Many
individuals are not aware of the availability of “SIMPLE” retirement plans:
“savings incentive match plan for employees.” This type of plan is targeted at
businesses with 100 or fewer employees, and is designed to offer greater income
deferral opportunities than individual retirement accounts (IRAs), with fewer
restrictions and administrative requirements than traditional pension or
profit-sharing plans.
Under
a SIMPLE plan, any employee with compensation of at least $5,000 must be
permitted to enter a “qualified salary reduction arrangement.” Under this
arrangement, an employee can elect to have a percentage of compensation not in
excess of $10,000 (in 2005) set aside in an IRA, instead of receiving it in
cash. After 2005, the $10,000 maximum will be indexed for inflation.
Amounts
taken out of the employee's salary and contributed to a SIMPLE IRA are not
taxed to the employee until withdrawn from the SIMPLE IRA. Early withdrawals
may be subject to a 10% penalty (25%, if the withdrawal is made within the
first two years).
Under
a qualified salary reduction arrangement, the employer must make “matching”
contributions to the SIMPLE IRA. That is, the employer must make contributions
to an employee's SIMPLE IRA in the same amount as the employer contributed
under the employee's salary reduction election, up to 3% of the employee's
compensation. For example, if an employee with compensation of $50,000 elects
to have 10% of his pay contributed to the plan ($5,000), the employer must
contribute an additional $1,500 (3% of $50,000). For these purposes, an
employee's compensation is the amount reported on his Form W-2, plus the amount
of elective deferrals (e.g., the amount of the salary reduction contributed to
the SIMPLE IRA). But the matching contribution for the year cannot exceed
$10,000 in 2005 (This amount will be indexed for inflation after 2005).
If an
employer wishes to contribute less than 3%, he can give employees proper notice
and drop the contribution to as low as 1% of compensation, as long as this
isn't done for more than two years out of the five-year period ending with the
year of reduced contributions. Alternatively, instead of making “matching”
employee contributions, the employer can simply contribute a flat 2% of
“compensation” (limited to $210,000 for 2005, and as adjusted for inflation in
following years), for every employee eligible to participate in the plan,
whether the employee elects to reduce his salary or not. Special notice must be
given to employees if the employer wishes to take this approach.
Instead
of adopting a simple retirement plan, an employer can set up a SIMPLE 401(k)
plan. By making matching contributions (or 2% nonelective
contributions) and satisfying rules similar to those for simple plans, SIMPLE
401(k) plans will be considered to satisfy the otherwise complex
nondiscrimination test for 401(k) plans. The contribution rules for SIMPLE
plans apply to simple 401(k) plans, except that if an employer adopts the
matching contribution approach (instead of the flat 2% option), the maximum
contribution percentage cannot be dropped below 3%. Unlike a SIMPLE plan, a SIMPLE
401(k) plan is part of a qualified plan, and is subject to the qualified plan
rules. Contributions to SIMPLE 401(k) plans are not subject to the 15 percent
limits on contributions to profit-sharing or stock
bonus plans.
SIMPLE
plans have the advantages of simplified reporting requirements and the absence
of the qualification rules prohibiting the plan from discriminating against
lower-level employees. Some employers may consider the matching contribution
requirements a disadvantage. Additionally, to be eligible to adopt a SIMPLE
plan, an employer must not contribute to, or accrue benefits under, any
qualified retirement plan for services provided during the year (or in any year
after the qualified salary reduction arrangement takes effect). But employers
that maintain a plan for collectively bargained employees can maintain a SIMPLE
plan for noncollectively bargained employees. A
restriction similar to the “exclusive plan requirement” applies to SIMPLE
401(k) plans, but only for services provided by employees eligible to
participate in the SIMPLE 401(k) plan.
Please
call our firm if you wish to discuss this topic further.