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There are several retirement plans available for the self-employed and small-business owners, among them is the SIMPLE IRA.
SIMPLE stands for Savings Incentive Match PLan for Employees and is, of course, another type of IRA and a defined contribution plan subject to the Employee Retirement Income Security Act (ERISA) and to IRS regulations.
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The appeal of SIMPLE IRAs is that they have minimal paperwork requirements, just an initial plan document and annual disclosures to employees. The employer establishes the plan through a financial institution that administers it. Startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees.
The SIMPLE IRA, sometimes called a “poor man’s 401(k)” because it provides many 401(k) advantages at a lower cost, has lower contribution limits than alternatives like SEP IRAs, but higher limits than a traditional IRA.
Here are some of the plan’s features.
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- Available to any small business – generally with 100 or fewer employees;
- Easily established by adopting a SIMPLE IRA prototype or an individually designed plan document;
- Employer cannot have any other retirement plan;
- No filing requirement for the employer;
- Employer is required to contribute each year;
- Employees may elect to contribute;
- Employee is always 100% vested in all SIMPLE IRA money.
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Generally, if an employer had 100 or fewer employees who received at least $5,000 in compensation the previous year, and there are no other retirement plans currently offered, the employer can set up a SIMPLE IRA plan.
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Employers establish the plan using IRS Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—Not for Use With a Designated Financial Institution, if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRAs, or using Form 5305- SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)— for Use With a Designated Financial Institution, if the employer wants to choose the financial institution where employees will hold their IRAs.
Employees must fill out a SIMPLE IRA adoption agreement to open their accounts. Once the plan is established, employers are required to contribute to it each year unless the plan is terminated.
You can set up a SIMPLE IRA plan effective on any date from January 1 through October 1 of a year, provided you didn't previously maintain a SIMPLE IRA plan.
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A participant in a SIMPLE IRA Plan may be an employee (including a self- employed individual) who:
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- Earned at least $5,000 in compensation during any 2 years before the current calendar year and
- Expects to receive at least $5,000 during the current calendar year.
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An employer can use less restrictive participation requirements, but not more restrictive ones. For example, an employer can eliminate or reduce the prior or current year compensation amounts. Employers cannot impose any other conditions for participating in a SIMPLE IRA plan.
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| An employer can exclude the following employees from a SIMPLE IRA plan: |
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- Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer;
- Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer.
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SIMPLE IRA contributions include salary reduction contributions and employer contributions: (a) matching contributions or (b) nonelective contributions. No other contributions can be made to a SIMPLE IRA plan.
Salary reduction contributions. The amount an employee contributes from their salary to a SIMPLE IRA cannot exceed $13,000 in 2019 ($12,500 in 2015 - 2018).
If an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $19,000 in 2019 ($18,500 in 2018).
Catch-up contributions. If permitted by the SIMPLE IRA plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The catch-up contribution limit for SIMPLE IRA plans is $3,000 in 2015 - 2019.
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Employer matching contributions. The employer is generally required to match each employee's salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee's compensation. This requirement does not apply if the employer makes nonelective contributions instead.
Nonelective contributions. Instead of matching contributions, an employer can choose to make nonelective contributions of 2% of each eligible employee’s compensation. If the employer makes this choice, it must make nonelective contributions whether or not the employee chooses to make salary reduction contributions. An employee's compensation up to $280,000 for 2019 ($275,000 for 2018) is taken into account to figure the contribution limit.
If the employer chooses this 2% contribution formula, it must notify the employees within a reasonable period before the 60-day election period for the calendar year.
Time limits for contributing funds. Employers must deposit employees’ salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the employee would have received them in cash. They must make matching contributions or nonelective contributions by the due date (including extensions) of their federal income tax return for the year.
You can deduct your contributions as employer and your employees can exclude these contributions from their gross income. SIMPLE IRA plan contributions aren't subject to federal income tax withholding. However, salary reduction contributions are subject to social security, Medicare, and federal unemployment (FUTA) taxes. Matching and nonelective contributions aren't subject to these taxes.
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Contributions you make for your common-law employees are deducted on your tax return. For example, sole proprietors deduct them on Schedule C (Form 1040) or Schedule F (Form 1040); partnerships deduct them on Form 1065; and corporations deduct them on Form 1120 or Form 1120S.
You generally have to start taking withdrawals from your IRA, SIMPLE IRA, and SEP IRA when you reach age 701⁄2. Distributions from a SIMPLE IRA are subject to IRA rules and generally are includible in income for the year received.
Your required minimum distribution (RMD) is the minimum amount you must withdraw from your account each year.
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You can withdraw more than the minimum required amount, and your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).
The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.”
A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner.
The plan’s terms may allow you to wait until the year you actually retire to take your first RMD (unless you are a 5% owner). Alternatively, a plan may require you to begin receiving distributions by April 1 of the year after you reach age 701⁄2, even if you have not retired.
If you own 5% or more of the business sponsoring the plan, then you must begin receiving distributions by April 1 of the year after the calendar year in which you reach age 701⁄2.
If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.
Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 591⁄2 are called ”early” or ”premature” distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies.
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Most retirement plans (401(k)s, regular IRAs, or Roth IRAs) have the 10% early withdrawal penalty if under the age of 59.5. But with the SIMPLE IRA, it takes it one step further.
If the SIMPLE IRA that you’ve started is less than two years and you cash it out, instead of the normal 10% penalty, you will be subject to a 25% penalty in addition to ordinary income tax.
One of the drawbacks of SIMPLE IRAs is that the business owner cannot save as much for retirement as with other small business retirement plans, such as a simplified employee pension (SEP) or a 401(k), which also offer higher catch-up contribution limits.
Other disadvantages include the lack of a Roth version of the plan, inflexible account portability and harsher early withdrawal penalties.
There is a lot more to know about these pension plans, and you can find details about the SIMPLE IRA in Publication 560, Retirement Plans for Small Business.
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Nevertheless, the best advice we can give you is to contact a professional advisor to make sure you comply with the tax law if you want to set up a retirement plan.
You should also keep up with our newsletters for regular updates on topics of general interest.
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