SIMPLE Retirement Plans
Overview as of 10/03/96
The information below is an overview of the SIMPLE retirement plan
as originally set up.
For more current regulations see: SIMPLE
Retirement Plans.
For a comparison of different types of plans see: Retirement Plans For Small Business.
Congress' passage of the Small Business Job Protection Act of 1996 has added a new retirement plan option which could be very attractive to many small business owners.
Effective for years beginning after 1996 (1/1/97 for companies on a calendar year basis), Congress added a significant new incentive designed to help employees of small businesses (including business owners and self-employed persons) save for retirement on a tax-favored basis: the SIMPLE (Savings Incentive Match Plan for Employees) retirement plan.
What it is and its advantages
A SIMPLE plan is a new type of simplified retirement plan for small businesses. Because of its streamlined features, it is not subject to the complex qualification requirements associated with other tax-qualified retirement plans. Administrative and legal costs therefore are minimized. We expect that a variety of providers will make standard versions of the SIMPLE plan available at a low cost.
Other key advantages of SIMPLE plans from an employer's standpoint include the fact that they are subject to simplified reporting requirements and the employer (and any other plan fiduciary) will not be subject to fiduciary liability resulting from the employee or the employee's beneficiary exercising control (direction) over the assets in his or her SIMPLE account.
Who can adopt the SIMPLE plan
A business is eligible to adopt a SIMPLE plan if it employs 100 or fewer employees who earned at least $5,000 in compensation for the preceding year and it does not maintain another employer-sponsored retirement plan (such as a 401K or SARSEP). If the business is eligible to establish a SIMPLE plan but later becomes ineligible, the company will have a two-year grace period during which it may continue to maintain the plan.
How SIMPLE plans work
A SIMPLE plan allows employees to make elective contributions to an IRA account. Employee contributions must be based on a percentage of their compensation and cannot exceed $6,000 per year (as indexed for inflation). The employer would have to satisfy one of two contribution formulas:
1. Under the matching contribution formula, the company would be required to match employee contributions dollar-for-dollar up to 3% of each participating employee's compensation. A special rule allows you to elect a lower percentage matching contribution for all employees (but not less than 1%). The lower percentage can be used no more than two out of any five years.
2. Instead of making matching contributions, the company can elect to make a flat 2% contribution on behalf of each eligible employee who earns at least $5,000 in compensation for the year.
No more than $150,000 of an employee's contribution can be taken into account in any year for contribution purposes. Only employee elective and required employer (1 or 2) contributions can be made to a SIMPLE plan.
Eligibility to participate
Generally, each employee who received at least $5,000 in compensation from the company during any two prior years and who is reasonably expected to receive at least $5,000 in compensation from the company during the current year must be eligible to participate in the SIMPLE plan. Self-employed individuals can also participate. All contributions to an employee's SIMPLE account must be fully vested.
Employee election to participate
An eligible employee can elect, within the 60-day period before the beginning of any year (or the 60-day period after first becoming eligible to participate), to participate in the employer's SIMPLE plan and to modify any previous elections regarding the amount of contributions.
Employee election to terminate
Employees must be allowed to terminate participation in the plan at any time during the year. A SIMPLE plan can provide that an employee who terminates participation cannot resume participation until the following year.
Employee election to change during year
The plan can permit an individual to make changes to his or her salary reduction contribution election during the year.
Taxability of contributions
Employer contributions, within limits, to an employee's SIMPLE account are generally deductible. Limitations apply for contributions owed but not actually made within a fiscal year.
Employer contributions (either type 1 or type 2) are exempt from employment taxes.
Contributions to a SIMPLE account (employer and employee) are excluded from employees' income and the assets of a SIMPLE account, like those of a qualified retirement plan, grow tax-free.
Taxation of distributions
Distributions from a SIMPLE plan generally are taxed the same as IRAs. Tax-free rollovers from one SIMPLE account to another are allowed. A SIMPLE account can be rolled over to an IRA tax-free after a two-year period has expired since the employee first became a participant in the SIMPLE plan. Other rules apply to employees who stop participating.
Early withdrawal penalties
Generally the same as an IRA - 10% penalty tax (plus income tax). If withdrawals are made during the first two years the penalty tax is 25%.
SARSEPs
The SIMPLE plan replaces the SARSEP. If the SARSEP was established before January 1, 1997, it can continue to make contributions under the SARSEP rules, and employees hired after December 31, 1996 can become participants in such a pre-existing SARSEP and be covered under the old rules. No new SARSEP may be established after December 31, 1996. A business cannot maintain both a SARSEP and a SIMPLE plan.
© Copyright 1997 Raymond S. Kulzick. All rights reserved. 961003
This publication provides business, financial planning, and/or tax information to our clients. All material is for general information only and should not be acted upon without seeking appropriate professional assistance.