A SIMPLE Solution for Company Retirement Plans
Business owners who wish to sponsor a retirement plan have many options from which to choose. The choices include 401(k), profit sharing, defined benefit, and simplified employee pension (SEP) plans. In some situations, yet another arrangement might work best: a SIMPLE (savings incentive match plan for employees) individual retirement account (IRA).
Keeping it simple
SIMPLE IRAs offer several benefits:
• As the name indicates, these plans require little paperwork, so they may be relatively easy to administer.
• SIMPLE IRAs have modest requirements for employer contributions.
The catch? The maximum SIMPLE IRA contributions are modest as well. In 2011, total contributions to any individual’s account cannot exceed $28,000, as explained later in this article. Other types of employer-sponsored retirement permit total contributions to reach six figures in some situations.
Strictly for small companies
To establish a SIMPLE IRA, your company must have 100 or fewer employees. An employee, for this purpose, is someone who earned at least $5,000 in compensation during any two preceding years and is reasonably expected to earn at least $5,000 in compensation during the current calendar year. Also, your company can’t have a SIMPLE plan if it already has a qualified retirement plan.
If your company qualifies, it can use IRS Form 5304-SIMPLE or Form 5305-SIMPLE to create the plan. The company also must set up an IRA account for each employee. The only other requirement is annual notification. You can fulfill this obligation by sending each employee a copy of the Form 5304-SIMPLE or Form 5305-SIMPLE your company used to set up the plan.
Once the plan is in place, each employee can defer as much as 100% of his or her annual pay, up to specified annual limits. In 2011, the cap is $11,500, plus a “catch up” contribution up to $2,500 for SIMPLE IRA participants who are over age 50 by year end. Thus, the maximum salary deferral is $14,000 in 2011.
In addition, the company can choose to match employee contributions, up to 3% of the employee’s compensation for the calendar year. Compared to the complex rules that apply to 401(k) plans, the rules for SIMPLE plans are, well, simple. If an employer chooses to match contributions, the matches are required for all employees, so business owners and key employees can maximize their contributions even if other employees contribute little or nothing. For example, a 50+ business owner whose pay is at least $466,667 can get the maximum $14,000 match (3% of $466,667) and put a total of $28,000 into his or her SIMPLE IRA this year.
As an alternative to making matching contributions, the employer can choose to make nonelective contributions of 2% of the income of each eligible employee that earns $5,000 (or a lesser amount if the employer selects) of compensation for the calendar year.
With most retirement plans, participants generally owe a 10% penalty for withdrawals before age 59½. With SIMPLE IRAs, participants owe a 25% penalty for such early withdrawals in the first two years they are in the plan. Subsequently, they’ll owe the regular 10% penalty. During those first two years, no one can roll over a SIMPLE IRA account to a traditional IRA. Such rollovers are permitted once this period expires.
Living with the limits
If those are the basic rules, which companies should consider SIMPLE IRAs? These plans may work best for companies where the owners and other key employees are satisfied with maximum contributions of $23,000 or—for those 50 and older—$28,000 per year. In addition, SIMPLE IRAs may be ideal for companies that have few employees, especially if those employees are likely to make minimal SIMPLE IRA contributions. The smaller the total amount of employee salary deferrals, the less money your company will have to provide as an employer’s match. Our office can help you go over the numbers if you are interested in setting up a SIMPLE IRA. Your company generally must establish a SIMPLE IRA by October 1 in order to have the plan in effect for the current year.