A savings incentive match plan for employees (SIMPLE IRA) allows employees and employers to contribute to an IRA-based plan that is set up for an employees' benefit. With a SIMPLE IRA, employees can defer a portion of their pay, known as salary deferral or salary reduction contributions. The employer makes either a matching or non-elective contribution. All contributions, both from the employee and from the employer, must be deposited into a SIMPLE IRA for each individual employee. The SIMPLE IRA plan is similar to a 401(k) without the required complexity and higher cost of administration.
Only employee salary deferral and employer contributions are allowed into a SIMPLE IRA. Employees can defer a percentage or a set amount from their individual pay during the course of the year. The maximum contribution amount for an employee in 2016 is $12,500. For employees older than age 50, a catch-up contribution of an additional $3,000 can be made, for a total of $15,500. This deferral amount is tax-deferred, similar to a 401(k) plan, so it reduces the taxable income for the employee.
Employers have two options when contributing to the plan. The first is to provide a matching contribution. This is the lesser of the participant's salary deferral or 3% of the participant's compensation. A lesser match (not less than 1%) cannot occur more than two years out of any five-year period. Unlike SEP IRAs, there is no compensation cap when using the match method for contributions.
The other method of contributing is the non-matching method. This amount is a fixed 2% contribution of all eligible employees’ compensation. Unlike the matching contribution method above, this is limited to the $265,000 compensation cap.
SIMPLE IRAs are similar to traditional individual retirement accounts (IRAs) when it comes to distribution rules. Any participants younger than age 59 ½ are subject to the IRS early withdrawal penalty of 10%. However, if this same penalty were to occur within the two-year holding period, the 10% penalty increases to 25%. In addition, any withdrawals made from a SIMPLE IRA would be considered ordinary income and taxed the year it was distributed. Like most other IRA and retirement plans, SIMPLE IRAs are subject to the required minimum distribution (RMD) rules for those who are 70 ½.
To encourage employee savings, SIMPLE IRA plans have a special holding period requirement. During the first two years starting from the date of the first deposit, SIMPLE IRAs can only be commingled (through transfers or rollovers) with other SIMPLE IRAs. After the participant has satisfied this two-year requirement, the balance can be transferred or rolled into other IRAs (such as SEP, SAR SEP, or traditional) or qualified retirement plans, assuming the retirement plan allows for such rollovers. Conversely, funds from a non-SIMPLE IRA account cannot be moved into a SIMPLE IRA regardless of the holding period.
Any employer that has 100 or fewer employees who earned at least $5,000 in the preceding year (via Form W-2) is eligible for a SIMPLE IRA. The employer must not maintain any other employer-sponsored retirement plan where contributions are made during the calendar year in which the SIMPLE plan is effective. New plans must be established anytime between Jan. 1 and Oct. 1 to be eligible for the same calendar year. Employers must also give employees at least 60 days' notification to enroll.
The employer establishes the eligibility requirements for the employees on the plan adoption agreement during the initial plan establishment. All employees who received at least $5,000 in compensation from the employer during any of the previous two years and are expected to continue to receive that amount must be eligible to participate in the plan for the current calendar year. The employer may also elect to exclude employees covered under a collective bargaining agreement as well. Once an employee satisfies these eligibility requirements, he will enter the plan based on the entry date defined within the plan documents.