SIMPLE IRAs for Small Businesses

Salary Reduction, Less Administration

Like the popular 401(k) Plan, the SIMPLE (Savings Incentive Match PLan for Employees) IRA Plan allows small businesses to offer a tax-advantaged, company-sponsored retirement plan — without being solely responsible for funding the plan. Not only is the SIMPLE IRA Plan relatively inexpensive to offer, it's easy to administer, for businesses with 100 or fewer employees.

SIMPLE plans are funded by employer contributions and elective employee salary deferrals.

A SIMPLE IRA Plan is a salary reduction retirement plan. That simply means that your employees decide how much they want to save for retirement — and that amount is automatically deducted from their salary each pay period before federal income taxes are withheld. These amounts are then contributed to a SIMPLE IRA for each participant. While SIMPLE IRA Plans are funded in part by employee salary reduction contributions, they do require employer contributions.

One of the biggest advantages of a SIMPLE IRA Plan is that it enables all participants to save for retirement while saving on taxes. In addition to reducing current taxable income, a SIMPLE IRA Plan also

  • Shifts some of the funding responsibility to employees
  • Offers flexible, tax-deductible employer contribution options
  • Helps retain and attract valuable employees
  • Allows any earnings to compound tax deferred

Eligible employees can elect to contribute as much as 100% of compensation, up to the limit for the plan year, to their SIMPLE IRAs before federal income taxes are withheld. These salary reduction contributions must be expressed as a percentage of each participant's compensation or as a specific dollar amount.

Key Features of a SIMPLE IRA Plan

Below are seven key things small business owners should know about a SIMPLE IRA.

Broad eligibility requirements
Significant tax advantages
Flexible contribution requirements
Self-directed investments
Access to assets
Low cost and minimum administrative requirements
Establishment deadlines


Broad Eligibility Requirements

Which Employers Can Establish a SIMPLE IRA Plan

You may find a SIMPLE IRA Plan particularly attractive if you are looking for the types of benefits the popular 401(k) Plan can offer — but without all the administrative responsibilities. In general, a SIMPLE IRA Plan is available to any business owner who:

  • has 100 or fewer employees who received at least $5,000 in compensation from your company for the preceding year; and

  • is not currently maintaining another employer sponsored retirement plan, such as a SEP IRA, Keogh, or 401(k). If you already have another type of retirement plan for your business, you can maintain the assets you have in that plan.

However, if you wish to establish a SIMPLE IRA Plan, you cannot make any contributions to or accrue benefits for any other employer-sponsored plan for any year for which your SIMPLE IRA Plan is maintained.

Once you know that your company can establish a SIMPLE IRA plan, you need to determine employee eligibility.

Which Employees Can Contribute to a SIMPLE IRA Plan

The eligibility rules for employee participation are slightly different than the rules determining company eligibility. Generally, eligible employees include those who:

  • Have earned at least $5,000 in compensation from your company in any two preceding years (whether or not consecutive), and
  • Are reasonably expected to earn $5,000 in compensation from your company during the current year

While employers cannot make these eligibility requirements more restrictive, they can generally liberalize them to include more employees.

For more information, see Frequently Asked Questions About SIMPLE IRAs.

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Significant Tax Advantages

Contributing to a SIMPLE IRA plan can help small business owners save on their business taxes as well as their personal income taxes.

Tax credit
The tax law enacted in 2001 grants a special nonrefundable tax credit of up to 50% of the first $1,000 of administrative and retirement education expenses for small businesses for the first three years of a new plan.

A non-refundable tax credit may alo be available to individuals who make pre-tax contributions to a SIMPLE-IRA. The credit applies to the first $2,000 in contributions. There are certain eligibility requirements that must be met and the rate of credit depends on the individuals adjusted gross-income.

Tax-Deductible Contributions for Employers
Contributing to a SIMPLE IRA Plan can help you save on current taxes. As an employer, all contributions you make on behalf of your plan participants are deductible as a business expense.

Tax-Advantaged Contributions for Participants
Contributing to a SIMPLE IRA Plan will also reduce each participant's current federal income taxes. That's because all salary reduction SIMPLE IRA contributions are made before federal income taxes are withheld, thus reducing each participant's current federal taxable income. Of course, taxes will be due upon withdrawal.

Offers tax-deferred growth
Another tax advantage of saving through a SIMPLE IRA Plan is that earnings have the opportunity to grow tax deferred until withdrawn. When your earnings aren't eroded by taxes each year, they have the potential to compound faster. Thanks to this tax-deferred compounding over the long term, you can earn significantly more in a SIMPLE IRA than you would in a taxable investment earning the same rate of return.

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Flexible Contribution Requirements

Employee Contributions
Eligible employees can elect to contribute up to 100% of compensation up to a maximum of $12,500 for 2016 or 2017 through salary reduction. (The amount elected by the employee may be expressed as a percentage of compensation or as a specific dollar amount.)

Additionally, participants age 50 and older in 2016 or 2017 may be able to make an additional annual $3,000 catch-up elective deferral contribution to their SIMPLE-IRA.

Provides for flexible employer contribution options
Employers can choose between the two different contribution methods described below. Employers generally can switch between these methods each year, as long as certain notification requirements are met. (Download the contribution worksheet to help estimate how much your company may have to contribute to the plan.)

  • 3% Matching Contribution. Choosing this option requires a dollar-for-dollar match of each participants' contributions — up to 3% of compensation each year (not to exceed $12,500 for 2016 or 2017). Also allows a match reduction to as little as 1% of each participant's compensation for any two years in a five-year period. Keep in mind that this method is based on matching each employee's contributions. So if an employee doesn't contribute, the employer does not contribute either; or
  • 2% Nonelective Contribution. Requires a 2% contribution of each eligible employee's compensation each year — up to a maximum of $5,000 for 2016 -- regardless of whether the participant contributes or not (the maximum annual compensation on which contributions can be based is $265,000 for 2016 or $270,000 for 2017).

To illustrate the differences between the two methods, look at hypothetical funding requirements for an employee making $40,000 a year in the table below. Which contribution method is right for you depends on your circumstances. If you're primarily interested in encouraging employees to save for their retirement, you may want to consider the Matching Contribution option. If you'd prefer to use this benefit to reward eligible employees, you may want the Nonelective Contribution method.

Comparing Employer Contribution Methods
3% Matching Contribution 2% Non-elective Contribution
EXAMPLE A: The employee contributes 5% of his salary ($40,000) or $2,000.
Employer matches employee's contribution on a dollar-for-dollar basis, up to 3% of the employee's compensation
(3% x $40,000 = $1,200).
Of course, in any two years in a five-year period, the employer has the flexibility to reduce the match to 1% of the employee's compensation
(1% x $40,000 = $400).
Employer contributes 2% of the employee's compensation
(2% x $40,000 = $800).
EXAMPLE B: The employee contributes 2.5% of his salary ($40,000) or $1,000.
Employer matches employee's contribution on a dollar-for-dollar basis, up to 3% of the employee's compensation. Since the employee chose to contribute only 2.5% of his or her compensation (or $1,000), the employer would only have to match $1000. In any two years in a five-year period, the employer could reduce the match to 1% or $400. Employer contributes 2% of the employee's compensation
(2% x $40,000 = $800).
EXAMPLE C: The employee decides not to contribute anything.
The employer is not required to contribute anything because there's no salary reduction contribution for the employer to match. The employer is required to contribute 2% of the employee's compensation
(2% x $40,000 = $800).

For more information, see Frequently Asked Questions About SIMPLE IRAs.

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Self-Directed Investments

All contributions to a SIMPLE IRA Plan are directed into each participant's own separate SIMPLE IRA. Each participant then makes and executes all investment decisions within his or her own account. For more information, see Frequently Asked Questions About SIMPLE IRAs.

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Access to Assets

All SIMPLE IRA contributions are immediately 100% vested, meaning that your employees are entitled to any SIMPLE IRA contributions at any time. However, to keep participants focused on one of the primary reasons you set up the SIMPLE IRA — to help them save for retirement — distributions from a SIMPLE IRA in the first two years of participation are subject to a higher early withdrawal penalty than traditional IRA distributions. If a participant is under age 59½:

  • any withdrawals taken within the first two years of plan participation generally will be subject to a 25% early withdrawal penalty; and
  • any withdrawals taken after the first two years are generally subject to a 10% early withdrawal penalty.

Withdrawals taken within the first two years of plan participation are not permitted for purposes of conversion to a Roth IRA or rollover by transfer to an IRA other than a SIMPLE IRA.

There are some exceptions to the early withdrawal penalties summarized above. For example, the early withdrawal penalties will be waived if the distribution is:

  • made due to death or disability, for qualified expenses such as a first-time home purchase (lifetime limit up to $10,000), higher education expenses, health insurance premiums paid by certain unemployed individuals, substantially equal periodic payments, and on account of an IRS levy and certain major medical expenses in excess of 7.5% of adjusted gross income;or
  • rolled over or transferred to another SIMPLE IRA; or
  • rolled over or transferred to another type of IRA after employee has participated in the SIMPLE IRA Plan for two years.

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Low Cost and Minimum Administrative Requirements

Not only is a SIMPLE IRA Plan attractive to employees, key advantages for an employer are that it is relatively easy to set up and maintain.

  • Unlike a 401(k) Plan, no annual employer plan-level tax filings are required by the IRS
  • No costly "anti-discrimination tests" to perform each year. (Such tests typically involve complicated calculations to make sure employer is not over- contributing for highly compensated employees.)
  • No need to track vesting, since all contributions are immediately 100% vested (which means each employee owns all SIMPLE IRA assets immediately and can take these assets with them if leaving the company.)

For more information, see Frequently Asked Questions About SIMPLE IRAs.

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Establishment Deadlines

For employers who want to establish a SIMPLE IRA plan for the current tax year, you must set up the plan and notify your employees by October 1 of the current tax year. (An exception applies for businesses which are established after October 1.)

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