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The SIMPLE IRA
Retirement plan solutions for small businesses
The Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRA was introduced as a new type of retirement plan in the Small Business Job Act of 1996, effective in 1997. Any type of business entity, including self-employed persons, partnerships or corporations, as well as certain tax-exempt organizations, can establish a SIMPLE IRA plan for its employees.
A SIMPLE IRA plan allows an employer to provide a benefit to its employees by helping them accumulate assets for their retirement. The plan is funded by both employee elective salary deferral contributions and contributions made by the employer. A SIMPLE IRA is a low-cost alternative for employers who view 401(k) administrative costs as prohibitive, but still want to offer some type of retirement savings plan to their employees. Both employee and employer SIMPLE IRA contributions are tax-deductible. Since the contributions are made to an IRA, the earnings inside the account are tax-deferred until they are withdrawn. Each employee can specify the percentage of pay he or she wants the employer to withhold and contribute to the plan. The maximum amount employees may defer each year is limited to $10,000 (indexed). In addition, the Economic Growth and Tax Relief Act of 2001 permits catch-up provisions for participants of SIMPLE IRA plans age 50 and older to contribute an additional $2,500.
The employer is required to make a fully vested contribution using one of the following formulas.
- Match elective deferrals dollar-for-dollar up to 3% of the participant’s compensation (compensation includes employee deferrals).
- Make a 2% contribution to all eligible employees, regardless of elective salary deferral, who received $5,000 in compensation from the employer in that year.
Simple Comparison Chart
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401(k) Plan |
401(k) Safe Harbor Plan |
SIMPLE IRA Plan |
Employee contribution limits |
Employees may defer up to $15,000 (indexed for 2006). Total of employee and business contributions for an individual is limited to 100% of compensation up to $44,000. $5,000 catch-up contribution. |
Elective salary deferral limit of $15,000 (indexed for 2006). Overall individual limit (deferrals and all business contributions) is limited to 100% of compensation up to $44,000. $5,000 catch-up contribution. |
Employees may defer a percentage of their compensation up to $10,000 (indexed for 2006). The mandatory business contribution described above will be in addition to the employee deferral limitation. $2,000 catch-up contribution. |
Employer contributions |
Profit sharing contributions and/or business matches are discretionary unless a 3% top-heavy minimum is required. Employee is limited to 25% of eligible payroll for the business contribution. |
Mandatory business contribution of either 3% non-elective to all eligible employees or a dollar-for-dollar match for the first 3% of compensation and $.50 on the dollar match on the next 2% of compensation. Business contribution limit is 25% of eligible payroll. |
Mandatory business contribution of either: 1) 100% match on the first 3% deferred (match may be reduced to 1% in two out of five years) or 2) a 2% non-elective contribution on behalf of all eligible employees. No additional business contribution may be made. |
Eligibility |
Employees age 21 or older with one year of service must be eligible. An employer may provide for more liberal eligibility requirements. |
Employees age 21 or older with one year of service must be eligible. An employer may provide for more liberal eligibility requirements.
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Any employee who earned at least $5,000 in any two preceding years and is expected to earn $5,000 in the current year is eligible to participate (more liberal eligibility requirements may be used). |
Account type |
Qualified plan trust account. |
Qualified plan trust account. |
Each participant has a SIMPLE IRA. |
Vesting |
Employee deferrals are always 100% vested. Employer contributions may be subject to a vesting schedule. |
Employee deferrals and mandatory employer contributions are always 100% vested. Additional employer contributions may be subject to a vesting schedule. |
SIMPLE IRA account balances are 100% vested at all times. |
Size limitation |
No minimum or maximum number of employees required. |
No minimum or maximum number of employees required. |
No more than 100 employees at any time during the preceding year.
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Distribution options |
Distributions are subject to the requirements of the plan, but in general a participant is entitled to a distribution in case of death, disability, termination of service or attainment of normal retirement age. Distributions may be subject to a 10% penalty if the participant is under age 59 1/2. |
Distributions are subject to the requirements of the plan, but in general a participant is entitled to a distribution in case of death, disability, termination of service or attainment of normal retirement age. Distributions may be subject to a 10% penalty if the participant is under age 59 1/2. |
Distributions are always available. Any distribution made to a participant under age 59 1/2 during the two-year period beginning with the employee’s initial participation date will be subject to a 25% premature penalty. Any distribution
prior to age 59 1/2 after the initial two-year period will be subject to a 10% penalty. |
Top-heavy/ non-discrimination testing |
Top-heavy rules apply. Average Deferral Percentage (ADP) and Average Contribution Percentage (ACP) tests are required. |
Top-heavy rules apply, however, the 3% non-elective contribution satisfies the required top-heavy contribution. Average Deferral Percentage (ADP) and Average Contribution Percentage (ACP) tests are not required if the employer makes
appropriate contribution described above. |
None. |
Combination of plans |
An employer may sponsor other qualified plans in conjunction with the 401(k). |
An employer may sponsor other qualified plans in conjunction with the 401(k). |
An employer may not sponsor any other retirement plan in conjunction with a SIMPLE plan. |
Reporting |
Form 5500 is required to be filed. |
Form 5500 is required to be filed. |
Form 5500 is not required to be filed. |
SIMPLE IRA Plan Investments
There are two basic investment formats for the SIMPLE IRA, a self-directed IRA and a vendor’s product. It is important for employers and employees to understand the advantages and disadvantages of each alternative before implementing or modifying their SIMPLE IRA plans.
Raymond James Self-Directed SIMPLE IRA
A self-directed IRA provides the flexibility to invest in almost the entire spectrum of investment alternatives, including individual stocks, bonds and independent money managers.
Vendor’s Product
This would include the investment alternatives offered by mutual fund and insurance companies, within a SIMPLE IRA “package.” Investment choices are limited to those funds available in the package. While the investment flexibility may be limited in comparison to the self-directed IRA alternative, the investing process is much more streamlined, resulting in lower custodial and service delivery costs to the participant. For someone investing small amounts on a periodic or payroll-deducted basis, a vendor’s product will be much less expensive and a more efficient way to invest.
Which format is best?
The answer to this question depends on two factors:
- The specific objectives of each individual employee and
- How the contributions are received by the custodian or depository.
It is inefficient and costly to invest small periodic amounts into anything other than a packaged product designed to accept such deposits. The self-directed IRA makes sense for rollovers or lump-sum deposits, such as bonus deferrals. Employers should consult with their financial advisor to determine which is best for their particular situation.
Establishing a SIMPLE IRA Plan
Setup and Administration
SIMPLE IRA plans are easy to set up and administer. To establish a SIMPLE IRA plan, the employer must sign an adoption agreement, which defines the plan provisions. All eligible employees complete and sign elective deferral agreements indicating the percentage of pay they wish to contribute. SIMPLE IRAs are then established to receive the contributions.
Listed below are several rules that an employer should consider before establishing a SIMPLE IRA plan:
- I An employer maintaining a SIMPLE IRA plan may not maintain any other qualified retirement plan in which employees currently receive benefits.
- An employer may not have more than 100 employees who received at least $5,000 in compensation from the employer in the preceding calendar year.
- The employer must allow employees to make deferral elections or modify previous elections within a
60-day period preceding an upcoming plan year. A plan year, for purposes of a SIMPLE plan, is a
calendar year.
Eligibility
Not all employees must be covered under a SIMPLE IRA plan. The employer may exclude any employees who have not earned at least $5,000 during any two preceding years and are not expected to earn at least $5,000 in the current year.
Other Considerations
Employees who participate in a SIMPLE plan are considered active participants for purposes of determining the deductibility of a regular IRA contribution. An employee must elect to defer a specified percentage of compensation as opposed to a dollar amount.
Participants who take withdrawals from a SIMPLE plan prior to age 59 1/2 are generally subject to the same 10% early withdrawal penalty applicable to IRAs. However, participants who withdraw SIMPLE plan contributions during the two-year period beginning on their initial participation date will be assessed a 25% penalty tax instead of the 10% tax.
For more information on the SIMPLE IRA, please consult your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.
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