A SIMPLE IRA plan is a Savings Incentive Match Plan for Employees. It gives small employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes required matching or nonelective contributions. All contributions are made directly to an IRA set up for each employee (a SIMPLE-IRA).
- Available to any small business – generally with 100 or fewer employees
- Employer cannot sponsor any other retirement plan
- Employees are always 100% vested in all SIMPLE IRA money
- The employer is required to contribute either (A) a dollar-for-dollar matching contribution up to 3% of total compensation or (B) nonelective contribution for all eligible employees – regardless of whether they make deferral contributions –- equal to 2% of compensation up to the annual compensation limit
- Employees may elect to contribute
- You may be eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting a SIMPLE IRA plan.
- A SIMPLE IRA plan account is an IRA and follows the same investment, distribution and rollover rules as traditional IRAs. A SIMPLE IRA can’t be a Roth IRA.
SIMPLE-IRA Detailed Overview
Any employer (including self-employed individuals, tax-exempt organizations and governmental entities) that meets the following requirements is eligible to establish a SIMPLE IRA plan:
- The employer employed 100 or fewer employees who earned at least $5,000 during the preceding year. All employees employed at any time during the calendar year are counted regardless of whether they are eligible to participate in the SIMPLE IRA plan.
- The employer maintains no other plans
The SIMPLE IRA allows eligible employees to contribute part of their pretax compensation to the plan. This means the income tax on the money is deferred until it is distributed. This contribution is called an elective-deferral or salary-reduction contribution.
SIMPLE-IRA Employee Eligibility Requirements
Employees who received at least $5,000 in compensation during any 2 years prior to the current calendar year and who are reasonably expected to receive at least $5,000 during the current calendar year must be treated as eligible to participate.
Timing for SIMPLE-IRA Plan Set-Up
If an employer did not previously maintain a SIMPLE IRA plan, it can set up a SIMPLE IRA plan effective on any date from January 1 through October 1 of a year. This requirement does not apply if you are a new employer that comes into existence after October 1 of the year the SIMPLE IRA plan is set up and you set up a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence.
If an employer previously maintained a SIMPLE IRA plan, it can set up a SIMPLE IRA plan effective only on January 1 of a year.
A SIMPLE IRA plan cannot have an effective date that is before the date the plan is actually adopted.
Timing for SIMPLE-IRA Individual Employee Account Set-Up
A SIMPLE IRA must be set up for an employee before the first date by which a contribution is required to be deposited into the employee’s IRA.
SIMPLE-IRA Employee Contributions
Employees can make salary reduction contributions in any amount to a SIMPLE IRA plan up to the legal limits. The maximum amount that an employee can contribute is $12,500 for 2016 and 2017. Additional employee contributions (catch-up contributions) are allowed for employees age 50 or over. The additional contribution limit is $3,000 for 2016 and 2017.
If an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the annual salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $18,000 for 2016 and 2017.
Each year, employees can change their contribution levels during the plan’s election period. This election period must be at least 60 days long, and employees must receive prior notice about an upcoming election opportunity. SIMPLE IRA plans that have already been established must have an annual election period that extends from November 2 to December 31. A plan can have more election periods each year in addition to this 60-day election period.
Employees may elect to terminate their salary reduction contributions to a SIMPLE IRA plan at any time.
The Tax Law governing SIMPLE-IRAs requires employers to deposit employees’ salary reduction contributions to a SIMPLE IRA no later than 30 days after the end of the month in which the amounts would otherwise have been payable to the employee in cash. Plans that benefit employees other than owner-employees (and spouses) are subject to Department of Labor rules that require employees’ elective deferral contributions to their SIMPLE IRAs be deposited at the earliest date on which the employer can reasonably segregate the contributions from the employer’s general assets. The DOL provides a 7-day safe harbor to deposit elective deferrals for which most SIMPLE IRA plans qualify.
SIMPLE-IRA Employer Contributions
Employers have two choices in determining their contributions to a SIMPLE IRA plan:
- A dollar-for-dollar match up to 3% of compensation, in which case only employees who make salary deferral contributions receive employer matching contributions.
- A 2% non-elective employer contribution, in which case where all eligible employees receive an employer contribution equal to 2 percent of compensation, regardless of whether they make their own contributions. Only $270,000 of the employee’s compensation can be taken into account to figure the contribution limit in 2017 ($265,000 in 2016).
An employer may select a matching contribution that is less than 3%, but the percentage must be at least 1% and cannot be used for more than 2 years during the 5-year period that ends with (and includes) the year for which the choice is effective.
Each year, the employer can choose which method it will use for the next year’s contributions. This choice is part of the information that must be communicated to employees before the beginning of the 60-day election period.
Employer contributions must be made by the due date – including extensions – for filing the business’s Federal income tax return for the year.
Tax Treatment of SIMPLE-IRA Contributions
Employee salary reduction contributions are not subject to income tax withholding, but are subject to social security, Medicare, and unemployment taxes (FICA, FUTA, SUTA).
Employer matching or nonelective contributions are tax-deductible to the employer and are not subject to FICA and FUTA taxes.
Establishing and Operating a SIMPLE-IRA
Step 1: Establish the Plan
Complete and sign IRS Form 5304-SIMPLE, IRS 5305-SIMPLE, a SIMPLE prototype, or individually designed SIMPLE plan document. When it is completed and signed, this document becomes the plan’s basic legal document, describing your employees’ rights and benefits.
- IRS Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – Not for Use with a Designated Financial Institution: Used if employees are allowed to select the financial institutions that will receive their SIMPLE IRA plan contributions.
- IRS Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – for Use with a Designated Financial Institution: Used if you require that all contributions under the SIMPLE IRA plan be initially deposited with a designated financial institution.
Step 2: Communicate the Plan
There are two key disclosure documents that keep participants informed about the basics of how the plan operates, inform them of changes in the plan’s structure and operation, and provide them a chance to make decisions and take timely action about their accounts.
- Summary Description: A plain-language explanation of the plan and is comprehensive enough to inform participants of their rights and responsibilities under the plan. It also informs participants about the features of the plan.
- Annual Election Notice: Provided annually and describes their right to make salary reduction contributions and the employer decision to make either matching or nonelective contributions for the following year.
SIMPLE IRA Rollovers, Transfers, and Distributions
During the first 2 years of participation in a SIMPLE IRA retirement plan, assets may be rolled-over only to and from another SIMPLE-IRA account. Rollovers to other types of accounts are treated as distributions and are subject to income tax and a possible 25% penalty. After 2 years of participation, SIMPLE-IRA assets may be rolled-over to-and-from Qualified Retirement Plans and IRAs.
The 2-year period begins on the first day on which the employer deposits contributions in the SIMPLE IRA individual account.
Distributions during the first 2 years of participation in a SIMPLE IRA retirement plan, if treated as an early withdrawal, are subject to a 25% penalty.
SIMPLE-IRA Required Minimum Distributions (RMDs)
A specific minimum amount of SIMPLE IRA contributions and earnings are required to be distributed by April 1 of the year following the year the participant reaches age 70½. After this initial RMD, the participant must receive a required minimum distribution for each year by December 31 of that year.