SIMPLE IRA Details

IRA Information

A Savings Incentive Match Plan for Employees (SIMPLE plan) is a written arrangement that provides you and your employees with a simplified way to make contributions to provide retirement income. Under a SIMPLE plan, employees can choose to make salary reduction contributions to the plan rather than receiving these amounts as part of their regular pay. Employers must contribute or match employees as well.

You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year. Under this rule, you must take into account all employees employed at any time during the calendar year regardless of whether they are eligible to participate. Employees include self-employed individuals who received earned income and leased employees.

Matching employer contributions Generally, your employer must make matching contributions to your SIMPLE IRA in an amount equal to your salary reduction contributions. These matching contributions cannot be more than 3% of your compensation for the calendar year.

The SIMPLE IRA can be an individual retirement account or an individual retirement annuity.

In addition to salary reduction contributions, your employer must make either matching contributions or nonelective contributions. See How Are Contributions Made?, later.

Eligible Employees
You must be allowed to participate in your employer's SIMPLE plan if you received at least $5,000 in compensation from your employer during any 2 years prior to the current year, and are reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made. The term employee includes a self-employed individual who received earned income.

Excludable employees. Your employer can exclude the following from the plan:

Employees whose retirement benefits are covered by a collective bargaining agreement (union contract).
Employees who are nonresident aliens and received no earned income from sources within the United States.
Employees who would not have been eligible employees if an acquisition, disposition, or similar transaction had not occurred during the year.

Employee compensation. For purposes of the plan rules, your compensation for a year generally includes the following:

Wages, tips, and other pay from the employer that is subject to income tax withholding
Deferred amounts elected under any 401(k) plans, 403(b) plans, government (section 457(b)) plans, SEP plans, and SIMPLE plans.

Self-employed individual compensation. For purposes of the plan rules, if you are self-employed, your compensation for a year is your net earnings from self-employment (line 4, Section A of Schedule SE (Form 1040)) before subtracting any contributions made to a SIMPLE IRA on your behalf.

How Are Contributions Made?

Contributions under a salary reduction agreement are called salary reduction contributions. They are made on your behalf by your employer. Your employer must also make either matching contributions or nonelective contributions.

Salary reduction contributions. During the 60-day period before the beginning of any year, and during the 60-day period before you are eligible, you can choose salary reduction contributions expressed either as a percentage of compensation, or as a specific dollar amount (if your employer offers this choice). You can choose to cancel the election at any time during the year.

Your employer cannot place restrictions on the contributions amount (such as by limiting the contributions percentage), except to comply with the salary reduction contributions limit, discussed later.

Matching contributions. Unless your employer chooses to make nonelective contributions, your employer must make contributions equal to the salary reduction contributions you choose (elect), but only up to certain limits. See How Much Can Be Contributed on My Behalf?,later. These contributions are in addition to the salary reduction contributions and must be made to the SIMPLE IRAs of all eligible employees (defined earlier) who chose salary reductions. These contributions are referred to as matching contributions.

Matching contributions on behalf of a self-employed individual are not treated as salary reduction contributions.

Nonelective contributions. Instead of making matching contributions, your employer may be able to choose to make nonelective contributions on behalf of all eligible employees. These nonelective contributions must be made on behalf of each eligible employee who has at least $5,000 of compensation from your employer, whether or not the employee chose salary reductions.

One of the requirements your employer must satisfy is notifying the employees that the election was made.

The limits on contributions to a SIMPLE IRA vary with the type of contribution that is made.

Salary reduction contributions. For 1999, salary reduction contributions (employee-chosen contributions) that your employer can make on your behalf under a SIMPLE plan are limited to $6,000.

If you are a participant in any other employer plans during the year and you have elective salary reductions or deferred compensation under those plans, the salary reduction contributions under the SIMPLE plan also are included in the $10,000 annual limit on exclusions 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 $8,000.

You, not your employer, are responsible for monitoring compliance with these limits.

Example 1. In 1999, Joshua was a participant in his employer's SIMPLE plan. His compensation, before SIMPLE plan contributions, was $41,600, or $800 per week. Instead of taking it all in cash, Joshua elected to have 12.5% of his weekly pay ($100) contributed to his SIMPLE IRA. For the full year, Joshua's salary reduction contributions were $5,200, which is less than the $6,000 limit on these contributions.

Under the plan, Joshua's employer was required to make matching contributions to Joshua's SIMPLE IRA. Because the employer's matching contributions must equal Joshua's salary reductions, but cannot be more than 3% of his compensation (before salary reductions) for the year, his employer's matching contribution was limited to $1,248 (3% of $41,600).

Example 2. Assume the same facts as in Example 1, except that Joshua's compensation for the year was $240,000 and he chose to have 2.5% of his weekly pay contributed to his SIMPLE IRA. In this example, Joshua's salary reduction contributions for the year (2.5% times $240,000) were equal to the 1999 limit for salary reduction contributions ($6,000). Because 3% of Joshua's compensation ($7,200) is more than the amount the employer was required to match ($6,000), the employer's matching contributions were limited to $6,000. In this example, total contributions made on Joshua's behalf for the year were $12,000, the maximum contributions permitted under a SIMPLE plan for 1999.

Matching contributions less than 3%. Your employer can reduce the 3% limit on matching contributions for a calendar year, but only if:

The limit is not reduced below 1%,
The limit is not reduced for more than 2 years out of the 5-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 they can enter into salary reduction agreements.

For purposes of applying the rule in item (2) in determining whether the limit was reduced below 3% for the year, any year before the first year in which your employer (or a predecessor employer) maintains a SIMPLE IRA plan will be treated as a year for which the limit was 3%. If your employer chooses to make non-elective contributions for a year (discussed next), that year also will be treated as a year for which the limit was 3%.

Nonelective employer contributions. If your employer chooses to make nonelective contributions, instead of matching contributions, to each eligible employee's SIMPLE IRA, contributions must be 2% of your compensation for the entire year. For 1999, only $160,000 of your compensation can be taken into account to figure the contribution limit.

Your employer can substitute the 2% nonelective contribution for the matching contribution for a year, only if:

Eligible employees are notified that a 2% nonelective contribution will be made instead of a matching contribution, and
This notice is provided within a reasonable period during which employees can enter into salary reduction agreements.

Example 3. Assume the same facts as in Example 2, except that Joshua's employer chose to make non-elective contributions instead of matching contributions. Because the employer's nonelective contributions are limited to 2% of up to $160,000 of Joshua's compensation, the employer's contribution to Joshua's SIMPLE IRA was limited to $3,200 for 1999. In this example, total contributions made on Joshua's behalf for the year were $9,200 (Joshua's salary reductions of $6,000 plus the employer's contribution of $3,200).

When Can I Withdraw or Use Assets?

Generally, the same distribution (withdrawal) rules that apply to traditional IRAs apply to SIMPLE IRAs.

Your employer cannot restrict you from making withdrawals from a SIMPLE IRA.

Are Distributions Taxable?
Generally, distributions from a SIMPLE IRA are fully taxable as ordinary income. If the distribution is a premature distribution, it may be subject to the additional tax on premature distributions. See Additional Tax on Premature Distributions (Early Withdrawals), later.

Rollovers and Transfers Exception

Generally, rollovers and trustee-to-trustee transfers are not taxable distributions. See Two-year rule, next.

Two-year rule. To qualify as a tax-free rollover (or a tax-free trustee-to-trustee transfer), a rollover distribution (or a transfer) made from a SIMPLE IRA during the 2-year period beginning on the date on which you first participated in your employer's SIMPLE plan must be contributed (or transferred) to another SIMPLE IRA. The 2-year period begins on the first day on which contributions made by your employer are deposited in your SIMPLE IRA.

After the 2-year period, amounts in a SIMPLE IRA can be rolled over or transferred tax free to an IRA other than a SIMPLE IRA.

Additional Tax on Premature Distributions (Early Withdrawals)

The additional tax on premature distributions applies to SIMPLE IRAs. If a distribution is a premature distribution and occurs during the 2-year period following the date on which you first participated in your employer's SIMPLE plan, the additional tax on premature distributions is increased from 10% to 25%.

Also, if a rollover distribution (or transfer) from a SIMPLE IRA does not satisfy the 2-year rule, and is otherwise a premature distribution, the additional tax imposed because of the premature distribution is increased from 10% to 25% of the amount distributed.

Compiled and edited from IRS information

IRA Information