Shara Fischer, Wealth Management Officer
Heartland Trust offers two of the most common types of employer-sponsored retirement plans: 401(k) and SIMPLEs. Both types of plans have many of the same features, but there are key differences that might make one a better fit for your business and employees. This article will cover the features of SIMPLE plans and next quarter we will take a closer look at 401(k) plans.
The Savings Incentive Match PLan for Employees (or SIMPLE) IRA lets you and your employees defer up to $14,000 of compensation in 2022, plus an extra $3,000 if age 50 or older. You promise to either match employee contributions dollar for dollar up to 3% of pay, or make a “nonelective” contribution for all eligible employees, whether or not they contribute, equal to 2% of pay. Note: The 3% of pay match may be reduced to as little as 1% in any two of five years. There is a limit of $305,000 of an employee’s pay can be taken into account when determining contributions in 2022.
Setting up a SIMPLE IRA plan
You can adopt a SIMPLE IRA plan if you have 100 or fewer employees (excluding employees who earned less than $5,000) and you don’t maintain or contribute to any other employer-sponsored retirement plan. If your business qualifies, follow these three simple steps to set up your SIMPLE IRA plan.
Step 1: Adopt a plan document
You can set up a SIMPLE IRA plan by completing either a pre-approved document provided by a financial institution or an IRS model document (either Form 5305-SIMPLE or Form 5304-SIMPLE).
Form 5305-SIMPLE lets you specify the “designated financial institution” that will both act as your plan’s custodian and initially receive all plan contributions. Form 5304-SIMPLE, on the other hand, lets each eligible employee select the financial institution that will serve as custodian and receive all plan contributions.
Step 2: Provide information to your employees
You must provide your eligible employees with the following information before the beginning of each election period:
- An explanation of the employees’ ability to make or change salary reduction elections
- A declaration of whether you’ll make matching contributions or nonelective contributions for the coming year
- A summary description of the plan
- A notice that employees can transfer their account balances to an IRA provider of their choice without cost or penalty, If you use a designated financial institution.
The election period is generally the 60-day period prior to the start of each calendar year (November 2 to December 31). However, the election period will be different if you set up a SIMPLE plan mid-year, or if an employee first becomes eligible after the 60-day period ends. Forms 5304 and 5305 contain most of the documents you’ll need to comply with these notice requirements.
Step 3: Set up employee accounts
A SIMPLE IRA account must be set up by or for each eligible employee, and all contributions to the plan must go into these accounts. In general, you must include all employees who’ve earned at least $5,000 during any two preceding years and who are expected to earn at least $5,000 in the current year.
Advantages of a SIMPLE IRA plan:
- SIMPLE IRA plans are not required to follow certain Internal Revenue Code rules that prohibit discrimination in favor of higher-paid workers. Therefore, even if no employees want to contribute, you can establish a plan, contribute on your own behalf, and provide an employer matching contribution.
- You aren’t required to file reports with the government — only the financial institution holding the IRAs is required to file reports.
- Once your employees exercise control over the assets in their accounts, you are relieved of any fiduciary responsibility.
- Employer contributions can be flexible. You can decide each year whether you want to provide a matching contribution or a nonelective contribution.
- The plan requires minimal paperwork.
- Your business can deduct contributions made to a SIMPLE IRA, whether you’re making contributions for only yourself, or for yourself and your employees.
- The dollars invested are pre-tax dollars and accrue tax deferred. That means that your employees can exclude the contributions from their gross income.
- Income-tax-free rollovers or direct trustee-to-trustee transfers can be made from one SIMPLE IRA to another SIMPLE IRA at any time. A tax-free rollover from a SIMPLE IRA to a traditional IRA or to another employer plan can be made only after you’ve participated in the SIMPLE IRA for at least two years.
- You are required to make a contribution every year.
- Your employees are vested immediately. As a result, the SIMPLE IRA might not be a good choice if your goal is to encourage employees to remain with your company. Furthermore, immediate vesting can be extremely costly if you have high turnover.
- You are not allowed to maintain any other employer-sponsored retirement plans.
- The annual employee deferral is more than an IRA, but significantly less than a 401(k) plan.
- Withdrawals from a SIMPLE IRA before age 59½ are subject to a 25% early distribution penalty (unless an exception applies) during an employee’s first two years of participation, and 10% thereafter, in addition to regular income tax. The 25% penalty also applies even if you are rolling the balance to another retirement account (within two years of the account opening).
- Minimal plan customizations.
- Only pre-tax deferrals allowed.
Talk to your tax advisor and financial advisor prior to adding a retirement plan. We can help you review your situation and find a solution that fits your business. We’re always here to help.