Introducing the Savings Incentive Match Plan for Employees (SIMPLE)
A SIMPLE plan is an inexpensive retirement plan that a small business owner may set up, even if the business has no employees other than the owner. SIMPLE plan contributions are made to special IRAs called SIMPLE Retirement Accounts, or SIMPLE IRAs.
A SIMPLE plan may be maintained by a corporation, a partnership, or a self-employed individual that meets the following requirements:
Any employees who receive at least $5,000 in compensation from their employer during any two previous years, and are reasonably expected to receive at least $5,000 in compensation during the current year, are considered "eligible employees" and must be allowed to participate. However, the employer may exclude employees who are: (1) union members, if retirement benefits were the subject of good-faith bargaining, and (2) nonresident aliens who receive no U.S. taxable earned income from the employer.
Employees may elect to defer up to 100% of their compensation, but not more than $6,000 per year. This limit will be periodically adjusted for cost-of- living increases, in $500 increments. The amount the employee elects to defer must be expressed as a percentage of compensation rather than a specified dollar amount.
Because the employee's income is reduced, for federal income tax purposes, by the amount of the elective deferral, the employer does not include the amount contributed to the employee's IRA as taxable income on the employee's W-2. Therefore, the contribution is known as a pre-tax contribution. Eligible deferred amounts are not considered wages for federal income tax purposes, but are wages for Social Security and Medicare (FICA) and unemployment (FUTA) tax purposes.
Employee deferrals must be fully (i.e., 100%) vested immediately. Employees may stop their elective deferrals at any time during the year; however, the SIMPLE plan may mandate that such employees may not resume participation until the beginning of the next year. A SIMPLE may, but does not have to, allow a participant to increase or decrease his deferral percentage during the year.
When the employee elects to defer a portion of his salary into his SIMPLE IRA, the employer must deposit such contributions to the employee's IRA as soon as possible but not more than 30 days after the last day of the month with respect to which the contributions are to be made.
In addition to allowing eligible employees to make elective deferrals, the employer must make SIMPLE contributions. Each year, the employer may choose either a matching or a nonelective contribution formula. A matching contribution formula requires the employer to match an employee's elective deferrals, dollar-for-dollar, up to 3% of the employee's compensation.
Example: Harry is an employee of ABC Corp, which sponsors a SIMPLE plan Harry's compensation for Year 1 is $100,000 He elects to defer 5% of his compensation, $5,000. ABC Corp matches his contribution dollar-for-dollar, up to 3% of compensation. Thus, ABC Corp must make a matching contribution of $3,000 (3% x $100,000) to Harry's SIMPLE IRA
An employer may choose to make matching contributions at a level that is less than 3% (but not less than 1%) in up to 2 years out of any 5- year period. The employer must notify employees of the election to make a matching contribution at a level that is less than 3% within a reasonable time before 60 days before the beginning of the calendar year.
Instead of matching contributions, an employer may choose to make a 2% nonelective contribution for each eligible employee who has at least $5,000 of compensation from the employer for the year. The employer must notify employees of the election to make a nonelective employer contribution within a reasonable time before 60 days before the beginning of the calendar year. If this option is chosen, the employer must make a 2% contribution for all such eligible employees, even those who choose not to defer. Compensation is limited to $160,000 (indexed) for purposes of this 2% nonelective contribution; therefore, the maximum nonelective contribution that could be made on behalf of any employee is $3,200 (2% x $160,000) for 1998.
Employer contributions must be made by the employer's tax-filing deadline, including extensions. Like employee elective deferrals, employer contributions must also be fully vested immediately.
Annual reporting to the IRS is not required from employers for SIMPLE plans. However, the employer is required to notify each employee of the employee's eligibility to elect to make salary reduction contributions under the SIMPLE, immediately before the employee becomes eligible to make such election. The employer must give notice to the employee before the 60-day election period starts. This notice must also include a copy of the summary description of the plan's provisions, which is prepared by the trustee.
Because SIMPLE plan contributions are made to SIMPLE IRAs, distributions are taxed under the rules generally applicable to distributions from Traditional IRAs (e.g., taxed as ordinary income). Distributions prior to age 59 1/2 are generally subject to a 10% early distribution penalty. However, a 25% penalty tax, rather than the 10% penalty tax, will apply if the distribution occurred within the two-year period commencing on an employee's first participation in a SIMPLE plan of the employer. Employees under age 59 1/2 who meet the two- year requirement are still subject to the 10% early distribution penalty unless another exception from the early distribution penalty (such as disability) applies.
Distributions from a SIMPLE IRA can be rolled over to another SIMPLE IRA. If the participant has participated in the SIMPLE for at least two years, distributions from a SIMPLE IRA can be rolled over to a Traditional IRA.
To establish a SIMPLE plan, the employer completes a SIMPLE plan agreement. Each "eligible employee" must establish a SIMPLE IRA, to accept the SIMPLE contributions. The only contributions permitted in a SIMPLE IRA are SIMPLE IRA contributions or rollovers or transfers from other SIMPLE IRAs. In other words, SIMPLE IRA contributions cannot be commingled with other IRA funds such as regular or spousal Traditional IRA contributions.
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