SIMPLE IRA vs. Roth IRA: What's the difference?

If you have the option between contributing to a SIMPLE IRA vs. Roth IRA, it's important to understand how each works and the benefits they can provide. Both offer a tax-advantaged way to save for retirement, although the rules concerning contributions, taxation and distributions work differently for each.

Depending on your situation, you may want to choose one or the other, but it's also possible to use both. Read on to learn how these plans work so you can decide the best way to incorporate them into your retirement savings plan.

A Savings Incentive Match Plan for Employees individual retirement account, or SIMPLE IRA, is a retirement plan available through small business employers. It offers a convenient way for a business owner to contribute to both their own and their employees' retirement savings.

Your employer—or you if you're self-employed—creates and manages SIMPLE IRAs. Employers with fewer than 100 employees can sponsor a SIMPLE IRA plan as long as they don't have another type of retirement plan.

If your employer offers a SIMPLE IRA, you can participate if you earned $5,000 or more in any two prior years and expect to make at least that much in the current year. Your employer can allow you to participate if you don't meet those criteria, but they can't keep you from participating if you do.

SIMPLE IRAs are funded by a combination of employee and employer contributions. If your employer offers a SIMPLE IRA, they are required to make contributions on your behalf.

• In 2024, you either can contribute an amount equal to 2% of an employee's compensation to their account regardless of how much the employee contributed or make a 100% matching contribution of up to 3% of the employee's compensation.

• Starting in 2025, you may make uniform additional contributions for each SIMPLE plan employee to a maximum of the lesser of up to 10% of compensation or $5,100 (inflation-adjusted).
  

• For 2024, your contributions are limited to $16,500 if you’re under age 50. If you're 50 or older, you can make an additional $5,250 catch-up contribution.

• For 2024, you can contribute up to $16,000 if you are under age 50, and an additional $3,500 catch-up contribution if you’re 50 or older.

Roth IRAs are individually owned retirement accounts that you can open at any financial institution that offers them. The hallmark of these accounts is their tax advantages: You fund them with dollars you've already paid taxes on, so you receive tax advantages later.

While employers don't operate these plans, you do need to have the IRS definition of earned income to open one. You can't contribute things that don't qualify as earned income (such as interest, Social Security, or dividends) to a Roth IRA.

Roth IRAs have income limits to participate. If you make more than the limit, your allowable contribution is reduced in phases until you reach the maximum, after which you can't contribute at all.

• For 2024, you can contribute up to $7,000 plus an additional $1,000 if you're 50 or older.

• For 2025, you can contribute up to $7,000 plus an additional $1,000 if you're 50 or older.
  

SIMPLE and Roth IRAs both offer tax benefits, but they do so differently. Here are the key points to know:

• SIMPLE IRA contributions aren't taxed. Your salary deferrals aren't included in your taxable income, which gives you a tax break for the year you make contributions.

• Roth IRA contributions aren't tax-deductible. You don't get a tax deduction for Roth contributions. Your Roth IRA contributions are made with dollars you've already paid taxes on, and they're still included in your taxable income.

All retirement accounts have specific rules surrounding qualified withdrawals, which means you won't face any penalties for withdrawing money from the account.We break down the specific rules below:

• As a tax-deferred account, you're liable for income taxes when you withdraw from your SIMPLE IRA. Your full withdrawal is taxed at your marginal tax rate.

• Withdrawals before you reach 59½ generally result in a 10% penalty on top of your regular income tax liability. If you withdraw from a SIMPLE IRA in the first two years after you start making contributions, the penalty is 25% rather than 10%.

• The IRS requires you to start taking required minimum distributions (RMDs) by the time you turn 73. Failure to do so results in additional penalties.

• Since the taxes have been paid on them, you can withdraw your contributions at any time without facing additional taxes or penalties.

• However, if you make a withdrawal from the account before age 59½ that reaches beyond your contributions and taps into your earnings, the earnings portion will be subject to both income taxes and a 10% penalty.

• There are no required minimum distributions at any point for the original account owner. However, inherited Roth IRAs will be subject to RMDs.

Neither retirement account is fundamentally a better choice than the other. You have to consider how the features of each fit into your particular financial strategy. But these are some general considerations to guide your decision-making:

• SIMPLE IRAs have higher contribution limits, provide an immediate tax deduction and allow you to receive employer contributions. These features could allow you to save more for retirement.

• Roth IRAs have relatively low contribution limits, and you may not be able to contribute at all if your income is too high. But they grow tax-free, which could offer tax efficiency in retirement.

It's also possible to use both a SIMPLE IRA and a Roth IRA. If you're eligible for both, it can make sense to max out contributions to your Roth IRA first and then use your SIMPLE IRA to save more.

For help understanding how these and other types of retirement accounts could work for you, contact a Thrivent financial advisor for guidance. They can work closely with you to craft a plan that fits your specific circumstances so you can accomplish your financial goals.