The SIMPLE Retirement Plan

An Easier Way for Employers to Provide Retirement Benefits The Small Business Job Protection Act of 1996 makes available a new type of retirement plan for employers with no more than 100 employees. This type of plan is referred to as the SIMPLE plan (for Savings Incentive Match Plans for Employees of Small Employers). The purpose of the SIMPLE plan is to allow employers an easier way to establish and maintain a retirement plan for their employees.
No more than 100 employees An employer must meet two basic requirements to have a SIMPLE plan. First, the employer must have no more than 100 employees (counting only employees with at least $5,000 of annual compensation). If an employer has adopted a SIMPLE plan and then grows to more than 100 employees, it's given a 2-year grace period to operate the SIMPLE plan and then must convert to another type of qualified retirement plan.
No other qualified plan The second requirement is that the employer have no other qualified retirement plan. For example, an employer with a defined benefit pension plan cannot establish a SIMPLE plan. However, as we shall see an employer that currently sponsors a 401(k) plan and has no other plan can easily modify their 401(k) plan to meet the rules for SIMPLE plans.
IRA version
or
401(k) version
There are two routes for setting up a SIMPLE plan:
  1. An employer can either use IRA's for holding the retirement accounts of each participant or
  2. can set up a trust or insurance contract and operate the plan as a kind of 401(k) plan.

Some of the rules for SIMPLE plans are the same for the IRA and 401(k) variations but other rules are significantly different. Understanding these differences is a key to deciding which arrangement will work better for a specific employer.

Basic Features

SIMPLE plans have a specified employer contribution and immediate vesting. The employer contribution required to a SIMPLE plan is a 100% match of the first 3% of pay an eligible employee elects to contribute to their retirement account.

Employees contribute up to $6,000 per year pre-tax Employees are allowed to contribute to the plan on a pretax basis as much as $6,000 per year.
HOW IT WORKS . . .

Step by Step

Simple IRA The IRA variation of the SIMPLE plan works like this:
Employees elect their contributions before the year starts In October of each year employees are given a description of the plan and an election to choose the percentage of pay they wish to contribute to the plan on a pretax basis. The employee can elect any percentage of pay but the maximum contribution for a year is $6,000. The $6,000 limit applies in 1997 and is indexed to the Consumer Price Index for years after that and rounded to the nearest $500. The eligible employee has the months of November and December to make their election for the following calendar year. To be eligible for the election the employee must have earned at least $5,000 in the prior year and be expected to earn at least $5,000 in the coming year.
Employer matches 100% up to 3% of pay Contribution to the employee's retirement account are deducted from each paycheck and transferred to the IRA no later than 30 days after the end of the month. Employer matching contributions are calculated as 100% of the employee contributions up to 3% of pay. The employer contributions can be transferred to the IRA with the employee contributions or the match can be deferred for as long as 2 months after the end of the calendar year.
100% vesting All employee contributions, employer matching contributions and investment earnings are fully vested at all times. This means, for example, that an employee who terminates during the year will receive a full employer match even if the employer has elected to make the match after the end of the year.
Money sent to IRAs The employer makes the contributions to individual retirement accounts either selected by the employer or by the employee. For administrative ease, the employer is allowed to select the individual retirement accounts for the plan. Each plan participant must be notified in writing that their balance may be transferred without cost or penalty to another individual retirement account or annuity.

Participants may receive their distribution at retirement or after age 59 . If a distribution is made before age 59 , it is subject to a 10% excise tax on early withdrawal as well as regular income tax. Exceptions apply for amounts paid as annuities or for death or disability.

Watch Out! 25% penalty tax for first 2 years If the employee elects to withdraw money from their IRA within the first two years, the early withdrawal excise tax is increased from 10% to 25%. This provides a strong incentive for employees to keep money in the plan, at least for the 2-year period.
Annual statements After the end of the year a statement must be provided to a participating employee within 30 days showing the contributions, investment earnings, and balance in the participant's retirement account.

Administrative Simplicity

No annual government filings The IRA-type SIMPLE plan is much less burdensome for an employer than other types of retirement plans. For example, the employer has no requirement to make annual filings to the IRS. Employers with other types of retirement plans must file Form 5500 each year.

The employer must provide a description of the plan to employees but it is a much simpler format than the Summary Plan Description required of other types of qualified plans. The SIMPLE summary description includes the name and address of the employer, eligibility requirements for employees, a description of the benefits provided, the time and method of collecting contributions, and the procedures and effects of withdrawals from the plan including rollovers. A one or two-page summary should be sufficient to meet this requirement as compared to the detailed summary plan descriptions that are often needed for other qualified retirement plans.

The other information that must be provided to an employee is the election form at least 60 days in advance of the year and an annual statement of accounts within 30 days after the end of the year.

The employer is also responsible for applying the proper tax treatment on employee and employer contributions. Employee contributions are not subject to income tax withholding but are subject to social security (FICA) taxes.

The employer must observe the $150,000 (indexed) limit on the compensation that can be considered in the plan as required for other qualified retirement plans.

Funding Flexibility for the Employer

The IRA-time SIMPLE plans also give the employer some flexibility in making the contribution. For example, the 100% match on the first 3% of employee contributions can be reduced to a 100% match on the first 2% or 1% of pay the employee contributes. This limit, however, cannot be used any more frequently than two years out of five. For example, an employer might match employee contributions of up to 3% for the first year, reduce the match to only 1% for the next two years, and revert to matching up to 3% for the following two years.

Option for employer to contribute 2% of pay The employer also has the option of making a uniform 2% of pay contribution for all employees eligible for the plan whether or not they contribute, in lieu of the matching contribution. Depending on how many employees elect to participate and the percentage of pay they choose to contribute, the 2% uniform contribution may be more or less expensive than the matching contribution. The matching contribution, however, provides more incentive for employees to save their own money towards retirement on a tax-efficient basis.
SIMPLE 401(k) The 401(k) SIMPLE Plan

The Act also extends the same concept in the SIMPLE plan to 401(k) plans. These plans can either be new plans set up under the SIMPLE rules or existing plans amended to meet the SIMPLE plan requirements.

The general requirements are similar to the IRA SIMPLE plans -- all accounts must be vested, the employer must make a matching contribution of 100% of the first 3% an employee elects to defer on a pretax basis, employee elective deferrals must be limited to no more than $6,000 and the employer must have no more than 100 eligible employees and cannot maintain another qualified retirement plan. Note that the normal limit on a pretax employee contribution to the 401(k) plan is $9,500 not $6,000; so some higher-paid employees might be better off under a regular 401(k) plan rather than the SIMPLE version.

The employer may also elect to make a 2%-of-pay contribution for all eligible employees rather than the matching contribution.

Some of the key differences between the 401(k) SIMPLE plan and the IRA SIMPLE plan are:

Differences between the IRA and 401(k) SIMPLE plans 10% excise tax for early withdrawals. In a 401(k) plan, the 10% excise tax on early withdrawals applies to all employees without modification. There is no 25% excise tax for employees withdrawing during their first two years as applies to the IRA plans.

Less employer flexibility on contributions. The employer in a 401(k)-type SIMPLE plan may choose between matching up to 3% of pay an employee contributes or a uniform 2% of pay for all eligible employees. The flexibility of reducing the match from 3% to 2% or 1% for as many as two of five years that applies to IRA-type SIMPLE plans is not granted to 401(k) SIMPLE plans.

No ADP or ACP tests No reduction in government reporting or employee disclosure. A SIMPLE 401(k) plan is subject to the same employee disclosure and government reporting requirements as any other 401(k) plan. Plan sponsors must provide a detailed summary plan description to employees and must file an annual Form 5500 with the IRS. A summary of the annual report must be given to employees after the 5500 is filed. The key administrative simplification for the SIMPLE 401(k) plan is that the average contribution percentage and average deferral percentage tests do not apply to the plan and the plan is not subject to top-heavy rules.

Employee elections. The rules for the timing of employee elections on the contributions they make to the plan are the same for regular 401(k) plans. The 60-day requirement election period used for IRA plans is not specified for 401(k) plans.

Financial arrangement. The money in the 401(k) plan is held in trust or in an equivalently secure insurance contract and investment earnings are allocated to individual participant accounts. This is a different structure than the IRA arrangement, and a trustee or insurance company are required.

Loans available. The 401(k) plan may allow employees to borrow against their account. Generally employees can borrow up to 50% of their vested account balance up to $50,000 with repayments made on a level basis by payroll deduction over no more than five years (15 years for home loans.) The plan may also allow withdrawals for reasons of financial hardship.

Contribution timing. Employee pretax deferrals in the plan must be transferred to the trust fund or insurance by the earlier of the date contributions can reasonable be segregated from employer assets, or 15 days after the month in which contributions were withheld. Note that contributions must be made faster under the 401(k) SIMPLE plan than under the IRA version.

 

 

If you have questions or comments, please contact us at Dean & Company.

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