in turn uses American Funds, the commission or whatever term is 2.5% which seems high to me, but it is “split between the ~7 employees. ” To me that doesn’t make sense, that still means 2.5% of my money will go to the broker/advisors/etc…
–> Is the 3% match worth the 2.5% fee?
2. One of your commenters above mentioned that a Simple IRA affects your ability to contribute to other retirement accounts. I make too much to contribute to my Roth IRA anymore, but from my understanding I could open a new Traditional IRA and convert it to a Roth? Would this Simple IRA prevent me from converting a new Traditonal to a Roth?
Yes, the match is worth it. As a general rule, if you won’t be there long, the SIMPLE is worth it too. When you leave, you can roll it into something else. However, a SIMPLE does prevent you from doing a backdoor Roth IRA unless you just wait on the conversion step until after you leave that employer.
My wife and I have just recently discovered your podcast and blog. Previously we’ve shuddered at the thought of financial planning (due to some bad experiences with financial planners in the past) but have recently decided to take charge on getting our financial plan in order. I have a leftover SIMPLE IRA from a previous employer. This year is the first year my wife and I won’t be able to directly contribute to a Roth IRA due to her new income after graduating from her fellowship. My understanding is that I need to rollover my SIMPLE IRA to another account before we can set ourselves up to do a back door Roth contribution for 2019. I have a 401k with my current employer. Should I just roll my SIMPLE IRA into my existing 401k or is there an advantage to doing something else with it.
I’d either roll it into the 401(k) or convert it to a Roth IRA (and pay the taxes on it.) Your call.
Hi WCI,
I was wondering if you could help with this scenario:
My significant other is the owner of a Plastic Surgery PLLC with one employee. 2015 was the first full year in practice and revenue was ~175k.
Our accountant is recommending putting money towards the small business loan and contributing to her Roth IRA. I feel that taking advantage of other tax sheltered accounts would be smart too. We are a two doctor family and have been living on my salary.
I’ve been reading your posts about Solo 401k, SEP-IRA, and Simple IRA. Any advice for the ideal approach?
Thanks
Once you have employees, the ideal approach requires a bit of a study done by a professional. I haven’t yet figured out a rule of thumb that will tell you what to do. With no employees, it’s easy- individual 401(k). But after that it comes down to how much you want to pay in matching dollars to the employee(s) in order to get your tax breaks.
I’m setting up a SIMPLE IRA for my dental office. I have 4 full time employees and 3 part time. I can contribute the max $12,500 to the simple, and have my business match 3% of my salary which will be an additional $6000. I’m putting my wife on the payroll for the occasional front office work she does. She’ll be salaried at $12,500 which will all be put into the SIMPLE. Her match will only be $375. Total IRA investment for our family will be just over $31,000. The key for me is that my cost to implement this plan will be minimal. My employees’ salaries total just over $200,000 which means my 3% match will at most be $6,000. Paperwork is easy and I don’t have to pay anyone to administer the plan. Additionally, I can invest $11,000 in traditional IRAs for my wife & me, although these will not be tax-deductible. A 401k is too expensive to administer and I can’t contribute as much. A SEP would cost me about $24,000 more in employee distributions for me to gain the same benefit as a SIMPLE.
I still haven’t made a decision on the life insurance, but want to let you know my employer has offered a SIMPLE IRA. The funds I have to pick from are Amerifunds A shares and charge a 5% sales load.
The agent/ advisor is with Northwestern Mutual and he said SIMPLE IRAs are protected by ERISA. It is my understanding they are not, but I didn’t want to argue. He did try to offer me a WL policy but I said, “N way, not a chance in Hades I want one of those.”
Ugh. Not a big fan of SIMPLEs for docs. Not only do they have low limits, but they prevent a backdoor Roth. And it’s not like your SIMPLE IRA is a good one. I mean, loads in a retirement plan? Does your employer hate you or are they just ignorant?
I just think they’re very cheap maybe even greedy but like to play the ignorant act. The plan is matched at 3%, so I figured I could just do 3%. I did a $5500 contribution my T- IRA in April but was going to wait until this month to backdoor it. I was told I have to move that $$ into a taxable account b/c I cannot do a backdoor or contribute to any other IRA and also participate in a SIMPLE IRA. I don’t know what to do here, but the 3% match does sound good. What do you think?
Also are SIMPLE IRAs protected by ERISA?
Hard decision. Lose your match or lose your ability to do backdoor Roths. How much is 3%?
Yes, SIMPLE IRAs are subject to ERISA.
The 3% match even with having to pay taxes, assuming they stay the same, works out to be more comparing it with an 8% return. I get what you’re saying, “If they did things the right way and setup a 401k, then I could do both. Contribute $18,000 to a 401k and $5,500 to a Backdoor IRA.”
Also, this is where I’m getting that SIMPLE IRAs are not protected in Ohio under ERISA.
http://www.nolo.com/legal-encyclopedia/are-my-retirement-accounts-protected-from-judgment-creditors-ohio.html
Ohio doesn’t have great asset protection for any retirement accounts, but it doesn’t seem that IRAs are any different from 401(k)s in that respect.
Exemption for Tax-Qualified Retirement Plans, IRAs & Roth IRAs (Note 2): Limited to to the extent reasonably necessary for support. — Ohio Rev. Code Ann. § 2329.66(A)(10)(b) and (c). SEP-IRA not protected. In re Rayl, 299 B.R. 465.
http://www.assetprotectionbook.com/forum/viewtopic.php?f=142&t=1566
hello, happened upon your website today.Trying,like so many other MD’s, to sort through the morass of investment decisions.Suggest they delete one organic chemistry class in med school and substitute finance 101;has anyone,ever,needed to know amino acid structure in their medical practice.So I need some help.I have five years to retirement,will be 59 1/ 2 in july.Currently have a trad IRA with Betterment and Simple with Vanguard.In love with idea of “backdoor”Roth.However I am employed W2,hence the Simple.Here’s the plan I’m considering:Convert to Independent Contractor,liquidate traditional Ira(non-deductible so pay tax on gains),open independent 401(k) and Roth IRa,contribute max to former and from that do 6500 backdoor to latter.If this is doable(is that a word?)where would this leave my Simple?Thanking you in advance,there’s a real need for advice for all of us in the trenches from someone in the trenches(…bit dramatic but worth saying).Look forward to your response.
I’m sorry your employer only offers a SIMPLE IRA. The fact that you have that (in addition to a traditional IRA) is going to keep you from doing a backdoor Roth IRA effectively. I’m sorry.
No sense in liquidating your traditional IRA that is mostly non-deductible. Just convert it after you roll that SIMPLE IRA into your new i401(k). Then you can start doing backdoor Roth IRAs. Not sure this is a big enough deal to change jobs though. Make sure if they change you to an IC that they pay you more to make up for your additional costs.
I just got off the phone with Vanguard and asked them specifically if I created a SIMPLE IRA for my small business (4 employees), that I’d still be able to utilize the backdoor Roth option.
They said because the SIMPLE IRA is a business account and the “BACKDOOR” options were all individual accounts, there would be no issue at all.
Can you direct me how to better find out why Vanguard is saying one thing, but you are saying the exact opposite?
I own a small Cash Clinic with one other doc and 3 employees and we’re looking to find a way to stash some of our cash away, and it seemed to me like a SIMPLE IRA was the way to go, but if I can’t participate in the Backdoor, it’s less interesting to me.
Vanguard suggested SIMPLE for employees 10 a Small Business 401(k).
I’d love to be able to contribute an additional $12,000+ out of my business to my retirement and think my staff would like it too!
Thanks – love the thread and the discussion!
Vanguard is saying the wrong thing because they’ve never read IRS Form 8606 Line 6. Here’s a link:
https://www.irs.gov/pub/irs-prior/f8606–2017.pdf
It says:
What’s to debate? Nothing I can see.
If a SIMPLE IRA is right for your practice, then maybe you don’t do the Backdoor Roth IRA. But I think you’d be a pretty rare doc.
Kirby and WIC, doesn’t the pro rata rule prevent you from completing a back door IRA when you already have a SIMPLE in place?
Peter and WIC,
Thanks again for clarifying – It makes sense what you say, not what Vanguard says, which sort of has me worried relying on their experts to help guide me.
This pro rata rule shouldn’t be that hard to understand –
Based on WIC’s link and the actual Tax form 8606, it’s much more clear to me that I can’t contribute BACKDOOR IRA contributions and SIMPLE IRA contributions in the same year.
That’s exactly the language I’ve been looking for.
As always, thanks WIC!
Why do I feel like I should be handing out free infant formula? 🙂
https://www.fns.usda.gov/wic/women-infants-and-children-wic