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A SIMPLE IRA is an employer sponsored retirement plan offered within small businesses that have 100 or less employees. SIMPLE is an acronym for savings incentive match for employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401k plan.

With a SIMPLE IRA, the employer matching incentive is built in to the plan. The employer must either match the contributions employees make to their plan, up to 3% of salary. Or the employer can make contributions for employees of a flat 2% of salary, whether or not the employee chooses to participate in the plan. This differs from 401k plans. An employer offering a 401k plan can choose whether to match employee contributions. Many do, but in difficult economic times, matching programs can be among the first benefits cut. Employers who choose to offer SIMPLE IRAs are generally required to match, dollar for dollar, from 1% to 3% of the employee’s salary.

A SIMPLE IRA works a lot like a 401k plan. Contributions to the plan are made pre-tax, and the money in the plan accumulates tax-deferred until the money is withdrawn at retirement. If the money is withdrawn before age 59 1/2, you will pay a 10% penalty fee. Within a SIMPLE IRA, your employer will likely offer a wide variety of stock and bond mutual fund investment options. A SIMPLE IRA cannot be a Roth IRA.

If you are a small business employer, the decision to offer a SIMPLE IRA vs a 401k is often not so much about the size of your company or the number of employees, as it is about how much you as the owner want to put into the plan. The contribution limits for a SIMPLE IRA are different than 401k contribution limits. In 2012, employees can generally contribute $11,500 to a SIMPLE IRA. The catch-up contribution limit for 2012 is $2,500. That means if you are age 50 or older and your employer allows catch-up contributions, you can put an additional $2,500 into the IRA this year. If you have a SIMPLE IRA and you participate in any other type of employer retirement plan during the year such as a 401k, the limit on how much you can contribute to all of the plans is $17,000.

With a 401k, individuals can save $17,000 in 2012, or up to $22,500 with a catch-up contribution. So, you can see, there is a big difference in the amount you can sock away in 401k. Small-business owners who are highly paid professionals, such as doctors, dentists or attorneys, tend to favor solo 401k plans over SIMPLE IRAs because of the higher contribution limits offered with a 401k.

SIMPLE IRA rollovers are anything but simple if you have been invested in the plan for less than two years. If two years have passed since you’ve begun participating in the plan, you can move the money into a rollover IRA or new employer 401k. If you’ve participated for less than two years, you can only roll it into another SIMPLE IRA or leave the money in the former employer’s plan.