A SIMPLE (Savings Incentive Match Plan for Employees of Small Employers) IRA is a retirement savings plan designed specifically for small employers. A SIMPLE IRA is an IRA-based plan with ease of use features intended to encourage small employers, which may otherwise not offer a retirement plan, to create a retirement plan.
Generally, any business with 100 or fewer employees can establish a SIMPLE IRA. If an employer establishes a SIMPLE IRA plan, all employees of the employer who received at least $5,000 in compensation from the employer during any two preceding calendar years (whether or not consecutive) and who are reasonably expected to receive at least $5,000 in compensation during the calendar year, must be eligible to participate in the SIMPLE IRA. For purposes of the 100-employee limitation, all employees employed at any time during the calendar year are taken into account
SIMPLE IRAs must be established under a written plan agreement. All employees must be notified about the SIMPLE IRA plan. Generally, employees must be informed about his or her opportunity to make or change a salary reduction choice under the SIMPLE IRA plan and the employer’s decision to make either matching contributions or nonelective contributions. Employees are always 100 percent vested in a SIMPLE IRA.
Salary reduction contributions
SIMPLE IRAs are subject to important limits on salary reduction contributions. The limit is $11,500 for 2012. However, employees age 50 or over may make so-called $2,500 “catch-up” contributions for 2012.
Employers have two choices in determining their contributions to a SIMPLE IRA plan:
- A two percent nonelective employer contribution, where employees eligible to participate receive an employer contribution equal to two percent of their compensation (limited to $245,000 per year for 2012 and subject to cost-of-living adjustments for later years), regardless of whether the employee makes his or her own contributions.
- A dollar-for-dollar match, up to three percent of compensation, where only the participating employees who have elected to make contributions will receive an employer contribution (this is called a matching contribution).
Each year, employers can choose which one they will use for the next year’s contributions. This choice must be communicated to employees. Owners of small businesses can use SIMPLE IRA plans as vehicles for retirement savings for themselves without reference to how many of their employees actually participate, as long as the employees are given the option.
The three percent matching contribution applies if the employee has made a contribution. In contrast, the two percent nonelective contribution applies even if the eligible employee did not make a contribution.
Let’s look at an example: Jacob, age 29, has worked for his employer for five years. This year, the employer established a SIMPLE IRA plan for Jacob and its other 44 employees. The employer will match contributions made by Jacob and the other employees dollar-for-dollar up to three percent of each employee’s compensation. Jacob contributes three percent of his yearly compensation to his SIMPLE IRA (three percent of $40,000 or $1,200). His employer’s matching contribution is also $1,200. The total contribution to Jacob’s SIMPLE IRA is $2,400.
The three percent limit on matching contributions may be reduced for a calendar year at the election of the employer, but only if the limit is not reduced below one percent; the limit is not reduced for more than two years out of the five-year period that ends with (and includes) the year for which the election is effective; and employees are notified of the reduced limit within a reasonable period of time before the 60-day election period during which employees can enter into salary reduction agreements. If an employer fails to satisfy the contribution rules, the SIMPLE IRA plan is in jeopardy of losing its tax benefits for the employer and all participants.
If you have any questions about matching contributions to SIMPLE plans or how to set up a SIMPLE plan, please contact our office at (908) 725-4414.