SIMPLE IRAs

A SIMPLE (Savings Incentive Match Plan for Employees) IRA is a salary reduction retirement plan that allows higher contributions than the traditional or the Roth IRA but it is much easier to set up than other retirement plans, making it more suitable for small employers who want to offer their employees a retirement plan. In fact, many financial institutions offer SIMPLE IRA plans preapproved by the IRS, so employers and the self-employed can simply choose the best plan offered by these institutions. Although financial institutions simplify the administration of SIMPLE IRAs, the employer has a duty to monitor the trustee to ensure that the IRS rules are being followed and that fees are reasonable. The SIMPLE IRA is set up under a salary reduction agreement between the employer and the employees.

A SIMPLE 401(k) plan is also available, which is easier to set up and maintain than a 401(k) plan, and nondiscrimination tests are more easily satisfied.

Since 2023, Roth SIMPLE IRAs are an available option. These accounts are like Roth IRAs. Contributions are not tax-deductible, but distributions of both earnings and contributions are tax-free. Moreover, there is no required minimum distribution for these accounts. The tax code now refers to the original SIMPLE IRA as the traditional SIMPLE IRA to distinguish it from the Roth version.

The maximum salary reduction contribution is adjusted for inflation:

Employers must make a matching contribution or a flat contribution that is a percentage of the employee's salary. The IRA must be on a calendar-year basis. A self-employed individual may also set up a SIMPLE IRA.

Setting Up the SIMPLE IRA

An employer can set up a SIMPLE IRA if, in the previous calendar year, the employer had no more than 100 employees, who earned at least $5000 and the employer does not maintain any other retirement plan unless an alternate retirement plan is for employees under a collective-bargaining agreement.

In counting the number of employees for the 100 employee test, all employees subject to the control of the employer are counted, even if the employees are employed by 2 or more separate businesses and even if each business has fewer than 100 employees. An employer who has satisfied the 100 employee test, but later grows to the point where the test is no longer satisfied, then the employer has a 2-year grace period in which to continue contributions.

Employers that do not have a qualified retirement plan can use Form 8881, Credit for Small Employer Pension Plans Startup Costs to claim the tax credit, which is part of the general business credit, for the administrative costs of setting up pension plans, profit sharing plan, 401(k) plan, set, or a SIMPLE IRA. The credit is a maximum of $500 for 50% of the 1^st $1000 spent to set up the retirement plan, for costs incurred in the year in which the plan takes effect and for the subsequent 2 years. To claim the credit, at least one non-highly compensated employee must be covered.

A self-employed individual may set up a SIMPLE IRA if minimum compensation requirements are met. Self-employed taxpayers who elected to exempt their income from self-employment tax on religious grounds under IRC §1402(g) may base their retirement plan contributions on the exempted income.

Any employee must be permitted to contribute to a SIMPLE IRA for any year in which compensation is expected to be at least $5000, but only if $5000 was received in any 2 prior years, whether those years were consecutive or not. All employees who satisfy the $5000 test must be allowed to contribute, even if they're in different businesses set up by the employer. However, employees can be excluded if they receive retirement benefits through a collective-bargaining agreement or if they are nonresident alien employees. The employer may choose to lower or eliminate the $5000 requirement so that more employees are eligible, but no other restrictions on eligibility, such as hours worked or age, are allowed.

So that employees can understand the benefits of the plan, and their rights and responsibilities under the plan, the employer must provide 2 disclosure documents: a summary description and an annual election notice. The summary description is usually provided by the financial institution providing the plan or either of the IRS model forms can be used. The summary description must include:

• the names and addresses of both the employer and the trustee
• eligibility requirements
• a description of the benefits
• the time and procedure for making salary elections
• the procedure for withdrawals and rollovers, and any resulting effects, such as the assessment of early withdrawal penalties.

The annual election notice must be provided annually, which describes the right to make the salary reduction contributions and the employer's choice for making either matching or nonelective contributions.

Employees can stop contributions at any time during the year, and if they do so, then they cannot resume until the next calendar year. However, an employer making nonelective contributions must continue to make contributions for those employees.

If the employer wants to terminate the SIMPLE IRA, then both the financial institution administering the plan and the employees must be notified of the termination. However, the IRS need not be notified.

When establishing a new SIMPLE IRA, the effective date must be between January 1 and October 1. If a SIMPLE IRA has already been set up previously, then any new SIMPLE IRA must become effective on January 1 of a new year. A business that starts after October 1 can establish a SIMPLE IRA for that year if it is done as soon as it is administratively feasible.

Initially the employer chooses the financial institution that will receive the SIMPLE IRA contributions. However, after the initial contributions, employees can choose the financial institution that will receive their individual contributions.

The employer must provide a minimum of 60 days before the new year (November 2-December 31) to allow employees to choose a salary reduction plan or to modify an existing one. Employees must receive a summary description of the financial institution chosen by the employer and must also receive written notice that their balance can be transferred without cost to their own chosen financial institution. Notification must also be provided about whether the employer will make matching contributions or nonelective contributions. For a new employee, the 60-day period is the period preceding the employee's 1^st day of eligibility. An employee has the right to terminate participation at any time during the calendar year, but the plan may prevent the employee from participating again until the beginning of the next calendar year. The employer can choose to give the employees a longer time to make their elections. Quarterly elections can also be provided, with the election period being 30 days before the quarter. The employer must notify the employees of any election to contribute less than 3%, giving a reasonable time before the 60-day period for the employees to make their choices.

Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) — Not for Use with a Designated Financial Institution allows each employee to choose her financial institution that will receive the SIMPLE IRA contributions. If the employer uses Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) — for Use with a Designated Financial Institution, then the employer designates the receiving financial institution. However the employee must be given a reasonable time every year to transfer the SIMPLE IRA balance to another financial institution without cost or penalty. Neither form is filed with the IRS, but the employer must keep the forms to show which plan was adopted. A minimum notification document is included in Form 5304-SIMPLE or 5305-SIMPLE.

Contributions

The only contributions permitted are elective salary reduction contributions by employees and matching or nonelective contributions by employers. All contributions must be fully vested and nonforfeitable. Contributions can be made for workers older than 73, if they are employed by the employer.

Eligible employees can decide how much to contribute, up to the SIMPLE IRA limit, regardless of compensation. Contributions are excluded from federal tax withholding but not from Social Security and Medicare (FICA) taxes withholding. However, the limit for each employee includes contributions to a SIMPLE IRA, 401(k) plan, 403(b) or other salary reduction plan for the same year. Any excess contributions above the dollar limit are taxable.

Lower income plan participants may also receive a Retirement Savings Contribution Credit (Saver's Credit) of up to $1,000 for a contribution of $2,000.

An employer must make either a matching or a fixed nonelective contribution. A matching contribution is one where the employer matches what the employee contributes, up to a limit of 3% of the employee's compensation. During any 5 year period, the 3% matching limit can be lowered, but not less than 1%, for 2 of those years. If the SIMPLE IRA has existed for less than the full 5 year period, then the employer may elect to contribute no less than 1% during any 2 years of the plan's existence.

The 2% nonelective contribution = 2% of the employee's compensation, up to the annual employee compensation limit:

So, for example, in 2024, the maximum compensation was $345,000, so the maximum 2% nonelective contribution limit is $6900, even if the employee earned more than $290,000. However, there is no compensation limit for the 3% matching contribution except for the annual salary reduction limit. The employer must notify the eligible employees as to which type of contribution will be made prior to the 60-day election period for the employees. The employer must make the contributions by the due date of the employer's tax return + extensions.

An employer can deduct SIMPLE IRA contributions made either during the tax year or, for contributions specifically designated for the previous tax year instead of the current year, by the due date, including extensions of the employer's tax return for that year.

Qualified Student Loan Payments

Qualified student loan payments (QSLPs) may be eligible for matching employer contributions under 401(k), 403(b), or 457(b) plans, or SIMPLE IRA plans, if the plan allows it.

A qualified student loan payment (QSLP) is paid by an employee for an education loan of the employee, employee’s spouse or dependent. The loan must qualify for the student loan interest deduction, to pay for higher educational expenses.

The employee must certify that the payments satisfy QSLP requirements. QSLPs + other employee elective deferrals cannot exceed the maximum annual limit for retirement contributions.

Distributions

The IRA provider reports distributions to both the IRS and the recipients on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. An annual statement, reported on Form 5498, Individual Retirement Arrangement Contribution Information, is also provided to the IRS and recipients.

Distributions from SIMPLE IRAs follow the same tax rules as for traditional IRA distributions. Distributions from a SIMPLE IRA are fully taxable unless they qualify as a tax-free rollover or a direct transfer where the distribution is contributed to another tax-deferred retirement account. A direct transfer is the transfer of money between the trustee of one account to that of another. Just as for the traditional and Roth IRA's, there is a 10% penalty that applies to any distribution that is received before the employee reaches 59½, unless an exception applies. However, during the 1^st 2 years that the employee is enrolled in the SIMPLE IRA, the penalty is 25%; thereafter, the penalty is reduced to the 10% applicable to IRA accounts.

During the 1^st 2 years, a tax-free rollover or direct transfer can only be made from a SIMPLE IRA to another SIMPLE IRA account; thereafter, the tax-free rollover or direct transfer can be made to a SIMPLE IRA, a traditional IRA, qualified plan, 403(b) plan, or a state or local government 457 plan.

The mandatory required minimum distribution rules that apply to regular IRAs also apply to SIMPLE IRAs. Required minimum distributions (RMDs) based on life expectancy must start by April 1 after the participant reaches age 73, even if still employed.

If a traditional IRA, SEP, SIMPLE, 401(k), or 403(b) account is converted to a Roth account, then the account cannot be recharacterized back to a traditional IRA (per Tax Cuts and Jobs Act).