SIMPLE IRA for a Sole Proprietor: Rules and Contributions
For sole proprietors, a SIMPLE IRA has unique financial mechanics. Understand how to correctly calculate contributions and navigate critical access and timing rules.
A SIMPLE IRA (Savings Incentive Match Plan for Employees) offers a retirement plan for self-employed individuals and small business owners. For a sole proprietor, this plan is advantageous because the business owner is treated as both the “employer” and the “employee,” allowing them to make contributions in both capacities. This dual-contribution system provides a tax-deferred savings vehicle that is less complex and has fewer administrative burdens than plans like a 401(k). It operates on a calendar-year basis and is designed to be accessible.
Establishing a SIMPLE IRA Plan
Before making contributions, a sole proprietor must establish a SIMPLE IRA plan. A key eligibility requirement is that the owner cannot maintain any other employer-sponsored retirement plan during the same year. The deadline for establishing a new plan is October 1 of the year for which it will be effective. If a new business is started after October 1, the plan must be set up as soon as feasible.
The IRS provides model plan documents to streamline the setup process, primarily Form 5304-SIMPLE and Form 5305-SIMPLE. The choice between these forms depends on who selects the financial institution. A sole proprietor uses Form 5304-SIMPLE to permit each employee, including themselves, to select their own financial institution. Conversely, Form 5305-SIMPLE is used when the sole proprietor designates a single financial institution for all SIMPLE IRAs in the plan. The chosen form is not filed with the IRS but is kept for business records and provided to the financial institution.
Contribution Rules and Limits for Sole Proprietors
As both the employee and employer, a sole proprietor makes two types of contributions to their own SIMPLE IRA. The first is the “employee” contribution, known as an elective deferral. For 2025, a sole proprietor can contribute up to $16,500 of their earnings. Individuals age 50 and over are permitted an additional catch-up contribution of $3,500, while participants aged 60 to 63 have a higher limit of $5,000 or 150% of the regular catch-up amount, whichever is greater.
The second part is the mandatory “employer” contribution. The sole proprietor has two choices: a dollar-for-dollar matching contribution of up to 3% of compensation, or a 2% nonelective contribution. The 2% nonelective contribution means contributing 2% of compensation regardless of whether the “employee” contribution was made. The 3% match can be temporarily reduced in certain years.
For a sole proprietor, defining “compensation” is a specific calculation. It is not the gross income of the business, but the net earnings from self-employment, calculated from the net profit on Schedule C of Form 1040. This figure is then reduced by one-half of the self-employment taxes paid and by the employer’s own SIMPLE IRA contribution. This adjusted compensation figure is then used to calculate the 3% match or 2% nonelective contribution, which is then deducted on Form 1040.
Funding the Account and Important Deadlines
The timing for depositing the two types of contributions differs. The “employee” elective deferral portion must be deposited into the SIMPLE IRA as soon as it can be reasonably segregated from the business’s general assets. For a sole proprietor, this is often interpreted as being deposited by January 30th of the following year, though depositing funds throughout the year is common.
The deadline for the employer contribution, whether matching or nonelective, is the due date of the sole proprietor’s federal income tax return, Form 1040. This includes any extensions filed, which can push the final funding deadline to October 15 of the following year.
Funding involves transferring money from the business’s bank account to the SIMPLE IRA custodian. It is important to clearly designate which portion of the deposit is the employee deferral and which is the employer contribution for proper record-keeping.
Rules for Rollovers and Withdrawals
SIMPLE IRAs have specific rules regarding the movement of funds, particularly within the first two years of participation. During this initial two-year period, money in a SIMPLE IRA can only be rolled over to another SIMPLE IRA. After the two-year period has passed, funds can be rolled over to other types of retirement accounts.
Withdrawals from a SIMPLE IRA are subject to income tax. For individuals under age 59½, a 10% early withdrawal penalty applies. However, a stricter rule applies during the initial two-year period of participation. If a withdrawal is made within the first two years, the early withdrawal penalty is increased from 10% to 25%. After this period, the penalty reverts to 10%.