What is a SIMPLE retirement plan?

By • on June 25, 2010 • Filed under: Articles of Interest

Many potential clients have asked about SIMPLE reirement plans. Below, I will explain them in simple to understand language.

SIMPLE stands for “Savings Incentive Match Plan for Employees” (SIMPLE). It was set up to provide a retirement plan for companies with 100 or fewer employees. It is designed for small companies and for the self-employed, because, as its acronym implies, it is considerably cheaper and easier to administer than a conventional 401(k) or pension plan.

The plan can be set up to operate as a 401(k) plan or as individual IRA plans. From an employee’s perspective, a SIMPLE IRA or SIMPLE 401(k) works much like a traditional 401(k) plan, although with a few restrictions. First, the employer must have no more than 100 employees earning at least $5,000 from the employer in the preceding year. These employees can contribute to the plan up to $11,500 each year, or 100 percent of their total compensation each year, whichever is lower. (The $11,500 limit was as of 2010; it is subject to inflation indexing.) Participating employees who are age 50 or older can elect to make additional catch-up contributions—that is, contributions of more than the specified annual limit—up to $2,500 as of 2010.

Like a conventional 401(k) plan, the contributions are directed into the account on a pre-tax basis. However, while matching employer contributions in 401(k) plans are entirely optional, under a SIMPLE plan, the employer is required to make contributions. Employer contributions to a SIMPLE plan can be made under one of two approved methods:

  1. The employer can choose to match employee contributions, $1 for $1, up to a maximum of 3 percent of the employee’s total compensation. In up to two of every five years, the employer can elect to match a percentage of less than 3 percent, perhaps falling to as little as 1 percent.
  2. The employer can elect to contribute an amount equal to 2 percent of compensation every year for every eligible employee earning more than $5,000 a year—regardless of whether that employee contributes to the plan personally.

As is the case with 401(k) plans, SIMPLE contributions that an employee makes are immediately vested. SIMPLE employer contributions must vest according to one of the following schedules:

  • 100 percent after completing three years of service; or
  • 20 percent each year (beginning with the second year), with 100 percent after six years.

For those who are self-employed, the match is not as attractive as the company match on a conventional 401(k), because the employee must provide the matching funds. However, the match does increase the amount that can be invested on a tax-deferred basis through the SIMPLE plan. SIMPLE plans have withdrawal restrictions that are similar to those of conventional 401(k) plans. In general, withdrawals made before age 59½ are subject to the same 10 percent early withdrawal penalty faced by 401(k) plan participants. One additional difference with SIMPLE plans is the early withdrawal penalty increases to 25 percent if the withdrawal is made within two years of the date the participant first participated in the plan. (Distributions from qualified retirement plans are discussed in more detail in Chapter 10.)

A SIMPLE plan works best for

  • a sole proprietorship with few or no employees;
  • a partnership where only one partner participates;
  • small family businesses that can hire a spouse and children and deduct 100 percent of W-2 up
    to the annual contribution limit;
  • corporations with high turn-over and low plan participation rates;
  • and businesses with 100 or fewer employees.

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