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A SIMPLE IRA plan is an IRA-based retirement plan designed for small businesses. The employer adopts the SIMPLE IRA plan. The employer notifies the employees to open a SIMPLE IRA where they wish. The employee chooses an amount to defer from their paychecks up to $11,500 per year, or $14,000 if the employee is age 50 or older.  Their deferred amount is not counted as income so taxable income is less thus lowering their tax bill.  Distributions from the SIMPLE IRA will be subject to ordinary income tax and may be subject to a federal additional tax if the distribution is made prior to age 59½. 

The employer must choose one of two kinds of contribution:

  • A matching contribution of $1 for each $1 the employee contributes up to 3%. For example, suppose employees Jack and Matt each earned $20,000. 3% of compensation for each is $600. Jack puts in the full $11,500, so the employer matches $600. Matt, however, puts in only $500. The employer only has to contribute $500 to Matt’s SIMPLE IRA.
  • There is some flexibility to reduce the match to 1%.
  • A 2% contribution for every covered employee, whether they contributed or not.
  • To provide a reduced match or a 2% non-elective contribution, the employer must provide a timely notice to employees and may have to meet other requirements.
  • To calculate the employer contribution, the employer must use the compensation the employee earned during the entire year, even if the plan is not established by January 1.

The employer can deduct its contribution to its employees’ accounts. 

The plan must cover eligible employees even if they are older than age 70½.

If the employer adopts a SIMPLE IRA plan, it is the only retirement plan they can have for the year.

Planning tip:

The SIMPLE IRA plan may be of particular interest for two kinds of business owners:

  • An employer with several employees that wants to offer a low-cost retirement plan but wants most of the contributions to come from the employees themselves.
  • A person who is self-employed who has low earnings (less than $40,000) but wants to make a relatively high contribution. The SIMPLE IRA plan will allow a higher contribution than a SEP IRA plan, without the cost of a 401(k) plan or defined benefit plan.

Once funds are in a SIMPLE IRA they are subject to SIMPLE IRA rules.

  • The employee cannot add other traditional IRA contributions or rollovers from any account other than a SIMPLE IRA.
  • The employee can’t roll funds out of the SIMPLE IRA (except to another SIMPLE IRA) for two years.
  • Any distribution from a SIMPLE IRA during the first two years of participation is subject to an additional 25% federal tax, unless an exception applies.

In other respects the SIMPLE IRA follows the traditional IRA rules. For example, the owner must begin required minimum distributions (RMDs) by April 1 of the year after age 70½.

You may ask questions in the comments or contact me privately here:

Tim Barton

Chartered Financial Consultant

 

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