Introduction
Recently we posted the first part of a three-part article that concentrates on Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) individual retirement account (IRA) plans. We discussed employer and employee eligibility as they relate to a SIMPLE IRA plan and provided an example relating to employee eligibility for a home remodeling business owned by an individual named Terry. This second part of our three-part article will concentrate on SIMPLE IRA plan establishment, SIMPLE IRA establishment, and SIMPLE IRA contributions.
An important point to note is that beginning in 2023 a provision under the SECURE 2.0 Act allows a SIMPLE IRA plan participant to designate his/her contributions (i.e., deferrals and employer matching or nonelective contributions) under the plan to be made to a Roth IRA, considering the Roth IRA does not restrict it and the SIMPLE IRA plan agreement allows it. Additionally, SECURE 2.0 includes other provisions applicable to SIMPLE IRA plans which are beyond the scope of this article as we await further guidance from the Internal Revenue Service (IRS).
What is a SIMPLE IRA plan?
A SIMPLE IRA plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. A SIMPLE IRA plan offers the simplicity of an IRA, but allows employee and requires employer contributions, and lacks most of the administrative complexities that usually accompany the more complicated employer qualified plans (QPs). There are two startup components to the SIMPLE IRA plan―the SIMPLE IRA plan establishment process and necessary documentation and the SIMPLE IRA establishment process and necessary documentation.
Establishing a SIMPLE IRA plan
Available from the IRS are two model documents that allow an employer to easily establish a SIMPLE IRA plan. Although an employer could establish a SIMPLE IRA plan with an IRS approved prototype document, this article will focus on establishment using an IRS model document. When using one of the IRS model documents, an employer’s choice of which document it uses to establish a SIMPLE IRA plan will dictate the subsequent responsibilities of the financial organization that maintains the SIMPLE IRAs.
IRS Form 5304-SIMPLE—Employees Choose Their SIMPLE IRA Custodian/Trustee
The Form 5304-SIMPLE document allows each employee to establish a SIMPLE IRA with a custodian/trustee of his/her choice. In this case, the individual custodian/trustee of each employee’s SIMPLE IRA must fulfill specific notice requirements which will be explained in Part III of this article.
IRS Form 5305-SIMPLE—Employer Chooses the SIMPLE IRA Custodian/Trustee
The Form 5305-SIMPLE document requires each eligible employee to establish his/her SIMPLE IRA with a “designated financial institution” (DFI). In this case, the DFI must fulfill the “Summary Description” requirement which will be explained in Part III of this article. Furthermore, due to the restriction placed on them by the employer, a DFI must allow plan participants to transfer SIMPLE IRA assets on a periodic basis without cost or penalty.
Establishing a SIMPLE IRA
Each eligible employee must establish a SIMPLE IRA to accept salary deferral and employer contributions. Custodians/trustees may use one of the IRS model SIMPLE IRA agreements (i.e., IRS Form 5305-S—SIMPLE Individual Retirement Trust Account, or IRS Form 5305-SA—SIMPLE Individual Retirement Custodial Account). Generally, SIMPLE IRAs accept and hold only SIMPLE contributions and rollovers and transfers of assets from other SIMPLE IRAs. However, after a two-year period beginning on the date the first contribution was made to an individual’s SIMPLE IRA, assets from a traditional IRA owned by that individual can be transferred or rolled over to his/her SIMPLE IRA.
SIMPLE contributions
Prior to the beginning of each SIMPLE IRA plan year, which is always calendar-year based, an employer must make an irrevocable election to deposit either a matching contribution or a nonelective contribution to all eligible participants’ SIMPLE IRA. Matching contributions will be made only on behalf of those eligible employees who choose to defer their own salary or wages into the plan. However, if selected, an employer must make nonelective contributions for all eligible employees, regardless of the employee’s choice to defer. SIMPLE IRA plans require an employer contribution each year.
Employee Deferral Contributions
Each eligible employee must be given the opportunity to elect to reduce his/her salary and have that amount contributed to a SIMPLE IRA, regardless of the type of contribution (i.e., matching vs. nonelective) the employer may choose to make.
An employee may express his/her pretax salary deferral amount as a percentage of compensation—with no percentage limit. However, the law limits salary deferral amounts, which are subject to an annual cost-of-living adjustment. Like 401(k) deferrals, an employee’s SIMPLE deferral amount is subject to social security withholding and federal unemployment taxes but is not subject to federal or state income tax withholding.
An employer has a responsibility to deposit an employee’s deferrals into the employee’s SIMPLE IRA as soon as reasonably possible, not to exceed 30 days from the end of the month in which the deferral occurred. Employers should not view the 30 days as an allowable “float” period either—it’s conceivable that with today’s technology, deferral deposits could be made almost instantaneously.
Matching Contributions
An employer’s matching contribution amount must equal an employee’s deferral amount but may not exceed three percent of the employee’s compensation. Employers may make matching contributions as late as the due date (plus extensions) of their tax return for the tax year within which the SIMPLE IRA plan year ends.
An employer may choose to reduce the three percent matching contribution requirement, however, never below one percent—and never any more than two years out of the five-year period that ends with the current year. For purposes of this rule, any year that a SIMPLE IRA plan did not exist or any year an employer makes a nonelective contribution may be “treated” as a year or “deemed” a year for which a three percent matching contribution was made.
Nonelective Contributions
Rather than making matching contributions, an employer could make a two percent nonelective contribution on behalf of each eligible employee, regardless of whether an employee chooses to make deferral contributions. The nonelective contribution amount is subject to an annual compensation limit which for 2023 is $330,000. As a result, the 2023 maximum nonelective contribution for any employee is $6,600 (i.e., $330,000 x .02).
Employers may also make nonelective contributions as late as the due date (plus extensions) of the employer’s tax return for the tax year within which the SIMPLE IRA plan’s calendar year ends.
Example
Terry, the owner of a home remodeling business, plans to establish a SIMPLE plan for 2023 and wants to restrict employer matching contributions of salary deferrals to one percent of compensation as often as possible for the first few years. The following chart shows which years Terry can lower matching contributions without violating the two-out-of-five-year rule.
