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A SIMPLE Kind of Plan

The SIMPLE Plan is a type of retirement account for small businesses that is simpler (ah hah!) to administer and more portable than the 401(k) plans that are more appopriate for larger businesses.  SIMPLE is an acronym (probably a backronym, more likely) which stands for Savings Incentive Match PLan for Employees.

200px-lynyrdskynyrdA SIMPLE Plan can be either a part of a 401(k) plan, or using IRAs – and what we’ll cover is primarily the IRA-type of SIMPLE plan.  The difference is that there are more restrictions on employer activities, and less room for error (as can be the case with 401(k) plans).

A SIMPLE Kind of Plan

Much like a 401(k) plan, a SIMPLE Plan is an agreement between the employer and employee wherein the employee agrees to a salary deferral.  This deferral effectively reduces the employee’s salary (take home pay), and the employer then agrees to contribute the deferred amount into the SIMPLE IRA account on behalf of the employee.  These contributions must be made to a SIMPLE IRA account, not a Traditional IRA.

To be eligible for a SIMPLE Plan, the employee must have received at least $5,000 in compensation during any two years prior to the current tax year, and can reasonably expect to receive at least $5,000 in compensation in the current tax year (calendar year).  For the purposes of the SIMPLE Plan, a self-employed individual would be considered an employee if she received earned income as described.  Also, certain classes of employees can be excluded from participation, such as union members subject to collective bargaining, or nonresident aliens who have received no compensation from US sources.

Types of Contributions

There are three different types of contributions that can be made to a SIMPLE Plan – salary deferrals, employer matches, and nonelective contributions.

Salary Deferrals are much the same as 401(k) salary deferrals.  The employee decides to defer a percentage of his salary, which reduces his taxable and take-home pay, and the deferral is contributed to a SIMPLE IRA on his behalf.

Employer Matches are also similar to the same activity in a 401(k) plan.  The employer elects to match the employee contributions, dollar-for-dollar, up to 3% of the employee’s salary, although this amount can be less.  (see Limits below for additional information)

Nonelective Contributions – in some cases, the employer may decide to make contributions on behalf of ALL eligible employees, rather than only for those that are participating in the SIMPLE Plan.  In this case, the employer has opted for making the Nonelective Contributions instead of Employer Matching Contributions.  These Nonelective Contributions are for 2% of employee salary.

Limits

For Employer Matching contributions, the employer has some leeway in making the contributions for a particular tax year, but there are quite a few restrictions on how this leeway can be applied:

  • as described above, in general the matching contribution must be dollar-for-dollar up to 3% of the employee’s deferral for the year; however –
  • the matching contribution can be reduced to as little as 1% (or any amount between 1% and 3%) for a tax year as long as the amount is not reduced below 3% for more than two out of five tax years (including the current tax year) and the employees are informed in a timely fashion of the reduction in match.
  • the Nonelective Contribution of 2% can be substituted for the Employer Matching Contribution for any given year as long as employees are notified.

Contributions (for 2009) are limited to $10,500 in employee deferrals, plus a catch up provision of $2,500 if the employee is age 50 or older during the tax year.  Employer matches are limited to the amount the employee defers, up to 3%.

Note that SIMPLE deferral is counted toward the overall 401(k) limit ($16,500 for 2009) in deferrals for the tax year.  If an employee is subject to more than one retirement plan, this limit applies to all deferrals for the tax year.

Gallimaufry*

There are a few additional things of interest regarding rollovers and the SIMPLE plan that must be pointed out:

  • You are not allowed to rollover or transfer funds from a Traditional IRA into a SIMPLE IRA.  If this is done by mistake, you can recharacterize those funds back into a Trad IRA (see this article for more information on recharacterizations)  This restriction has been lifted. After you’ve had the SIMPLE IRA open for 2 or more years, you are allowed to rollover other IRA funds into a SIMPLE IRA.
  • In order to rollover amounts from your SIMPLE IRA into a Traditional IRA, the account must have been in existence for at least two years; otherwise your only option for a rollover is into another SIMPLE IRA (which then inherits the earlier SIMPLE IRAs starting date for rollover purposes).
  • The same two-year rule applies to Converting a SIMPLE IRA to a Roth IRA.
  • Early distributions (not subject to any of the exceptions) that occur during the first two years of the account’s existence are subject to a 25% additional penalty (instead of the usual 10% penalty for other IRA accounts).

Other than those restrictions, all of the other distribution rules apply to SIMPLE IRAs that apply to Traditional IRAs:  distributions are taxable as ordinary income; with some exceptions, qualified distributions can not begin until age 59½; rollovers and trustee-to-trustee transfers are allowed as non-taxable events (subject to the two year rule above); conversions to Roth IRAs are allowed without penalty (subject to the two-year rule); and early distributions not subject to exception are subject to an additional 10% penalty (25% in the first two years as described above).

(* a hodgepodge of additional stuff)

Contest for today:  The first person to leave a comment that explains why I used the particular picture above for this article will receive a pound of our delicious virtual back-bacon.  Extra points if you can mention something unique about that particular picture, as well.  Best of luck to all participants! (Canadians are welcome to guess this time as well!) :-)

Photo by Thomas Hill

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