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What is a SIMPLE IRA?

The Savings Incentive Match Plan for Employees (SIMPLE) became effective on January 2, 1997. It is offered in two forms: the 401(k) and the IRA. The SIMPLE IRA is an ideal enhancement to the benefit package of any small employer of up to 100 eligible employees, and it can bring a company's benefit package into the big leagues at a very small cost to the business. The SIMPLE can also be a very effective tool for attracting and retaining key employees in a competitive labor market. Surveys show that a pension plan is the second-most-requested employee benefit after group medical insurance.

Why do employers choose SIMPLE IRAs?

There are many aspects of a SIMPLE IRA that make it attractive to small businesses. There are no initial set-up costs for a SIMPLE IRA and no ongoing administration fees for the business. Participants will normally pay a $10-$25 per year custodial fee for each account. There is no requirement to file with the Internal Revenue Service. The business is simply required to maintain the plan document in an inspection-ready file, if requested by an audit.

A SIMPLE IRA is available to sole proprietors, partnerships, and corporations; the owners, partners, or corporate officers may participate. There are neither top-heavy limitations nor discrimination testing. There are no participation requirements under the SIMPLE IRA. The business can allow employees to be eligible immediately upon hire for a SIMPLE IRA, or they can impose a maximum qualification period of $5000 in earnings over a period of two years (with the expectation of earning at least $5000 in the current year).

The qualifications can change from year to year; however, those hired under one set of qualifications remain under those rules even if the qualifications are later altered. The maximum salary deferral is $6000 per employee. There are penalties for early withdrawals during the first two years of the SIMPLE IRA's establishment. A 25% penalty applies for two years, then it drops to 10% until age 59½. In addition, a rollover from a SIMPLE IRA into a Traditional IRA cannot be made for two years. If both a husband and wife work in the business and both receive separate paychecks, then both can contribute to a SIMPLE IRA. In addition to the $6000 salary deferral, the business will match the employee contribution under one of three formulas:

  • match of the employee contribution up to 3% of salary up to a maximum salary of $200,000;

  • match up to 3%; however, the business can elect to drop the matching contribution down to 1% in two out of any five years; or

  • flat 2% contribution on every eligible employee up to a maximum salary of $150,000.

All matching contributions are tax-deductible to the business, which further decreases the net cost of implementing a SIMPLE IRA. All contributions are vested immediately.


Who uses SIMPLE IRAs? A SIMPLE IRA is ideal for any business that wants a pension but has difficulty in getting employees to participate. With no participation requirements, a business with 50 employees can still have a SIMPLE IRA even if only five out of 50 participate. So with no top-heavy testing, the contributions made by the owners or highly-compensated individuals will not be affected by the contributions (or lack thereof) by employees. The SIMPLE IRA is also ideal for any business with no pension that is concerned about the cost of the employee-matching contributions. In the first two years, the business can start out at a 1% match and use the 3% match for years three through five. On a $1,000,000 payroll, the maximum liability to the business in years one and two is only $10,000 (assuming everyone in the company participates). At a 50% participation rate, the cost reduces to $5000. This cost might even be less than their group dental insurance!

There is not the percentage-of-salary contribution limitation under the SIMPLE IRA that there is with a SEP or 401(k). Any employee, including the owner, can defer up to 100% of income into the SIMPLE IRA, as long as they do not exceed the $6000 per year maximum. This is ideal for business owners who generate a large portion of their income from profits or distributions rather than a fixed salary. NOTE: A business cannot maintain any other qualified plans in conjunction with the SIMPLE IRA. In addition, any business that maintains a 401(k) may not roll out of the 401(k) for twelve months after establishing a SIMPLE IRA and must freeze contributions to the 401(k). If any contributions have been made to the 401(k) for the current year, a SIMPLE IRA cannot be implemented until the following year.

Employees retain control over their accounts. Individuals who participate in a SIMPLE IRA are also eligible to contribute an annual maximum of $2000 into the new Roth IRA as of 1998. Each employee retains control over his/her own account and can take it with them if they leave the employment of their company. There is no need for the employer to make a special disbursement when an employee terminates. An employer can choose between a 4304 or 4305 SIMPLE IRA. A 4304 allows each employee to designate a financial institution of their choosing, while a 4305 allows the employer to restrict the contributions to one designated financial institution. Either way, there is a wide variety of funding options available.

These funding options include mutual fund companies, banks, and insurance companies. While it is generally agreed that there is no fiduciary responsibility to the employer, participants in a SIMPLE IRA should be given adequate investment choices and should be properly educated on those choices. The employee retains control of the account at all times. The employer does have the responsibility to remit payroll deductions no later than 30 days following the month of deferral. The employer match is not due until the tax-filing date of the business, plus any extensions. However, the matching contributions can be remitted sooner if the employer so desires.

Contact us to find out more about the SIMPLE. Our registered representatives are here to help you identify and achieve your financial goals.

 

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