You may be wondering if you can contribute to a SIMPLE Roth IRA, but they don’t exist. Instead, to take advantage of a Roth IRA account’s benefits, you can convert a SIMPLE IRA to a Roth IRA. Learn the difference between these two types of IRAs, the pros and cons of each, and how conversion works.
SIMPLE IRAs Do Not Have a Roth Option
A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a retirement plan that allows business owners and employees to contribute to traditional IRAs. It’s designed for smaller employers with 100 or fewer employees who each received $5,000 or more from their employer during the year. You can’t include a Roth IRA option in an employee plan, because SIMPLE IRAs are funded with earnings that have been deducted from your income, while Roth IRAs are funded with after-tax funds.
SIMPLE IRAs vs. After-Tax Retirement Plans
The IRS has several options for after-tax retirement plans, for both individuals directly or through an employer’s retirement plan. A traditional IRA is any IRA that isn’t a Roth or a SIMPLE IRA. Traditional IRAs are individual retirement arrangements in which an individual’s contributions are tax-deductible. Contributions to SIMPLE IRAs and other after-tax retirement plans are tax-deductible, but are taxed when funds are withdrawn.
SIMPLE IRA Contributions and Distributions
Participating employees with a SIMPLE IRA plan contribute to the plan each year and their employer generally must match dollar-for-dollar up to 3% of their compensation or make a 2% nonelective contribution for each eligible employee. For example, say an employee whose yearly pay is $50,000 contributes 5% of their salary ($2,500) to the SIMPLE IRA one year. The employer matches up to 3% ($1,500), making the employee’s total contribution $4,000 for that year. The other option is for the employer to contribute 2% of compensation for all eligible employees, even if the employee doesn’t contribute. Employee contributions to SIMPLE IRAs are limited to a maximum each year. For 2022, the maximum employees can contribute is $14,000, but employees age 50 or over can contribute an additional $3,000.
Roth Accounts Are After-Tax Retirement Plans
A Roth 401(k) is similar to what you might envision a SIMPLE Roth IRA to be in that it is an employer-sponsored retirement plan in which you can contribute after-tax dollars for tax-free withdrawals in your retirement years. Employers can make matching contributions. This account works the same as a Roth IRA, with after-tax contributions. There’s no tax on withdrawals of earnings if they are made at least five years after the first contribution and after age 59½. You can withdraw your original Roth 401(k) or Roth IRA contributions with no penalties or taxation at any time, but there are penalties for early withdrawal of any earnings you made on your investments. Some exceptions for withdrawing earnings before your retirement age include withdrawing from a Roth IRA if you are using the funds to buy your first home.
Changing a SIMPLE IRA to a Roth IRA
A rollover is a way to transfer money from some types of retirement accounts to others. To avoid tax issues, you must deposit the payment from one retirement account to another within 60 days or have a financial institution do the transfer. You can make only one rollover transaction of any type each year. Other IRS rollover rules include:
You can rollover a traditional IRA to a Roth IRA (called a conversion). You must include the Roth amount in your taxable income for the year. You can convert a SIMPLE IRA to a non-SIMPLE IRA tax-free, but you must participate in the SIMPLE plan for two years first. You can’t rollover amounts from a Roth IRA to an employer retirement plan, including a SIMPLE IRA or a Roth 401(k). Roth IRAs can only be rolled over to another Roth IRA.
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