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FAQs: Plan Sponsor
- SIMPLE IRA Basics
- Establishment and Termination
- Eligibility and Participation
- Problem Resolution
SIMPLE IRA Basics
Q. What is a SIMPLE IRA retirement plan, and what are its advantages?
A. A SIMPLE IRA plan is a type of salary reduction retirement plan for small businesses. Due to its basic design features, it is not subject to the complex eligibility and testing requirements associated with traditional 401(k) plans or Salary Reduction-Simplified Employee Pension Plans (SARSEPs). Administrative and other plan costs, therefore, are minimized. Another advantage of SIMPLE IRA plans, from an employer's standpoint, is that they are not subject to annual reporting and testing requirements.
Q. How does a SIMPLE IRA plan work?
A. A SIMPLE IRA plan allows employees to make pretax elective contributions to a SIMPLE individual retirement account (IRA). Employee contributions may be any percentage of their compensation (up to 100%), but they cannot exceed $13,500 per year in 2021 ($16,500 if an employee will turn age 50 or older in 2021).
* Annual limit may be indexed in future years for cost-of-living adjustments in $500 increments.
Establishment and Termination
Q. Which employers can adopt a SIMPLE IRA plan?
A. Employers are eligible to adopt a SIMPLE plan if they: 1) employ 100 or fewer employees who each received at least $5,000 in compensation for the preceding calendar year, and 2) do not maintain another employer-sponsored retirement plan. Employers can be corporations, partnerships, sole proprietors, tax-exempt organizations, and state or local governments or agencies.
Q. An employer wants to establish a SIMPLE IRA plan to be effective July 1. Employees will not be able to start their salary deferrals until the first July payroll. Does an employer base its required matching or nonelective contribution on each employee's compensation from July 1 through the end of the year, or the entire year?
A. An employer must use employee compensation for the whole year to determine its required contribution, even if the plan and employee salary deferrals did not start on January 1. Employee compensation for calculating employer contributions to a SIMPLE IRA plan is defined in Internal Revenue Code Section 408(p)(6)(A). An employee's compensation for this purpose is his or her total wages as reported by the employer on IRS Form W-2, Wage and Tax Statement, plus the employee's total salary deferrals made through the SIMPLE IRA plan during the year.
Q. Can an employer terminate his 401(k) and then establish a SIMPLE IRA plan?
A. Yes, but not within the same year. The SIMPLE IRA plan has an "exclusive plan rule" that generally limits it to being the only plan of the employer during any one calendar year. There are exceptions to this rule if the other qualified plan is only for employees covered under a collective bargaining agreement; the other qualified plan is maintained in a year where an employer acquisition, disposition, or similar transaction occurs.
Q. When can an employer terminate a SIMPLE IRA Plan?
A. There is no formal guidance from the IRS or DOL with respect to terminating a SIMPLE IRA plan. However, on the IRS website there is an article concerning this subject. The IRS article dealing with terminating a SIMPLE IRA plan contains the following statement: "A SIMPLE IRA plan can only be terminated prospectively, beginning no earlier than the next calendar year. Contributions must continue until then." The employer must also notify the financial institution and the employees that the SIMPLE IRA will be discontinued "for the next calendar year."
Eligibility and Participation
Q. Who is eligible to participate in a SIMPLE IRA plan?
A. Generally, any employee who received at least $5,000 in compensation from the employer during any two prior calendar years, and who is reasonably expected to receive at least $5,000 in compensation from the employer during the current calendar year, is eligible to participate in a SIMPLE plan. An employer may elect more liberal eligibility rules. All SIMPLE contributions (employee and employer matching) must be fully vested when made.
Q. Can a person who is both an employee of one business and a self-employed owner of another business have a SIMPLE IRA with respect to his or her self-employment income? Does it matter if he or she is a participant in a SEP plan with the other employer?
A. A person who is self-employed can have a SIMPLE IRA for his or her business, assuming all SIMPLE IRA eligibility requirements are met. The fact that this individual is a participant in a SEP plan where he or she is a common-law employee has no effect on any type of plan for the business that he or she owns. If this individual had ownership in both businesses, the controlled group rules under IRC section 414 could have an effect on the coexistence of the two different types of retirement plans. Professional tax or legal guidance is recommended if not required in these situations to ensure compliance.
Q. How do employers calculate the matching contributions for a SIMPLE IRA plan?
A. The employer is generally required to match the employee's elective deferral contributions dollar for dollar, up to 3% of compensation. Therefore, the maximum match for any employee would also be the elective deferral limit. If an employee defers less than 3% of compensation, the employer would still match the employee's deferral on a dollar-for-dollar basis.
Q. Why doesn't Fidelity code contributions for prior year?
A. The instructions on IRS Form 5498 for SIMPLE IRA Contributions instruct preparers to enter any contributions made to a SIMPLE IRA (including salary deferrals and employer matching or nonelective contributions) during the calendar year. The trustee does NOT report based on the employer's tax year "for which" these contributions are being made. The trustee does report the dollar amount of employer SIMPLE contributions paid to this SIMPLE IRA during the year. This amount includes any salary reduction contributions and the employer's matching or non-elective contributions under the SIMPLE plan. No other contributions are permitted into a SIMPLE IRA except salary deferrals, employer matching or nonelective contributions, or rollovers/transfers from another SIMPLE IRA.
Q. How are SIMPLE IRA plan contributions treated for federal income tax purposes?
A. All SIMPLE IRA contributions are tax deductible for the employers. In addition, employee elective deferrals to a SIMPLE IRA account are excluded from an employee's income for federal income tax purposes in the year contributed, and any earnings on the assets of a SIMPLE account may grow on a tax-deferred basis. The employee's pretax contributions are included in income for Social Security (both retirement and Medicare benefits) and unemployment taxes, if applicable. Thus, participation in a SIMPLE IRA plan will not reduce an employee's Social Security benefits.
Q. Does an employer's contribution under a SIMPLE IRA plan have to be made at the same time an employee's salary deferrals are being deposited to his or her SIMPLE IRA?
A. No. An employer maintaining a SIMPLE IRA plan has until the due date of the employer's federal income tax return, plus allowable extensions, to make either their matching contributions or nonelective contribution. An employer could make these contributions during the plan year but, because they are both affected by each employee's total compensation for the year, it may be more practical to make them after the end of the plan year when compensation figures have been finalized.
Q. When should an employer deposit employee salary deferral contributions to an employee's SIMPLE IRA?
A. As a general rule, an employee's salary deferrals must be deposited into his or her SIMPLE IRA as soon as they can be reasonably segregated from the employer's general assets. In no event can this be later than 30 days after the end of the month in which the deferrals were made. The Department of Labor (DOL) includes SIMPLE IRA salary deferrals along with 401(k) salary deferrals in its enforcement of the plan asset rules under ERISA Regulation Section 2510.3-102. The DOL recently issued final guidance establishing a safe-harbor for small plans with 100 or fewer participants (such as SIMPLE plans) where amounts deposited within 7 business days following the day on which they are withheld from wages for contribution purposes are deemed to satisfy the general plan asset rule under ERISA.
Q. An employer with a SIMPLE IRA plan had an employee who did not defer any of his or her salary and terminated his employment prior to earning $5,000. Does the employer need to include this terminated employee when making its elected two percent nonelective contribution?
A. Because eligibility is determined before the start of a plan year, and all eligible employees are required to receive the nonelective contribution, it would appear that the employer is required to make a nonelective contribution to such an employee. The IRS has not provided any guidance on this situation, and you should consult a tax advisor for advice specific to your situation.
Q. An employer with a SIMPLE IRA plan has an employee who was expected to attain the plan's $5,000 compensation level required for eligibility in the plan year. The employee terminated his employment prior to reaching that level. While employed, the employee made elective deferrals. Since the employee did not earn the expected amount, is the employer required to make a matching contribution for this former employee?
A. Yes. An employer that elects to make a matching contribution under its SIMPLE IRA plan must make that matching contribution for each eligible employee who made salary deferrals during the SIMPLE IRA plan year. An eligible employee is an employee who was reasonably expected to have $5,000 in compensation by the end of the plan year. If an employee is deemed to be eligible because of his or her expected compensation and made deferrals during the year, a matching contribution must be made on his or her behalf, even if he or she ceases employment during the year. The SIMPLE IRA matching contribution is a dollar-for-dollar match of an employee's salary deferral contributions, not to exceed three percent of his or her annual compensation.
Q. Can an employer who has a SIMPLE IRA plan for his business change its contribution in the middle of the plan year?
A. No. An employer cannot change either a matching contribution or a nonelective contribution after the 60-day notice period has begun. The annual SIMPLE IRA notification process requires an employer to notify its eligible employees before the beginning of a plan year of its contribution intentions for the coming year. This is a commitment that, once disclosed, cannot be changed without risking the qualified status of the SIMPLE IRA plan. The promise made by the employer may directly affect the salary deferral elections made by its employees, as the promise of larger matching contributions could provide an incentive to elect larger salary deferrals.
Q. How are distributions from a SIMPLE IRA plan taxed?
A. Generally, distributions from a SIMPLE IRA plan are taxed under the rules applicable to IRAs. Distributions from IRAs are taxable as income when taken and may also be subject to a 10% penalty if taken before age 59½. However, for SIMPLE IRAs, a 25% early distribution penalty applies to distributions taken prior to the two-year anniversary of the first contribution deposited into the account (unless the employee is age 59½ or older or another exception applies). After the two-year period, the penalty is reduced to 10%. Direct rollovers may be made from one SIMPLE IRA account to another without incurring income taxes.
Q. Can a SIMPLE IRA account be rolled over to a Traditional IRA?
A. If an employee is no longer making contributions under the SIMPLE IRA plan and two years have passed since a contribution was first deposited into the account, a SIMPLE IRA may be rolled over to a Traditional IRA without incurring income taxes. A SIMPLE IRA account may also be transferred to a SIMPLE IRA account at another financial institution.
Q. How can an employer correct plan deficiencies?
A. In general, the Employee Plans Compliance Resolution System (EPCRS) is a program employers can use to correct certain plan failures to keep the plan from being disqualified and to continue to provide their employees with retirement benefits on a tax-deferred basis. Using EPCRS is voluntary on the part of the employer and cannot be initiated by the financial institution without the employer's written direction. From time to time the IRS updates EPCRS with a revenue procedure. The current revenue procedure governing EPCRS is Revenue Procedure 2008-50.
Q. What happens if an employer over-contributes to a SIMPLE IRA?
A. Generally, an employer contribution that exceeds the applicable matching or non-elective contribution limit is considered to be a nondeductible employer contribution. The IRS has not issued any substantive guidance on whether these amounts can be corrected by the employer. However, under EPCRS, the employer may be able to request a corrective distribution adjusted for earnings to the employer. The employer should consult with legal counsel or a tax advisor for further guidance.