SIMPLE IRA Basics

A relative newcomer to the retirement plan market, the SIMPLE plan can be a cost-effective retirement planning alternative for small employers and their employees.

A SIMPLE plan consists of a deferral program for eligible employees, along with a matching contribution by employers. An eligible employer is defined as an employer that has no more than 100 employees that received at least $5,000 in compensation from the employer in the preceding calendar year. And an employer maintaining a SIMPLE plan may not maintain any other qualified retirement plan in which employees currently receive benefits.

Employers may either establish a SIMPLE 401(k) plan in which contributions are made into a trust account, or SIMPLE IRA retirement accounts, in which contributions are made into IRA accounts. While the two types of plan arrangements are similar with regard to contributions, the SIMPLE 401(k) plan places considerably more burden for reporting and disclosure on both the employer and the custodian of the plan assets. For this reason, many employers favor the SIMPLE IRA plan.

Employees are eligible to make deferrals if they receive at least $5,000 in compensation from their employer during any two preceding years and they are reasonably expected to receive at least $5,000 in compensation for the current year. For 2006 for SIMPLE IRA plans they can defer up to $10,000 ($12,500 with catch-up contributions) with no limit as to percentage of compensation, and must elect to defer a specified percentage of compensation as opposed to a dollar amount. For SIMPLE 401(k) Plans the contribution limits for 2007 are $15,500 and $20,500 with catch-up contributions.

The employer is required to make a fully vested contribution by either:

• Matching elective deferrals dollar-for-dollar up to three percent or
• Making a two-percent contribution to all eligible employees, regardless of elective salary deferral, who received $5,000 in compensation from the employer in that year.

Employees are allowed to terminate deferrals at any time during the year. But be mindful that participants who take withdrawals from a SIMPLE plan prior to age 59 ½ are generally subject to the same 10% early withdrawal penalty applicable to IRAs. Moreover, participants who withdraw SIMPLE plan contributions during the two-year period beginning on their initial participation date will be assessed a 25% penalty tax.

A SIMPLE plan distribution may be rolled over to a regular IRA account, but only after the employee has participated in a SIMPLE plan for at least two years.

Features

• For companies with fewer than 100 eligible employees.
• Funded by employee salary deferrals.
• Employer generally matches up to 3% of each participant's compensation.
• Matching contributions are immediately 100% vested.
• Elective Salary deferrals are not subject to non-discrimination tests.

Tax Benefits

• Salary deferrals reduce employee's current taxable income.
• Employer contributions are 100% tax deductible.
• Earnings compound tax deferred.
• Distributions are taxed under IRA rules.

Maximum Annual Contributions¹

• For 2006, annual contribution limits for participants under age 50, are $10,000.
  

  Retirement Plan Contribution Limits

  
  
  


• Employer must match deferrals dollar for dollar up to 3% (match) of compensation (can be lowered to 1% in two out of five years), OR employer can make a 2% (non-elective) of compensation contribution for each eligible employee.
• Participants who are 50 years or older, can take advantage of additional catch-up deferrals to their SIMPLE IRA plans.

¹Contribution limits were established by the Economic Growth and Tax Relief Reconciliation Act of 2001 (click here) . Several states have not yet passed legislation to conform their income tax laws with the provisions of the Act, including the increases in benefit and contribution limits. In order to determine whether your state has adopted conforming laws, you should consult us or your tax or financial advisor.

Deadline to Set Up/Contribute

• All eligible employees must receive a 60-day notice explaining the new plan's benefits.
• Deposits of salary deferrals must be made no later than the 30th day after the month in which the deferral took place. This is an absolute deadline, not a safe harbor.
• Employer contributions must be made by the employer's tax filing deadline, plus extensions.
• Deadline for start-up plans is October 1. Employees must have 60-day election period prior to January 1 (or the first day they are eligible) in which they can modify elections.

Distributions

Distributions are not subject to a 10% federal tax penalty if the individual:

• receives the distribution after age 59 1/2;
• uses the distribution (up to $10,000) to purchase a first-time home;
• uses the distribution for qualified education expenses;
• takes lifetime equal periodic payments;
• uses the distribution for health insurance during unemployment lasting at least 12 weeks; or
• uses the distribution for deductible medical expenses.
• becomes permanently disabled; or
• dies.

All other distributions before age 59 1/2 are subject to a 10% tax penalty and federal income tax.
Required distributions must begin no later than April 1 following the year in which the participant reaches age 70 1/2.

This article is meant to provide an overview of the basic provisions of the SIMPLE plan. For a more complete understanding of these plans and potential implications for your business, speak with your Financial Advisor.