There's a new type of retirement plan that's available for small businesses
if they don't maintain any other retirement plan and have no more than 100 employees
- the SIMPLE. That's short for Savings Incentive Match Plan for Employees.
A SIMPLE plan can be in the form of an IRA or 401(k) plan.
Simple Plan Features
The most important features of SIMPLE plans are as follows:
- Non-discrimination rules that apply to other retirement plans do not
apply to SIMPLE plans.
- There's no requirement that a minimum number of employees elect to participate.
Thus, the plan can be set up and an employer can make contributions even
if no employees choose to participate.
- Self-employed persons can participate in a SIMPLE plan.
- There are simplified reporting requirements.
- Contributions must be fully vested immediately.
- Contributions are mandatory despite fluctuations in profits.
- Employees may make elective contributions expressed as a percentage of
compensation and not as a fixed dollar amount, up to a maximum of $6,000
- All employees earning at least $5,000 per year must be eligible to participate
in the plan.
Employees may make elective contributions of up to $6,000 per year. Employers
must make matching or fixed contributions (even in years when the business
has no profits) in accordance with the following formula:
Matching formula. Under the matching formula an employer is required to match
an employee's elective contribution on a dollar-for-dollar basis, up to a
maximum of 3% of an employee's compensation.
The maximum employer contributions under the matching formula is different
for SIMPLE-IRAs and SIMPLE-401(k) plans because each type of plan uses different
maximum employment compensation amounts to figure the maximum matching amount.
For SIMPLE-IRAs maximum employer contribution under the match formula is
$6,000 (3% x $200,000 compensation).
For SIMPLE-401(k)s maximum employer contribution under the match formula
is $3,200 (2% x $160,000 compensation).
LOOPHOLE. SIMPLE-IRA type plans allow
an option to drop contributions to as low as 1% of compensation in up to 2
years in any 5 year period. This option is not available in 401(k) type SIMPLE
Fixed contribution formula. In lieu of matching employees' contributions, an
employer can choose to make a fixed contribution of 2% of the compensation of
each eligible employee (regardless of whether the employees put any of their
own money in the plan).
Under the fixed contribution formula the maximum compensation per employee
is limited to $160,000, thus, limiting an employer's contribution, under both
SIMPLE-IRAs and SIMPLE-401(k)s, for an employee to no more than $3,200 per
year ($160,000 x 3% = $3,200).
TAX TREATMENT OF SIMPLE ACCOUNTS
1. Contributions. Employee and employer contributions to a SIMPLE account
are excluded from the employee's income and are not subject to income tax
withholding. However, the employee's (but not the employer's) contributions
are subject to Social Security tax.
The employer's matching (or fixed) contributions are deductible as long as
they are contributed to the employee's SIMPLE account by the due date for
the employer's tax return. Employer's must deposit the employees' elective
contributions to the SIMPLE account within 30 days after the end of the month
in which they are deducted from the employees' pay.
2. SIMPLE accounts. SIMPLE accounts themselves, like IRAs, are not subject
to tax. All earnings accumulate tax-free.
3. Distributions. Distributions from SIMPLE accounts are taxed in the same
manner as distributions from IRAs. They are subject to tax at ordinary income
tax rates as received.
CAUTION - TAX TRAP. There's a 25% penalty tax, in addition to the regular
income tax, if an employee withdraws the money within the first two years
of plan participation.
Early withdrawals, before age 59 1/2, after the two year period, are subject
to a 10% penalty.
LOOPHOLE. SIMPLE plan money can be
rolled over tax-free to a qualified employer pension plan.