Setting up a SIMPLE IRA Retirement Plan.
SIMPLE stands for Savings Incentive Match Plan for Employees.
The SIMPLE IRA
The SIMPLE IRA is a pretax deduction for Federal and State Income tax purposes; however, it is not a pretax deduction for Social Security and Medicare taxes. In order to have a SIMPLE IRA, the employer must have one hundred employees or less and may not maintain another qualified plan unless the other plan is pursuant to a collective bargaining agreement with collective bargaining employees.
Eligibility
Employees eligible to participate are any employee who receives at least $5,000 in compensation during any two years proceeding the current calendar year and is reasonably expected to receive at least $5,000 during the current calendar year. The term “employee” includes a self-employed individual who received earned income. The employer can use less restrictive requirements but not more restrictive requirements. The following employees do not need to be covered under a SIMPLE IRA plan: 1. Employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees’ union and you, and 2. Nonresident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from you.
Plan Form and Notification
The SIMPLE IRA plan must be written. You can use IRS Form 5304-SIMPLE or IRS Form 5305-SIMPLE or another document that meets plan and disclosure requirements. The SIMPLE IRA plan may become effective on any date between January 1st through October 1st provided you did not previously maintain a SIMPLE IRA plan. If you did previously maintain a SIMPLE IRA plan the subsequent one may only become effective on January 1st. If you are a new employer, you may set up the plan as soon as it becomes administratively feasible.
SIMPLE IRAs are individual retirement accounts or annuities into which contributions are deposited. A SIMPLE IRA must be set up for each eligible employee. A trust document must be completed for each participating employee and the IRS has created Form 5305-S and 5305-SA to satisfy these requirements.
The deadline for setting up an IRA would be before the first date by which a contribution is required to be deposited into the employee’s IRA.
When you adopt a SIMPLE IRA plan, you must notify each employee of the following information before the beginning of each election period.
1. The employee’s opportunity to make or change a salary reduction choice under a SIMPLE IRA plan.
2. Your choice to make either matching contributions or non-elective contributions.
3. A summary description provided by the financial institution.
4. Written notice that his or her balance can be transferred with cost or penalty if you use a designated financial institution.
The election period is generally the 60-day period immediately proceeding January 1 of a calendar year.
Contributions
Contributions are composed of employee salary reduction contributions and employer contributions. The employer must make either matching or non-elective contributions. The employee can contribute up to $10,500 during 2007. These contributions must be expressed as a percentage of the employee’s compensation unless you permit the employee to express them as a specific dollar amount.
Catch-up Contributions for Employees 50 and Older
Employees who are 50 or older at the end of the calendar year may make catch-up contributions of up to $2,500 in 2007. The catch-up contributions a participant can make in a year cannot exceed the lesser of 1) the catch-up contribution limit ($2,500 in 2007) or 2) the excess of the participant’s compensation over the salary reduction contributions that are not catch-up contributions. In other words, for 2007 your contribution can not exceed the lesser of $13,000 or your compensation.
Employer Matching Contributions
You are generally required to match each employee’s salary reduction contributions on a dollar-for dollar basis of at least 1% and up to 3% of the employee’s compensation. This requirement does not apply if you make non-elective contributions as discussed later. Employees must be notified of the match percentage within a reasonable time before the 60 day election period. You cannot choose a less than 3% for more than 2 years during the 5 year period that ends with (and includes) the year for which the choice is effective.
Instead of matching contributions, you can choose to make non-elective contributions of 2% of compensation on behalf of each eligible employee (not necessarily participating employees) who has at least $5,000 of compensation from you for the year. If you make this choice, you must make non-elective contributions whether or not the employee chooses to make salary reduction contributions. Only $220,000 of the employee’s compensation can be taken into account to figure the contribution limit.
If you choose this 2% contribution formula, you must notify the employees within a reasonable period of time before the 60 day election period for the calendar year.
Time Limits for Fund Contributions
You must make the salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the amounts would otherwise have been payable to the employee in cash. You must make matching contributions or non-elective contributions by the due date (including extensions) for filing your federal income tax return for the year.
When to Deduct Contributions
You can deduct SIMPLE IRA contributions in the tax year with or within which the calendar year for which contributions were made ends. You can deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including extensions) of your federal income tax return for that year.
Tax Treatment of Contributions
You can deduct your contributions and your employees can exclude these contributions from their gross income. SIMPLE IRA plan contributions are not subject to Federal income tax withholding. However, salary reduction contributions are subject to social security, Medicare, and federal unemployment taxes. Matching and non-elective contributions are not subject to these taxes.
SIMPLE IRA Withdrawals
Distributions from a SIMPLE IRA are subject to IRA rules and generally are includible in income for the year received. Tax-free rollovers can be made from one SIMPLE IRA into another SIMPLE IRA. However, a rollover from a Simple IRS to a non-SIMPLE IRA can be made tax free only after a 2 year participation in the SIMPLE IRA plan.
Early withdrawals generally are subject to a 10% additional tax. However, the additional tax is increased to 25% if funds are withdrawn within 2 years of beginning participation.
Effect of a SIMPLE IRA on a Traditional and Roth IRA
Part or all of the IRA contribution may be considered nondeductible if the taxpayer is an active participant in an employer-sponsored pension plan including a SIMPLE IRA. For example, if you filed as Married Filing Joint in 2006 and your modified adjusted gross income (MAGI) exceeded $85,000, you would not be allowed even a partial deduction. If your MAGI were $75,000 or less, you would be allowed a full deduction. If your MAGI is between $85,000 and $75,000, you may be allowed to deduct part of your IRA contribution depending on other factors.
Even if the deduction is limited, the taxpayer can still make a maximum contribution to an IRA. For example, if a taxpayer is limited under active participation rules to a $1,200 IRA deduction, he or she may still contribute the full $4,000 to an IRA account (assuming qualifying compensation of $4,000 or more). The result would be an IRA deduction of $1,200, and a nondeductible IRA contribution of $2,800. Use Form 8606 to report nondeductible IRA contributions.
Roth IRA contributions are never deductable to arrive at taxable income; however, the allowable contribution to a Roth IRA is limited depending on the taxpayers filing status and their MAGI.
