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.