What is a SIMPLE Plan?

Savings Incentive Match Plan for Employees (SIMPLE) plans are special retirement programs for small firms (less than 100 employees) and self-employed individuals that allow eligible employees to deduct some of their pre-tax salary, then place the funds in either a SIMPLE IRA or a SIMPLE 401(k) plan. While similar to standard 401(k) and 403(b) plans, SIMPLE IRAs are easier and less expensive to administer. Employers providing a SIMPLE IRA cannot also provide another type of retirement plan.

Note: These salary deductions are subject to Social Security, Medicare and Federal Unemployment Tax Act (FUTA) tax assessments.

The employer can match the employee’s contribution up to three percent of the employee’s compensation below $170,000 or up to two percent of an employee’s fixed, non-elective contributions, up to a maximum salary of $230,000. Contributions to the SIMPLE plan made by the employee are tax-deductible in the year they are made, while the employer contributions are taxed upon withdrawal.

The Contribution Limit for 2008 is $10,500. Standard, employer-provided retirement plans have a higher contribution limit of $15,500. Also, the taxpayer, not the employer, is responsible for monitoring compliance with the contribution limits.

If the employee will be 50 years old by the end of the tax year and is unable to make other elective deferrals within the year because of limits or restrictions, they may be allowed to “additional elective contributions” up to limits defined in the rules.

IRS Publications No. 560: “Retirement Plans for Small Business” and No. 590: “Individual Retirement Arrangements” contain additional information on employer requirements for establishing and administering a SIMPLE IRA or 401(k) plan, as well as information for employees on eligibility and contribution rules. Small businesses and self-employed individuals should also consult with CPAs, professional tax preparers and business advisors to assess whether creating a SIMPLE IRA or 401(k) plan is beneficial to their firm and their employees.

Eligible Employees

Employees eligible to participate in a SIMPLE Plan include all employees receiving at least $5,000 in compensation during any two years prior to the current year AND who are “reasonably expected” to receive at least $5,000 in compensation within the calendar in which the contributions are made.

Under the rules for SIMPLE Plans, “eligible employees” include any self-employed individuals who received earned income during the year.

Excluded Employees

Employees who are excluded from participation in a SIMPLE Plan are those employees who:

- have retirement benefits provided under a union contract (collective bargaining agreement);

- are nonresident aliens with no earned income from U.S. sources;

- would not have been eligible unless an acquisition, disposition or similar transaction occurred during the calendar year.

Compensation

Under SIMPLE Plan rules, compensation is generally defined as all wages, tips and other pay from an employer that is subject to income tax withholding or any deferred amounts elected under any 401(k) plans, 403(b) plans, government (section 457) plans, SEP plans and SIMPLE plans.

For self-employed individuals, SIMPLE plan rules define compensation as the individual’s net earnings from self-employment, as reported on Form 1040’s Schedule SE: Section A, line 4, or Section B, line 6, before deduction of any contributions made to a SIMPLE IRA.

Plan Contributions

During the 60-days before the beginning of any year or 60-days before an employee is eligible to participate in a SIMPLE Plan, the employee enters into a “salary reduction agreement” setting the amount of their “salary reduction contributions” (also referred to as “elective deferrals”), as a percentage of their compensation or as a specific dollar amount, if the employer offers a choice. Except under the limits prescribed by SIMPLE Plan rules, the employer cannot restrict the employee’s contribution amount.

The employer must match an employee’s salary reduction contributions (“matching contributions”), up to set limits, then add these funds to the employee’s SIMPLE IRAs. The employer can choose to match less than three percent of the employee’s compensation, but has to meet specific criteria and must provide the employees adequate time to participate in a salary reduction agreement to make their contributions.

Alternatively, the employer can make “non-elective contributions,” equal to two percent of the employee’s salary, instead of matching contributions, for all eligible employees, whether or not they chose to make salary reduction contributions. There are specific requirements the employers must meet to opt for non-elective contributions that can be found in the relevant IRS publications and should be discussed with tax experts, whether a CPA, professional tax preparer or business advisor.

Converting a SIMPLE IRA

SIMPLE IRAs can be converted to a Roth IRA under the standard rules for converting a traditional IRA to a Roth IRA. However, the conversion of any amount distributed from a SIMPLE IRA cannot be made within two years from the date the employee began participating in the SIMPLE IRA.

Withdrawal and Distributions

Generally speaking, the same withdrawal and distribution rules applied to traditional IRAs also apply to SIMPLE IRAs and an employer cannot restrict employees from taking distributions from a SIMPLE IRA. However, distributions from a SIMPLE IRA are normally taxed as ordinary income, though “early” distributions may be subject to certain additional taxes. Rules on withdrawals and distributions are covered in the relevant IRS publications, but should also be discussed with CPAs, professional tax prepares and business advisors to avoid unnecessary tax liabilities.

Rollovers and Transfers

Usually rollovers and trustee-to-trustee transfers of SIMPLE IRAs are not taxable distributions. However, if the rollover or transfer occurs within two years from the date of the employee’s initial contribution to the plan, then the funds must be placed into another SIMPLE Plan. If the rollover or transfer occurs over two years from the date of the initial contribution, then the funds can be placed into any type of IRA, qualified plan, tax-sheltered annuity plan [Section 403(b) plan] or deferred compensation plan administered by a local or state government (Section 457 plan).

Trustees

Employers must notify employees in writing that the employee can select the financial institution they want to serve as trustee of their SIMPLE Plan and that the plan can be rolled over or transferred to another financial institution.

Conclusion

SIMPLE Plans are useful tools for small businesses and their employees, as well as for self-employed individuals, to benefit from tax-deferred earnings under an uncomplicated set of rules that are easy to administer.

As with all such tax issues, employers and employees should discuss the advantages and disadvantages of SIMPLE Plans with their CPAs, professional tax preparers and business advisors.

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