SIMPLE IRAs are up next as we continue the series exploring three different types of retirement plans ideal for small business owners and the self-employed. Yesterday, we started the series with an in-depth look at the SEP-IRA.
SIMPLE IRA Overview
SIMPLE stands for Savings Incentive Match Plan for Employees. SIMPLEs were established to encourage small businesses to open retirement plans without the expense of maintaining a qualified plan.
Only businesses with less than 100 employees are eligible to establish a SIMPLE. A SIMPLE can actually use an IRA or a 401(k) to “hold” the contributions, but we are focusing only on the SIMPLE IRA since the 401(k) is rarely used. SIMPLE IRAs are easy to establish, have no annual filing requirements, and relatively few administrative expenses.
SIMPLE IRA Basics
- Coverage: SIMPLE IRAs must cover all employees who either made $5,000 in two preceding calendar years or are expected to make $5,000 in the current calendar year.
- Contributors: SIMPLE IRAs are funded by both employees and employers. Employees contribute by deferring a certain percentage of their income. Employers can choose to either match employee contributions or contribute to all eligible employees, regardless of participation. Employers who match contributions must generally match 100% of contributions up to 3% of employee compensation, with some exceptions. Alternatively, employers can contribute 2% of compensation to all eligible employees.
- Contribution limits: During 2009-2012, the maximum SIMPLE IRA contribution per employee is $11,500 per year, including the employer match. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $2,500. The catch-up amount is reduced by catch-up contributions to a 401(k), SEP-IRA, or 403(b).
- Deadlines: Employers must establish SIMPLE IRA plans by October 1 of the calendar year that employees can first contribute. Employer contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. Note that this only applies to the employer match portion. The employer must forward compensation deferred by employees no later than 30 days after the end of the month in which it was deferred (e.g., April 30 for March contributions).
- Taxation: Both employer and employee contributions to a SIMPLE IRA are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
- Vesting: There is no vesting period for SIMPLE IRA contributions. An employee has access to 100% of the contributions as soon as they are made.
- Withdrawals: SIMPLE IRA withdrawal rules are the same as those for traditional IRAs. Employees can withdraw at all times, including while they are employed. Withdrawals will be subject to ordinary income tax regardless of age or reason for withdrawal. In addition, SIMPLE IRA withdrawals will be subject to a 10% penalty if the account owner is younger than 59½. Some exceptions to the 10% penalty apply. If it is applicable, the 10% penalty increases to 25% if withdrawals are made within the first two years of participating in the SIMPLE IRA.
- Employers who maintain SIMPLE IRAs cannot maintain any other type of retirement/deferred compensation plan.
- SIMPLE IRAs can be rolled over to other SIMPLE IRA accounts for the first two years of plan participation without tax or penalty. After two years, you can do a tax- and penalty-free rollover into an IRA, qualified plan, 403(b), or 457.
- Airline pilots, nonresident aliens, and union employees who have separate retirement agreements can be excluded from the coverage requirements noted in the “Coverage” section above.
Establishing a SIMPLE IRA
To establish a SIMPLE IRA, an employer must only file a Form 5304 SIMPLE or a Form 5305 SIMPLE. The first is for employers who allow participants to select an institution to hold their SIMPLE IRAs, while the second allows the employer to select the institution for all employees. Any financial institution that offers traditional IRAs should be able to set up SIMPLE IRAs.
SIMPLE IRA Pros
The biggest advantage of a SIMPLE is that it allows both employers and employees to save in a manner similar to a qualified plan without extensive set-up or administrative fees.
SIMPLE IRA Cons
Because a SIMPLE IRA requires contributions to all employees, it is not a good plan for someone with employees who only wants to beef up his or her own retirement savings. The SIMPLE IRA has a lower contribution limit than any other retirement plan. If your small business is the sole source of your income and you make more than a few thousand dollars, a SIMPLE IRA will severely limit your ability for tax advantaged retirement savings.