Can an Employee Deduct SIMPLE IRA Contributions?
Original post by Deborah Barlowe of Demand Media
The Internal Revenue Service allows companies with less than 100 employees who receive $5,000 or more in compensation to establish SIMPLE IRA retirement plans. The IRS requires employers to make annual contributions to their SIMPLE IRA plans, but employees retain their right to choose to contribute to their individual accounts. While the IRS allows an employer to deduct its contributions to a SIMPLE IRA plan on the company’s tax return, the IRS does not allow employees to deduct their own elective contributions.
The IRS considers an employee eligible to participate in his employer’s SIMPLE IRA plan if his employer reasonably expects to pay him at least $5,000 during the year the company intends to contribute to the plan and the employee earned at least $5,000 during either of the two previous years. An employer may choose to waive or lessen the eligibility standards identified by the IRS, but the company cannot mandate more stringent standards.
An eligible employee participates in his employer’s SIMPLE IRA plan if he chooses to defer a portion of his pay into his individual retirement account. As of the time of publication, the IRS allows an employee under 50 to reduce his taxable pay by up to $11,500 through elective salary deferrals into his IRA. The IRS permits an employee who is at least 50 years old to further reduce his taxable income by an additional $2,500, meaning the employee can selectively defer up to $14,000 of his annual compensation into his retirement account.
An employer must choose to make either matching or nonelective annual contributions to its SIMPLE IRA plan. The IRS requires an employer making matching contributions to contribute to the IRAs belonging to every eligible employee participating in the plan. An employer may make a matching contribution of up to 3 percent of either a participating employee’s annual compensation or $245,000, whichever is less. The IRS requires an employer choosing to make nonelective contributions to its SIMPLE IRA plan to contribute 2 percent of an eligible employee’s first $245,000 of compensation to the employee’s retirement account. All of a company’s eligible employees must receive employer contributions in their individual retirement accounts if their employer chooses to make nonelective contributions regardless of whether or not the employees electively participate in the SIMPLE IRA plan.
Because an employee contributes to his SIMPLE IRA account with pre-tax dollars, his employer does not include the amount the employee contributed to his retirement account as part of the compensation reported on the employee’s Form W-2, meaning the IRS does not consider the employee’s own contributions to be taxable income in the year he makes them. The IRS taxes contributions made to an employee’s SIMPLE IRA account and the interest earned on them when the employee withdraws funds from his account.
- IRS.gov; Publication 590 Individual Retirement Arrangements (IRAs); February 2011
- IRS.gov; Retirement Plans FAQs Regarding SIMPLE IRA Plans; May 2011
- U.S. Department of Labor: SIMPLE IRA Plans for Small Businesses
About the Author
Deborah Barlowe began writing professionally in 2010. Earning securities and insurance licenses and having owned a successful business, her articles have focused predominantly on finance and entrepreneurship. Barlowe holds a bachelor?s degree in hotel administration from Cornell University.