- Companies with no more than 100 employees can establish SIMPLE IRAs on behalf of employees as an alternative to 401k plans or pensions. Any employees who earned at least $5,000 working for the company in either of two prior years and who are expected to earn at least $5,000 in the current year are eligible to participate in the plan. The employer can contribute to SIMPLE IRA in one of two ways: He can make dollar-for-dollar matching contributions not to exceed 3 percent of the employee's compensation for eligible employees who make elective deferral contributions. The alternative is for the employer to make a 2 percent nonelective contribution to all eligible employees, regardless of whether they make deferral contributions.
- Employers hire outside investment firms to administer SIMPLE IRA plans. Typically, these firms invest the funds in mutual funds or investment portfolios that contain a variety of securities, such as stocks and bonds. Mutual funds and most individual securities have no principal guarantees. Stocks become worthless when the company that issues the stocks goes bankrupt. Bonds can also lose value and become worthless if the bond issuer defaults on debts. However, stocks and bonds can also grow in value, and stocks offer unlimited growth potential. In a diversified SIMPLE IRA plan, the chances of you losing all of your money are remote, but during a market downturn you could lose a significant amount of money.
- Some employers invest SIMPLE IRA funds in conservative investments, such as certificates of deposit (CDs), because these instruments offer principal protection in the form of federal deposit insurance. As long as your SIMPLE IRA CD balance does not exceed the maximum deposit insurance level of $250,000, you cannot lose any money. However, CD rates often fail to keep pace with the rising cost of living. Over time, you lose some spending power if your SIMPLE IRA CD does not grow fast enough to keep up with inflation.
- SIMPLE IRAs are funded with pre-tax money, which means you pay ordinary income tax when you make withdrawals. If you withdraw money from your SIMPLE IRA before you reach age 59 1/2, you are penalized 10 percent of the amount withdrawn in addition to the income tax. Also, the IRS imposes a 25 percent tax penalty on any withdrawals made from your SIMPLE IRA within the first two years of its existence.
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