As an employer with 100 or fewer employees, you have the ability to establish a simple and cost-effective retirement plan for you and your staff. There are a few options available, but one you may want to consider is the Savings Incentive Match Plan for Employees, commonly known as a SIMPLE IRA. This plan type is an attractive recruiting and retention tool for highly compensated employees who are deterred from traditional 401(k) plans due to discrimination testing.
What Is a SIMPLE IRA?
A SIMPLE IRA is an employer-sponsored IRA set up for employees. Contributions to the plan can be made by employees and the employer.
Who Can Set Up a SIMPLE IRA?
This type of IRA is suitable for corporations, partnerships, sole proprietors, and tax-exempt or government employers with 100 or fewer eligible employees.
Features of a SIMPLE IRA
- SIMPLE IRAs are low-cost plans that are easy to establish and maintain because there are minimal IRS filing requirements and no annual compliance tests.
- Unlike some other retirement plans, SIMPLE IRAs are not required to follow certain Internal Revenue Code rules that prohibit discrimination in favor of higher-paid workers.
- Employers must make the plan available to any employee who received at least $5,000 in compensation during any two preceding years and who is expected to receive at least $5,000 in compensation during the current calendar year.
- Employee deferrals and employer matching contributions are made to the account. Employers have the option of contributing employee deferral matches or non-elective contributions.
Maximum Annual Contribution Limits and Rules
| 2023 | 2024 | |
|---|---|---|
| Maximum annual contribution limit | $15,500 | $16,000 |
| Catch-up contribution limit for individuals age 50 and older | $3,500 | $3,500 |
| Annual compensation limit | $330,000 | $345,000 |
Employers are required to contribute to employee plans and can select from one of two options:
- Match each employee’s salary deferral on a dollar-for-dollar basis up to 3 percent of the employee’s annual compensation (not limited by the annual compensation limit).
- Make nonelective contributions of 2 percent of the employee’s annual compensation up to the annual compensation limit as set by the IRS.
The first is a mandatory match for only those employees who make salary deferrals into the plan while the second is mandatory for all eligible employees, regardless of whether they contribute to the plan.
* Starting in the 2024 plan year, for employers with 25 employees or less, the deferral amount is increased by 10 percent to $17,600 ($21,450 if age 50 or older). Employers with more than 25 employees must either increase the match to 4 percent or increase the non-elective contribution to 3 percent for deferral limits to increase by 10 percent. Employers may make additional non-elective contributions not to exceed the lesser of 10 percent of compensation or $5,000.
Important Considerations
Please keep in mind that no other retirement plan can be offered concurrently with a SIMPLE IRA.
SIMPLE IRAs also have a unique two-year rule that prevents assets from being distributed or rolled over too soon. For a participant younger than 59½ without a premature penalty exception (see below), the 10 percent premature penalty increases to 25 percent if it’s been fewer than two years since the first employer contribution was made into the account. If the participant is older than 59½ and within the two-year timeframe, no penalty applies.
Lastly, SIMPLE IRAs can be rolled into other SIMPLE IRAs only within the two-year timeframe. Any rollovers into other types of retirement plans, such as traditional IRAs, SEP IRAs, and 401(k)s, can be made only after two years.
Distribution Rules
SIMPLE IRA distribution rules generally are the same as traditional IRA rules, with the exception of the two-year rule. Distributions are taxed at current income tax rates in the year of distribution. If the employee is younger than 59½, the premature distribution penalty of 10 percent may apply (25 percent if within the two-year rule). Exceptions to the premature penalty are as follows:
- Reaching retirement age of 59½
- Death of participant
- Disability of participant
- Qualified higher-education expenses
- Qualified first-time home purchase (up to $10,000 per lifetime)
- Unreimbursed medical expenses (greater than 10 percent of adjusted gross income; 10 percent if younger than 65)
- Health insurance premiums paid while unemployed
- Series of substantially equal periodic payments (e.g., SEPP or 72(t) plan)
For employees ages 73 and older, required minimum distributions must be taken annually, even if they are still working.1
Getting Started
Required documents vary by institution but usually include an adoption agreement and IRS Form 5305 or 5304. Form 5305 means the entire plan and all participant SIMPLE IRAs are established at one institution, whereas Form 5304 allows the accounts to be established at different institutions. A SIMPLE IRA must be established between January 1 and October 1 of the calendar year. A 60-day notice must be given to all eligible employees, offering them the right to make a salary deferral contribution for the year or to modify a previous election.
SIMPLE IRAs offer a way to take advantage of the benefits of a qualified retirement plan for your employees without having to deal with the complicated tests and filings required to maintain one. They are a great incentive for your employees and a great way to save for your retirement!
1 If the account owner turned age 70½ before January 1, 2020, RMDs must begin at age 70½. If they turned 72 before January 1, 2023, RMDs must begin at 72.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Authored by Commonwealth Financial Network. © 2023 Commonwealth Financial Network®