Playing It SIMPLE
Small businesses have never had it easy when it comes to employer-sponsored retirement plans. Nondiscrimination rules have traditionally limited the ability of highly compensated owners and executives to maximize contributions to such plans.
Established in 1996, SIMPLEs (Savings Incentive Match Plans for Employees) make employer-sponsored retirement plans more appealing for small businesses. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) makes SIMPLEs, and other qualified plans, even more favorable in coming years.
Structuring a SIMPLE IRA
Although a SIMPLE plan may be structured as either an Individual Retirement Account (IRA), or as part of a 401(k) plan, this discussion will focus on SIMPLE IRAs.
Generally, small businesses with 100 or fewer employees who earned at least $5,000 from their employers during the preceding year—and who do not currently maintain another qualified plan—can set up a SIMPLE IRA. The plan must ordinarily be open to all nonexcludable employees who received at least $5,000 in compensation during any two preceding years with that business, and who are reasonably expected to receive at least $5,000 in compensation during the current year.
The employer may elect to exclude employees covered by a collective bargaining agreement (if retirement benefits were the subject of good faith bargaining) and nonresident aliens with no income from sources within the United States. However, self-employed individuals may participate.
Details on Contributions
SIMPLE IRAs allow employees to make elective contributions of up to $10,500 per year for 2008 ($13,000 for workers age 50 and older). Employers are also required to make matching contributions, or nonelective contributions. Employer contributions generally must satisfy one of two contribution formulas.
Under the matching contribution formula, employers must match employee contributions on a dollar-for-dollar basis up to 3% of employee compensation for the year. However, a special rule permits the employer to elect a lower percentage (not less than 1%) for any year for all employees eligible to participate in the plan for such year, provided employees are notified of this election a reasonable time before the 60-day period for electing into the plan. Additionally, the employer cannot use the lower percentage if it would result in the percentage being lower than 3% in more than two out of five years ending with the current year.
An added benefit of a SIMPLE IRA is that, unlike other qualified plans, SIMPLE IRAs are not subject to top-heavy rules. While SIMPLE IRAs are not subject to traditional nondiscrimination rules, specialized statutory nondiscrimination rules apply. This feature provides flexibility to highly compensated employees (HCEs) whose contributions under the typical qualified plan would be limited by lower-paid employee contributions.
Weighing the Benefits
SIMPLE IRAs were designed to make pensions more attractive to small businesses by eliminating some of the more onerous regulations and reporting requirements that generally apply to other qualified retirement plans. However, employers will need to evaluate if pension simplification is worth limiting annual deferrals to $10,500, or $13,000, compared to higher limits for more popular qualified plans such as the 401(k) ($15,500 for 2008).