A relative newcomer to the retirement plan market, the SIMPLE IRA can be a cost-effective retirement planning alternative for small employers and their employees.
A SIMPLE IRA plan consists of a deferral program for eligible employees, along with mandatory contributions by employers. An eligible employer is defined as an employer who has no more than 100 employees that received at least $5,000 in compensation from the employer in the preceding calendar year. An employer maintaining a SIMPLE plan may not maintain any other qualified retirement plan in which employees currently receive benefits.
What makes the SIMPLE IRA so attractive to business owners is their ability to defer the maximum ($13,500 for 2020) without regard to employee participation. There is no ADP test, which limits how much an employer may defer based on average deferrals of non-highly compensated employees. Also, there is no top-heavy testing, which in other plans requires contributions to all eligible employees when the plan is deemed too heavy.
Employees are eligible to make deferrals if they receive at least $5,000 in compensation from their employer during any two preceding years, and they are reasonably expected to receive at least $5,000 in compensation for the current year.
Participants can defer up to $13,500 for 2020 with no set maximum percentage of compensation and elect to defer a specified percentage of compensation as opposed to a dollar amount. In addition, for the tax year 2020, individuals born before 1970 will be allowed to contribute an additional $3,000.
There is a trade off for allowing flexible deferrals. The employer is required to make a fully vested contribution by either:
Matching elective deferrals dollar-for-dollar up to three percent or
Contributing two percent of compensation to all eligible employees, regardless of elective salary deferral (limited to the current compensation cap for the year – $285,000 for 2020).
Employees are allowed to terminate deferrals at any time during the year and depending on the plan provisions, may or may not be able to re-initiate deferrals again that same year.
Be mindful that participants who take withdrawals from a SIMPLE IRA prior to age 59½ are generally subject to the same 10% early withdrawal penalty applies to IRAs. However, participants who withdraw SIMPLE IRA contributions during the two years, beginning with their initial participation date, will be assessed a 25% penalty tax.
A SIMPLE IRA plan distribution may be rolled over to a regular IRA account, but only after the employee has participated in the SIMPLE IRA for at least two years. Keep in mind neither IRA assets nor any other retirement plan assets may ever be rolled into a SIMPLE IRA.
This article is meant to provide an overview of the basic provisions of the SIMPLE IRA plan. For a more complete understanding of this plan and opportunities for your business, speak with your Financial Advisor.