Over the years, I have had many clients complain about the complexity of setting up and maintaining a retirement plan at work, whether it’s a 401(k), 403(b), 457, or some type of pension plan. When you look at the annual testing, reporting, etc., it becomes just one more thing that can get expensive and require more “attention to details” than you have available in navigating often cumbersome rules. Instead, have you thought about avoiding the complexity of those retirement plans by establishing a SIMPLE IRA? As the name implies, a SIMPLE IRA is just that … far fewer rules to deal with for the small business owner or medium-sized business owner. What’s required and what are the benefits? Let’s look …
Benefits of a SIMPLE IRA retirement plan to a small business owner or medium-sized business owner:
- This retirement plan it’s easy to establish and maintain
- It has lower start-up and annual costs than virtually any other retirement plan
- Contributions and earnings grow tax-free until withdrawn at retirement
- It still attracts and retains quality employees
- The business is not required to file annual financial reports, such as IRS Form 5500
- The business may be eligible for a tax credit of up to $500 per year for the first three years of the plan to help cover costs
Who is eligible to establish a SIMPLE IRA?
Businesses with 100 or fewer employees are eligible, and employees who earned at least $5,000 during the last calendar year are eligible to participate in a SIMPLE IRA retirement plan. Eligible businesses can include state and local governments as well as tax-exempt organizations. One “catch” is that the business cannot presently have another retirement plan in place.
What form must be filled out for a SIMPLE IRA retirement plan?
The IRS has two forms that can be used to establish the SIMPLE IRA plan. The 5304-SIMPLE form is selected if the employees are allowed to choose the financial institution which will receive their retirement plan contributions. The 5305-SIMPLE form is selected if the business requires all retirement contributions to be initially deposited with a specific financial institution. Eligible financial institutions include banks, mutual funds, insurance companies that issue annuity contracts, and other financial institutions that have been approved by the IRS.
Who is a covered in the SIMPLE IRA retirement plan?
There is much more flexibility in determining who is going to participate in the SIMPLE IRA plan. The company can choose to include all of its employees without restriction. Alternatively, the small business owner or medium-sized business owner can limit the employees covered to those who received at least $5,000/year in compensation during the last two years and who are expected to receive at least $5,000 in the current calendar year.
Employee contributions to their SIMPLE IRA
An eligible employee funds their SIMPLE IRA through salary reduction contributions. An employee can contribute up to $12,500 in 2017. Employees age 50 or older are permitted to make an additional “catch-up” contribution of $3,000 in 2017 (i.e., an employee age 50 or more can contribute up to $15,500 for 2017.) After 2017, cost-of-living adjustments will be made to the maximum contribution amount and the catch-up provision.
Small business owner and medium-sized business owner contributions to the SIMPLE IRAs
Here’s where it gets even more interesting … a business owner has two options in determining contributions to the SIMPLE IRA:
- An eligible employee receives an employer contribution equal to 2% (not the 3% required in other retirement plans for a “safe harbor”) of their gross pay, regardless of whether the employee makes their own contribution into the plan. As with any pre-tax retirement plan, the maximum amount of income which can be used for retirement contribution calculation is $270,000 and is adjusted annually for inflation.
- A dollar-for-dollar match up to a certain percentage of compensation for employees who have made contributions to the retirement plan. The business owner match does not have to be more than 3% of pay, which may be reduced to as low as 1% for two out of every five years. An example of a staggered employer match could involve a newly established small business with not much income—the company would match 1% of employee’s pay in years one and two, and then match 3% of pay for the next three years.
Simple doesn’t always mean easy, especially when the government is concerned. But, in this case, the government makes SIMPLE IRAs an easy and painless way for a small business owner or medium-sized business owner to establish a retirement plan, set money aside for themselves, and take care of their longer-term team members.
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Written by R. J. Kelly – January 2018