Think of how many small business owners enter your financial organization every day. Among others there are barbers, florists, farmers, designers, writers, dentists, and realtors. You name it. Small business owners are everywhere!
And many of them are in need of retirement plan that will help secure a better retirement for themselves and their employees. Most of all, they need plans that are easy to understand, easy to maintain, and easy on the budget. That means minimal discrimination testing, administration headaches, and reporting procedures.
A Savings Incentive Match Plan for Employees of Small Employers, or SIMPLE plan, may be just the solution. While the SIMPLE plan requires employ-er contributions and allows employ-ee salary reduction contributions, it also offers the simplicity of funding an individual retirement account (IRA) and lacks most of the administrative hassles that usually accompany the more complicated qualified plans. As a bonus, an employer may deduct on its tax return any contributions made for the benefit of its employees.
SIMPLEs are available in two versions—401(k) and IRA. This three-part article will discuss only the SIMPLE IRA plan version and the variables unique to it. Any reference to SIMPLE plan means the IRA version of it unless specifically stated otherwise. To further “clarify” these terms, remember that a participant in an employer’s SIMPLE plan must establish a unique type of IRA, a SIMPLE IRA. Whereas a participant in a SIMPLE 401(k) will see his/her contributions and the employer’s contributions deposited into a tax-exempt trust.
In this part of our three-part article dedicated to SIMPLEs we’ll explain what a SIMPLE plan is and discuss employer and employee eligibility. Parts two and three of this series will review the different types of SIMPLE plan contributions, the rules for establishing employees’ SIMPLE IRAs (including the required documents), explain the maintenance and Internal Revenue Service (IRS) reporting requirements for these plans, and review what a financial organization’s responsibilities are as they specifically relate to SIMPLE plans.
What is a SIMPLE Plan?
A SIMPLE plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. It is a low-maintenance alternative to the ever-popular 401(k) plan, but not quite as easy to administer as the Simplified Employee Pension (SEP) plan. On one hand, a SIMPLE plan allows employee deferrals while avoiding the testing and reporting headaches typical of the more complicated 401(k) plan. On the other hand, it requires an employer contribution each year, has some unique notice requirements, and is somewhat more restrictive and less flexible than a SEP plan. But for some employers, it may be the right plan.
Any employer—whether incorporated or not incorporated (including tax-exempt organizations and governmental entities)—can establish and maintain a SIMPLE plan. However, the employer must meet three eligibility requirements.
No More Than 100 Employees
An employer must have had no more than 100 employees who each received at least $5,000 in compensation during the preceding calendar year. If an employer is a member of a controlled group of corporations, a group of trades or businesses under common control, or an affiliated service group, all employees of all members of the group must be considered in determining the 100-employee limitation. This determination also includes leased employees and collectively bargained employees (even if the plan will exclude these employees from participation). An employer must consider the greatest number of employees it had at any time during the preceding calendar year, whether or not those employees will personally be eligible to participate in the plan.
Employers must meet the 100 or fewer employees rule for each year the SIMPLE plan exists. If an employer ceases to meet this requirement after maintaining the plan for one or more years, the employer will be able to continue the SIMPLE for the two years following the last year it was eligible.
No Other Plans
A SIMPLE plan cannot coexist with certain other plans sponsored and maintained by the employer. This includes qualified plans under IRC Section 401(a), annuity plans under IRC Section 403(a), tax-sheltered annuities under IRC Section 403(b), and SEP plans under IRC Section 408(k). For this purpose, a plan is “maintained” if an employee receives an allocation of contributions (defined contribution plan), or has an increase in accrued benefits (defined benefit plan) for the plan year beginning or ending in the calendar year.
An employer must terminate or freeze any plans currently maintained prior to the first calendar year the SIMPLE plan is effective.
October 1 Establishment Deadline
A SIMPLE plan operates on a calendar year basis and an employer that wants to establish a new SIMPLE for the current calendar year must do so by October 1.
If an employer establishes a SIMPLE plan after the October 1 deadline, it can only be effective for the following calendar year. However, the October 1 deadline does not apply to a new employer that comes into existence after October 1 of the year for which the SIMPLE plan is established if the employer establishes the SIMPLE plan as soon as administratively feasible after the employer comes into existence. So based on this establishment timing rule a business that wishes to establish a SIMPLE Plan for 2023 generally must do so by October 1, 2023.
Any employee that meets certain employer-specified service and compensation requirements must be eligible to participate in a SIMPLE plan. The SIMPLE plan rules provide maximum service and compensation requirements—but an employer may always apply more lenient (or eliminate) eligibility rules, which will allow employees to participate earlier.
Years of Service and Compensation
To participate in a SIMPLE plan under the most restrictive criteria, an employee must have had at least $5,000 of compensation from the employer during each of any two preceding calendar years, and be reasonably expected to earn $5,000 in the current year.
Terry, the owner of a home remodeling business, is working on his business plan for 2023 which includes the establishment of a SIMPLE plan, effective in 2023. The following chart shows the service and compensation histories for Terry and his four part-time employees: