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Retirement Plans For The Self-Employed
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Article 6: SIMPLE-IRA
The SIMPLE-IRA plan is intended to make it easier for small businesses to offer a tax-advantaged, company-sponsored retirement plan for 100 or fewer employees.
SIMPLE-IRA plans are funded by employer contributions, but employees also can choose to make contributions from their salary rather than receiving that money in their paychecks. Employers must contribute matching contributions. Contributions to a SIMPLE-IRA by employers and employees are made in pre-tax dollars.
SIMPLE-IRA plans can be set up as a SIMPLE-IRA or SIMPLE 401(k). Any small business employing 100 or fewer people who earned $5,000 or more in the prior year can establish a plan as long as the employer doesn’t maintain other employer-sponsored retirement plans.
The eligibility rules for employees differ from rules for the company. Eligible employees must have earned at least $5,000 from the employer in any two preceding years and be reasonably expected to earn $5,000 in the current year. Employees can earmark up to $10,000 a year by payroll deduction. Employers can either match those contributions up to 3 percent of an employee’s wage or make a contribution of 2 percent of the employee’s pay.
Small-business owners can save on their business taxes as well as save on personal income taxes by contributing to a SIMPLE-IRA plan by deducting from business expenses any contributions made on behalf plan participants. A special non-refundable tax credit of 50 percent for some expenses up to $500 a year for the first three plan years also may be available.
When the business owner and eligible employees defer part of their salaries into an individual SIMPLE-IRA before taxes are withheld, it reduces their taxable income. Earnings enjoy tax-deferred growth until withdrawn.
Employees can choose to contribute up to 100 percent of compensation up to $10,000 for the year. Those age 50 and older may make an additional annual $2,000 catch-up contribution.
There are two different ways for employers to contribute, and they may switch between them each year. The first is a “matching option” that requires the employer to match each participant’s contributions dollar-for-dollar up to 3 percent of compensation, and up to $10,000. The “non-elective contribution” option requires an employer to contribute 2 percent of each eligible employee’s compensation each year up to $4,200, regardless of whether the participant contributes.
As with a traditional IRA, SIMPLE-IRAs permit participants to withdraw their money at any time. But distributions from a SIMPLE-IRA in the first two years trigger a higher early withdrawal penalty than from traditional IRAs or Roth IRAs.
For the employer, the advantages of a SIMPLE-IRA plan are that it is cost-effective to set up and easy to maintain, with no special reporting or other administrative requirements.
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