Payroll Deduction IRA

What is a Payroll Deduction IRA and How Does It Work?

A Payroll Deduction IRA is a convenient and no-cost way for you to help employees save for their retirement. You’ll be setting up the program with an insurance company, a bank, or other qualified financial institution, and then your employees will be the ones to decide whether to participate. 

After they have decided, they will set up a traditional or Roth IRA on their own and elect a certain percentage or set a dollar value to be withheld from their paycheck as a contribution to their IRAs. These funds can be invested in mutual funds, stocks, savings accounts, money market funds, and similar investments.

Payroll deductions can be classified into mandatory deductions (those required by the law), such as those withheld for Social Security and Medicare, and voluntary deductions, which happens when an employee opts to give written consent to allow employers to make certain deductions. The latter is the focus of this article. 

For small business owners who can’t afford to offer other retirement plans, a payroll deduction IRA is a great way to encourage workers to retain their service to the company. On the other hand, it also gives employees an efficient way to save for their retirement by automatically deducting money from their paycheck.

Who is Eligible to Contribute to a Payroll Deduction IRA?

Any employee who works for your company is qualified to participate in a payroll deduction IRA. They’ll be the ones to make all the contributions and have complete control over where they would want to invest their money in. 

How to Establish a Payroll Deduction IRA

Setting up a Payroll Deduction retirement plan is perhaps the easiest among all IRAs. Here’s how you can establish one: 


You’ll be working with a qualified financial institution to set up the program. 


The employees will select either a traditional or Roth IRA and authorize payroll deductions. 


You will then withhold and transmit the authorized amount to the financial institution. 

What are the Contribution Rules for a Payroll Deduction IRA?

Here are some essential contribution rules for you to remember:


Your employees shall fund their own IRA through an automatic pre-tax (if they opt for traditional IRA) or after-tax (if they opt for Roth IRA) deduction from their paycheck. They also have the discretion to invest and roll over their IRAs. 


You do not make contributions to the Payroll Deduction IRA.


You have no further responsibility for the contributions after transmitting the payroll to your employees’ IRA account provider.


The employee can only contribute up to $6,000 or $7,000 (if they’re beyond 50 years old) annually in 2021 and 2022. 

What are the Withdrawal Rules for a Payroll Deduction IRA?

You have two options to take a withdrawal: 

If the employee opted for traditional IRA

Generally, the employee may withdraw at any time. However, withdrawals made before age 59 1/2 shall be subject to an additional tax of 10%. Certain exceptions may apply to this rule, such as withdrawals made for disability, first-home purchase, and unreimbursed medical bills. 

If the employee opted for Roth IRA

Withdrawals are tax-free and penalty-free if the account has been open for at least five years and the holder is beyond 59 ½ years old, or the employee is qualified for any exceptions under the IRS rules. If not, taxes and penalties still apply.

Pros and Cons of Payroll Deduction IRA

A payroll deduction plan can have certain benefits and drawbacks for you and your employees. Here are a few you should note of: 

The Pros of a Payroll Deduction IRA: 

Easy to Maintain

The simplicity of this plan makes it easy to set up and maintain. It requires little administration requirements and paperwork.

No Government Filings Needed:

Generally, employer-sponsored retirement plans require government filings, but with payroll deduction IRAs, there’s no need to file for any government documents at all. You won’t even need to create an annual program report. This is a huge benefit, especially for small businesses, because there will be less administrative work.

Automatic Savings

Although you can also diversify with stocks and bonds, diversification in precious metals entails better benefits. With precious metals IRAs, your portfolio can continue to grow, regardless of the domestic economy’s performance.

The Cons of a Payroll Deduction IRA

No Deduction for Business

Although a payroll deduction IRA can help you retain employees, you as an employer don’t really get to share the tax benefits as with other retirement plans. Since you don’t even contribute to the plan, you don’t get any tax deductions for the business. So, you basically just act as the medium between your employee and the IRA provider.

Limited Contributions

As with other IRA plans, payroll deduction IRAs are subject to the same contribution limits of $6,000 or $7,000 (if you’re 50 or older) for 2022. This is significantly lower than a SEP or SIMPLE IRA.


A payroll deduction IRA can be an excellent way for your employees to save for retirement automatically. It’s also a great tool that’ll help retain your employees. 

However, there are also some drawbacks to consider before opening an account. As mentioned, you’re basically just acting as an intermediary between the IRA provider and your employee. So, you don’t get to enjoy any tax benefits at all. But, if your purpose is just to encourage your employees to keep working for your company, then this can be a good option for you. 

There’s no government filing and complicated paperwork involved, so you can set it up in just a breeze. Plus, you won’t need to make contributions. 

As always, make sure you understand all the terms and conditions of any plan you’re considering before signing up. Reach out to us if you have any more questions!

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