ComplianceFinanceSeptember 18, 2018

Small employer retirement plans! A SIMPLE solution—part I

Introduction

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.

Employer eligibility

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 businesses that wishes to establish a SIMPLE Plan for 2018 generally must do so by October 1, 2018.

Employee eligibility

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.

Example

Terry, the owner of a home remodeling business, is working on his business plan for 2019 which includes the establishment of a SIMPLE plan, effective in 2019. The following chart shows the service and compensation histories for Terry and his four part-time employees:

Employee Eligibility
Employee 2015 2016 2017 2018 2019 (Projected)
Terry $30,000 $35,000 $40,000 $48,000 $70,000
Mike 0 0 16,000 25,000 42,000
Shelly 0 0 3,000 6,500 10,000
Danny 0 5,200 0 7,000 8,000
Jack 0 0 0 5,000 7,500

If it is projected that all employees will have more than $5,000 of compensation in 2019, Terry, Mike, and Danny will be eligible to participate in 2019 based on a service requirement of two preceding years with $5,000 or more of compensation. Neither Shelly nor Jack will be able to participate in 2019 since they will both have made less than $5,000 of compensation in all but one year previous to 2019.  As a result, neither Shelly nor Jack will meet the minimum compensation requirements in each of any two years preceding 2019.

An employer could lower the $5,000 compensation requirement and/or the two-year service requirement, but cannot create eligibility requirements that are more restrictive than the law, as stated above, allows.

An employer may not impose any other requirements for participation, but may legally exclude from participation any employees who are covered under a collective bargaining agreement, and certain nonresident aliens who have no income from sources within the U.S. Employers may need professional tax or legal guidance when determining employee eligibility for a SIMPLE plan.

An employee who is eligible to participate must establish a SIMPLE IRA. All employer SIMPLE plan contributions during a year must be made to this SIMPLE IRA. Neither a traditional nor Roth IRA can accept SIMPLE plan contributions. Look forward to Part II of this article as it will explain SIMPLE plan establishment, SIMPLE IRA establishment, and the different types of contributions that are made to a SIMPLE IRA.

Mike Schiller
Manager, Specialized Consulting, Tax Advantaged Accounts
With more than 22 years of experience, Mike has worked closely with hundreds of financial organizations to help them create, implement, and maintain their tax-advantaged accounts program.
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