Retirement Planning Information

Savings Incentive Match Plans For Employees of Small Employers

A Small Business Retirement Savings Advantage

Introduction

Small businesses have a new vehicle to help their employees save for retirement. Called the SIMPLE plan—Savings Incentive Match Plan for Employees of Small Employers—it gives businesses with 100 or fewer employees an affordable way to offer retirement benefits through employee salary reductions and matching contributions (similar to those found in a 401(k) plan).

SIMPLE plans are authorized by the Small Business Job Protection Act of 1996. They offer employees of small businesses—which comprise over 38 percent of the nation's private workforce—a convenient and inexpensive way to save. Having a SIMPLE plan may also offer another advantage: It can provide small employers with a new incentive to attract and retain qualified employees in a competitive environment.

A SIMPLE plan is ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a retirement plan. Some advantages are:

• Eligible employees can contribute up to $6,000 each year through convenient payroll deductions.

• Employers offer matching contributions equal to employee contributions (up to 3 percent of employee wages) or fixed contributions equal to 2 percent of employee wages.

• SIMPLE plans eliminate many of the administrative costs associated with larger retirement plans.

• Model plan documents, employee notices and salary reduction agreements are available from the IRS.

This booklet highlights the basic features and requirements of SIMPLE plans that involve individual retirement accounts or annuities (SIMPLE IRAs). It does not address SIMPLE 401(k) plan arrangements.

Which Employers Can Start SIMPLE Plans

• Any employer with no more than 100 employees who earned $5,000 or more during the preceding calendar year is eligible to establish a SIMPLE plan.

• However, an employer that currently sponsors another retirement plan generally cannot sponsor a SIMPLE plan.

• SIMPLE plans can be sponsored by most types of organizations, including C-corporations, S-corporations, partnerships and sole proprietorships. Related employers (businesses under common control, for instance) are treated as a single employer.

• A tax-exempt employer or governmental entity may start a SIMPLE plan as long as the basic requirements are met.

An added note for employers establishing a SIMPLE plan: When employers start these plans, they have two options as to where the contributions are deposited:

• The employer may choose the financial institution that will receive all contributions under the plan. In this case, employees will have a right to transfer contributions to a SIMPLE IRA at another financial institution without cost or penalty.

• Each employee may make the initial choice of financial institution to receive contributions. In this case, an employee does not have the right to transfer to another financial institution without cost or penalty.

Who Can Participate in SIMPLE Plans

SIMPLE plans can be considered an across-the-board savings opportunity since they allow most employees to participate. Small business owners also can take part as owner/employees. Here are the key participation rules:

• Employees who are reasonably expected to receive at least $5,000 in compensation from their employer during a calendar year and who did so in any 2 preceding years must be eligible.

• Employers can increase the number of employees eligible to participate by lowering the amount an employee must earn (for example, from $5,000 to $3,000) or by allowing all employees to participate regardless of how much they earn.

• Employees covered by a collective bargaining agreement for which retirement benefits were part of good-faith bargaining may be excluded from SIMPLE plan participation.

SIMPLE Plans Contributions

SIMPLE plans offer small businesses the opportunity to join millions of other employers who have established retirement plans. In addition, they allow some flexibility in the type of contributions employers provide to employees.

• Employees contribute to SIMPLE plans by agreeing to a salary reduction from each paycheck; they can contribute up to $6,000 a calendar year.

• Generally, contributing employees receive a matching contribution equal to their salary reduction contribution (up to 3 percent of their pay).

• Alternatively, employers may contribute a "nonelective" or fixed contribution of 2 percent of pay for eligible employees.

• Employers also may reduce the matching contribution amount to a limit of one percent of compensation, but certain restrictions apply to this choice.

• Contributions are transferable to another SIMPLE IRA tax-free in a trustee-to-trustee transfer. (Trustees are the financial institutions that handle SIMPLE IRAs).

• However, there is a 2-year waiting period after the date the employee first enrolls in a SIMPLE plan to transfer tax-free his or her contribution to another IRA other than a SIMPLE IRA. Until this 2-year period expires, any transfer from a SIMPLE IRA to an IRA other than a SIMPLE IRA will incur tax consequences.

• All contributions made under a SIMPLE plan are fully vested—that is, all contributions by the employer and the employee immediately belong to the employee.

Employee Elections

SIMPLE plans operate on a calendar year basis, except that an employer may initially set up a SIMPLE plan effective as late as October 1 of the calendar year. Employees must be given the chance to enter into a SIMPLE plan salary reduction agreement at least once a year. Election periods must be at least 60-days long, and employees must receive notice about an upcoming enrollment opportunity prior to the election period.

Other election features:

• Each annual election period immediately precedes January 1 of that calendar year (i.e., November 2 to December 31), except that there is more flexibility with the election period requirement when a SIMPLE plan is initially established.

• During the election period, employees can make a new salary reduction agreement or modify a prior agreement.

• Employees must receive a copy of the plan's "summary description" when they receive notice about the election period.

• Employees may elect to terminate their salary reduction contributions to a SIMPLE plan at any time. However, if they end a salary reduction agreement at a time other than a designated election period, employers may preclude them from participating again until the beginning of the next calendar year.

• In certain cases, employees may also use the election period to select the financial institution they wish to receive their SIMPLE IRA contributions.

Notification Requirements

When employers give each year's notice about the enrollment period, they must:

• Provide a copy of the summary description of the terms of the plan. This may be accomplished by providing a completed copy of IRS Forms 5304-SIMPLE or 5305-SIMPLE (including the financial institution's procedures for withdrawal), if the employer used these IRS-approved forms to establish its SIMPLE plan.

• Include information about the method the employer will use in contributing to employees' SIMPLE IRAs, for example, whether the method will be to match employee contributions up to 3% of their pay or another authorized method.

• Notify employees that they can choose their own financial institution to serve as trustee for their SIMPLE IRA. Or, if the employer chooses the financial institution to receive contributions for all employees under the SIMPLE plan, notify employees that they have the right to transfer contributions to a SIMPLE IRA at another financial institution without cost or penalty.

There are two additional facets of notification employers should consider:

• Employers may provide additional or longer periods of election time to their employees (for instance, extend the election period to 90 days or provide quarterly or semi-annual election periods).

• There are substantial penalties for failure to notify employees before an election period.

Trustee Requirements

Choosing a financial institution to maintain employees' SIMPLE IRAs is one of the most important decisions employers or employees will make. Trustees work closely with employers to receive contributions, invest them and issue certain required information.

For SIMPLE plan purposes, only these institutions can be designated as trustees: banks, savings and loan associations, insured credit unions, insurance companies (that issue annuity contracts), or IRS-approved non-bank trustees.

Trustees must agree to:

• Accept and deposit contributions.

• Prepare and provide the employer with a summary description each year that includes:

1. The name and address of the employer and trustee

2. A description of eligibility requirements

3. The benefits provided

4. The time and method of making salary elections; the procedure for and effects of withdrawals and rollovers (including the penalties for early withdrawals)

• The requirement that the trustee provide the employer a summary description may be satisfied by providing the most recent copy of IRS Forms 5304-SIMPLE or 5305-SIMPLE (if these forms are used to establish the SIMPLE plans), along with the financial institution's procedures for withdrawals and transfers. Timing is important, because substantial penalties maybe imposed and employers depend on receiving summary descriptions in time to notify employees of each year's election period.

There are three additional trustee requirements:

• Within 30 days after the close of each calendar year, the trustee must provide each individual on whose behalf an account is maintained with a statement of the account balance and activity during the year.

• The trustee reports SIMPLE IRA information to the IRS, the same as it does with any IRA account.

• A trustee that is a "designated financial institution" by agreement with the employer also agrees to transfer, upon request, an individual's SIMPLE IRA balance to another IRA or SIMPLE IRA without cost or penalty to the participant.

How to Start SIMPLE Plans

Eligible employers can start a SIMPLE plan by using IRS Form 5304-SIMPLE, IRS Form 5305-SIMPLE or by using an IRS-approved alternative form provided by a financial institution. While IRS Forms 5304-SIMPLE and 5305-SIMPLE are similar, there is the following difference: Form 5304-SIMPLE is to be used by employers whose employees select their own financial institutions to accept SIMPLE plan contributions; Form 5305-SIMPLE is to be used by employers who wish to designate the financial institution that will receive all SIMPLE plan contributions.

Copies of both forms are available from IRS field offices located throughout the country and listed in the phone directory under the Federal Government, Internal Revenue Service. Financial institutions may also be able to provide IRS-approved alternative forms.

As with all retirement savings vehicles, employers may wish to discuss the specifics of this new savings plan with a tax advisor or attorney.

Frequently Asked Questions

Can an employee who has more than one employer participate in a SIMPLE plan sponsored by one employer while contributing to the plan of a different employer?

Yes, employees can participate in the retirement savings plans of more than one employer. However, there are limits on the employee's combined salary reduction-type retirement savings contributions during a calendar year.

Does an employee have the right to terminate a salary reduction agreement outside of a SIMPLE plan's normal election period?

Yes, an employee may terminate the agreement at any time. However, a SIMPLE plan may provide that an employee who ends a salary reduction agreement at times other than those specified is not eligible to resume participation again until the next calendar year.

How can employers make fixed-amount contributions instead of matching contributions?

Employers can make fixed-amount contributions equal to 2 percent of each eligible employee's pay by notifying eligible employees, within a reasonable time before the 60-day election period, that the 2 percent fixed-amount contribution will be made.

When must an employer deposit employee contributions under a SIMPLE plan that involves SIMPLE IRAs?

An employer must forward employee contributions to the financial institution as soon as they can reasonably be segregated from the employer's general assets, but in no event later than 30 days following the month in which they were withheld from the employee's paycheck.

When must an employer make matching and fixed-amount contributions under a SIMPLE plan that involves SIMPLE IRAs?

An employer's contribution must be made to the selected financial institution no later than the due date for filing the employer's tax return (including extensions) for the employer's tax year for which the contribution was made.

What if money is withdrawn from a SIMPLE IRA before an employee turns age 59½?

Generally, employees who withdraw funds before age 59½ may have to pay a 10 percent tax on any withdrawals, in addition to any regular income tax. However, if the withdrawal occurs during the employee's first 2 years of participation, the additional tax is increased to 25 percent