In 1997, a new type of retirement plan called a SIMPLE IRA (Savings Incentive Match Plans for Employees) became available to small businesses that do not maintain other qualified plans. A small business is defined as one having no more than 100 employees who receive at least $5,000 in compensation. SIMPLE accounts are similar to SAR-SEPs and 401-K plans. They are salary- reduction arrangements. Special individual retirement accounts and 401-K plans will be used to hold SIMPLE contributions.
A SIMPLE plan is a written agreement between an employer and an employee that allows an eligible employee (including a self-employed individual) to choose to reduce his or her compensation by a certain percentage each pay period and to have the employer contribute the salary reductions to a SIMPLE account on behalf of the employee. These contributions are called salary-reduction contributions.
Setting Up a SIMPLE Plan
SIMPLE plans are established by the employer completing IRS Form 5304-SIMPLE or Form 5305-SIMPLE. Form 5304-SIMPLE is used if each plan participant is allowed to select the financial institution for receiving his or her SIMPLE IRA contributions. Form 5305-SIMPLE is used if all contributions under the SIMPLE IRA are deposited initially at a financial institution designated by the employer.
The SIMPLE plan is considered adopted when all of the appropriate boxes and the blanks on the form have been completed, and the form has been signed and dated by the employer. The form must be kept on file by the employer. It is not filed with the IRS.
The model IRS forms can be used to satisfy other requirements, including:
1. Meeting employer notification requirements for the SIMPLE plan. Page 3 of Form 5304-SIMPLE and Page 3 of Form 5305-SIMPLE contain a Model Notification to Eligible Employees which provides the necessary information for the employee, and
2. Maintaining the SIMPLE plan records and as proof of having established a SIMPLE plan for employees.
All contributions under a SIMPLE plan must be made to SIMPLE IRAs, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account or an individual retirement annuity. Special forms are required for establishing SIMPLE IRAs.
SIMPLE IRAs are the individual retirement accounts or annuities into which the contributions are deposited. A SIMPLE account must be set up for each eligible employee. Forms 5305-S and 5305-SA are model trust and custodial account documents that the participant and the trustee (or custodian) can use for this purpose.
A SIMPLE account must be set up for an employee before the first date for which a contribution is required to be deposited.
A SIMPLE account cannot be designated as a Roth account or as a traditional individual retirement account. Contributions to a SIMPLE account will not affect the amount that an individual can contribute to a traditional or Roth account.
Those adopting a SIMPLE plan must notify each employee before the beginning of a 60-day election period of the following:
1. The employee's opportunity to make or change a salary-reduction election under a SIMPLE plan,
2. The employer’s election to make either reduced matching contributions or nonelective contributions, and
3. A summary description and the location of the plan.
4. If a designated financial institution is used, each employee must be notified in writing that his or her balance can be transferred to another custodian or trustee without cost or penalty.
The 60-day election period is the 60-day period immediately preceding January 1 of a calendar year (November 2 to December 31 of the preceding calendar year). However, the dates of this period are modified if a SIMPLE plan is adopted in mid-year (for example, on July 1) or if the 60-day period falls before the first day an employee becomes eligible to participate in the SIMPLE plan. A SIMPLE plan can provide longer periods for permitting employees to enter into salary-reduction agreements or to modify prior agreements. For example, a SIMPLE plan can provide a 90-day election period instead of the 60-day period. Similarly, in addition to the 60-day period, a SIMPLE plan can provide quarterly election periods during the 30 days before each calendar quarter, other than the first quarter of each year.
Contributions consist of employee salary-reduction contributions and employer contributions. Employers are required to make either matching contributions or nonelective contributions. No other contributions can be made to an employee's SIMPLE account.
The amount that an employee elects to contribute to a SIMPLE IRA cannot be more than $11,500 for 2012 and $12,000 for 2013. These contributions must be expressed as a percentage of the employee's compensation unless the employer permits the employee to express them as a specific dollar amount. Restrictions cannot be made by the employer on the contribution amount (such as limiting the contribution percentage), except to comply with the $11,500 or $12,000 or limits.
Those who are at least 50 years old can make catch-up contributions to SIMPLE IRAs. The catch-up amount for 2012 and 2013 is $2,500.
If an employee is a participant in any other employer plan during the year and has elective salary-reductions or deferred compensation under those plans, the salary reduction contributions under the SIMPLE plan are included in the $16,500 annual limit on exclusion of salary reductions and other elective deferrals. If the other plan is a deferred compensation plan of a state or local government or a tax-exempt organization, the limit on elective deferrals is also $17,000 for 2012 and $17,500 for 2013.
Employers will be required to satisfy one of two contribution formulas.
1. Employers can make dollar-for-dollar matching contributions up to the lesser of 3% of the employee’s compensation or the percentage deferred by the employee. The rate can be as low as 1% if the employees are notified before the 60- day election period is reached, and if the lower rate is not effective for more than 2 of the 5 previous years. Total compensation is used for the purpose of this rule. A matching contribution cannot exceed 3% of compensation
2. Alternatively, employers can elect to make a nonelective contribution of 2% of compensation for each employee who is eligible to participate in the SIMPLE plan. The employees must be notified of this election before the 60-day election period is reached. For the purpose of this rule, compensation is limited to $250,000 for 2012 and $255,000 for 2013.
Salary-reduction contributions to a SIMPLE IRA must be made within 30 days after the end of the month in which the amounts were withheld from the employee’s pay.
Matching contributions or nonelective contributions made by the employer must be made the due date (including extensions) for filing the employer's federal income tax return.
During the first two years of participation in a SIMPLE plan, distributions from SIMPLE IRAs can be rolled or transferred into another SIMPLE IRA, but not into any other IRA or qualified plan.
The two-year period begins on the first day on which contributions are deposited in the individual's SIMPLE IRA. After the first two years of participation, distributions from SIMPLE IRAs can be rolled or transferred into another SIMPLE IRA or into a traditional IRA.
The additional tax on premature distributions under section 72(t) applies to SIMPLE IRAs. If a distribution is a premature distribution and occurs during the 2-year period following the date on which the individual first participated in his or her employer's SIMPLE plan, the additional tax on premature distributions is increased from 10% to 25%. The tax will be assessed unless an exception applies or unless the employee has attained the age of 59 1/2.
After the first two years of participation, early distributions will be subject to the 10% tax on early withdrawals unless an exception applies or unless the SIMPLE IRA owner has attained the age of 59 1/2.
Elective deferrals are excluded from income on Form W-2. These deferrals are not subject to income tax, but are subject to social security, medicare, and federal unemployment taxes (federal unemployment taxes are paid by the employer, not the employee).
The employer is allowed to deduct matching and nonelective contributions on his or her tax return. The deduction is taken of Schedule C (unincorporated small businesses), Schedule F (farmers), Form 1065 (partnerships), or Form 1120 (corporations).
Matching and nonelective contributions are not subject to income, social security, medicare, or unemployment taxes.
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