September 2, 2010
Continuing with more detailed descriptions from my Small Business Retirement Plans Quick List, the next plan I wanted to detail was the Savings Incentive Match Plan for Employees, or as it is more commonly known, the SIMPLE IRA. Just as the name suggests, it is a Simplified plan. Here I will discuss the SIMPLE IRA from the employer and the employee perspectives highlighting the pros and cons of each.
What is a SIMPLE IRA and How Does it Work?
In order to have a SIMPLE IRA plan, you must be a small business – generally, you must have 100 or fewer employees. However, there is a 2-year grace period for growing employers to still be considered a small business even if they go over the 100-employee limit. If you do opt for a SIMPLE IRA plan, your employees can elect to defer part of their salary. Each employee is immediately 100% vested in (or “owns”) all contributions to his or her SIMPLE IRA.
A SIMPLE IRA plan is a Savings Incentive Match Plan for Employees. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SIMPLE IRA plan, employees and employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self-employed individuals), subject to certain limits. It is ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a retirement plan.
Employers MUST make contributions, however employees can if they would like.
Setting Up a Simple IRA
The process behind establishing a SIMPLE IRA is incredibly easy. It only requires a couple of forms to get it up and running. A SIMPLE IRA can only be established if you have fewer than 100 employees and no other current retirement plan available.
Step 1: Contact a retirement plan professional or a representative of a financial institution that offers retirement plans. Many financial institutions will probably have a pre-approved SIMPLE IRA plan form that you can review.
Step 2: Choosing a financial institution to maintain employees’ SIMPLE IRAs is one of the most important decisions you will make, since that entity becomes a trustee to the plan. (Alternatively, you can decide to let employees choose the financial institution that will receive their contributions.)
Regardless of who makes the choice, only the following institutions can be designated as trustees of SIMPLE IRA plans: banks, mutual funds, insurance companies that issue annuity contracts, and certain other financial institutions that have been approved by the IRS.
Trustees agree to:
a) Receive and invest contributions, and
b) Provide the employer with a summary description of the plan features each year.
Step 3: Choose a model form or other plan document offered by your financial institution. If your financial institution offers a model SIMPLE IRA plan document, you will have a choice of two forms to use:
a) IRS Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – Not for Use With a Designated Financial Institution; or
b) IRS Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – for Use With a Designated Financial Institution.
The model form you use will depend on whether you decide to select the financial institution that will receive contributions or to let your employees select financial institutions.
c) If employees are allowed to select the financial institutions that will receive their SIMPLE IRA plan contributions, you will fill out Form 5304-SIMPLE.
d) If you require that all contributions under the SIMPLE IRA plan be initially deposited with a designated financial institution, you will fill out Form 5305-SIMPLE.
Your choice of the employees covered will be set out in your selected plan document. You can choose to cover all employees without restriction. Alternatively, you can limit the employees covered to those 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.
Step 4: Complete and sign the selected IRS form (or other plan document, if not using a model form). When it is completed and signed, this document becomes the plan’s basic legal document, describing your employees’ rights and benefits. Do not send it to the IRS; instead keep it handy.
Employee Eligibility for a SIMPLE IRA
Eligibility for a SIMPLE IRA is any employee who has made $5,000 or more in the previous 2 years, and who is expected to earn at least $5,000 this year.
SIMPLE IRA Contribution Limits
Employee – $10,500 in 2007 and 2008. If the employee is age 50 or over, a “catch-up” contribution is also allowed. This additional catch-up contribution amount is: 2007 and 2008 – $2,500.
Employer – Generally, a dollar-for-dollar match up to 3% of pay or a 2% non-elective contribution for each eligible employee.
SIMPLE IRA Filing Requirements
An employer generally has no filing requirements. The annual reporting required for qualified plans (Form 5500 series) is not required for SIMPLE IRA plans. The financial institution that holds the SIMPLE IRAs for the plan handles most of the other paperwork.
SIMPLE IRA Withdrawals:
Permitted, but withdrawals are included in income and are subject to a 10% additional tax if the participant is under age 59-1/2. Also, if withdrawals are made within the first two years of participation, the 10% additional tax is increased to 25%.
SIMPLE IRA Pros and Cons
SIMPLE IRA Pros and Cons
Pros:
1. Easy to set up and run – usually just a phone call to a financial institution gets things started.
2. Administrative costs are low.
3. Employees can contribute, on a tax-deferred basis, through convenient payroll deductions.
4. You can choose either to match the employee contributions of those who decide to participate or to contribute a fixed percentage of all eligible employees’ pay.
Cons:
1. Employers MUST contribute to the plan regardless of whether and employee contributes or not.
2. Contributions are not flexible.
3. Contribution limits are lower than other retirement plans.
Overall this plan is really more of a benefit to the employee than the employer, or small business owner. Though it is a nice incentive to maintain employees, it is fairly skewed into the employee’s favor. This plan is something I would typically use if you have some employees that are with you for many years. People you just want to reward for their service and dedication to your business since you are required to contribute every year regardless.
If you are considering a SIMPLE IRA, the IRS has put together a nice little SIMPLE IRA Checklist that will help you in determining if the play is right for you.
Filed under Financial Planning, Retirement Planning, Small Business Financial Planning