A savings incentive match plan for employees (SIMPLE plan) can be used to provide retirement benefits to employees on an extremely tax-efficient basis. Contributions made under the plan are deposited into a SIMPLE IRA established by the employee. SIMPLE IRA plans are suited for companies that have fluctuating profits and fewer than 100 eligible employees.
Most of the rules and the minimum distribution requirements applicable to a traditional IRA also apply to a SIMPLE IRA. However, unlike a traditional IRA, SIMPLE contributions can be made after age 70 1/2.
Under a SIMPLE, an employer is required to make a matching contribution (or, alternatively, a 2% nonelective contribution) based on compensation. Employees may make elective contributions but are not required to do so. This article discusses only a SIMPLE that utilizes a special IRA called SIMPLE IRA, which offers convenience and cost efficiency for both the employer and employee. The article will continue next month and conclude in the May issue of Rough Notes.
For 2000, the maximum contribution and employer deduction limit per participant under a SIMPLE is the lesser of:
* $12,000 (the maximum elective contribution of $6,000 plus a dollar-for-dollar matching contribution ($6,000 times 2); or
* $6,000 (maximum elective contribution) plus 3% of compensation.
Compensation is limited to $200,000 for employer matching contributions, but only $170,000 for 2000 when the employer elects to make a 2% nonelective contribution (which is based on compensation) instead of a matching contribution (based on an employee's elective deferrals). In the case of a self-employed individual, compensation generally means 92.35% of net profits from self-employment.
When the employer elects to make a matching contribution (instead of the nonelective contribution), the maximum contribution is $12,000, but less if the employee earns below $200,000 because of the 3% limit. For example, an employee with a wealthy spouse is paid $10,000 and elects to defer $6,000 into the SIMPLE IRA. The employer's matching contribution is limited to $300 because of the 3% rule (and assuming the employer did not select a lower than 3% cap on matching contributions for the year, explained later).
If an employer chooses to make a 2% nonelective contribution, then only the first $170,000 of compensation can be considered, resulting in a maximum contribution of $11,100 ($6,000 plus $5,100 [$170,000 times 3%]).
Contributions are somewhat limited under a SIMPLE. However, because neither the individual limit of 25% of compensation under Code Section 415, nor the employer's 15% of aggregate compensation deduction limit under Code Section 404 applies, many lower-paid individuals will be able to defer and receive more under a SIMPLE. Whether they can afford to do so is another matter.
There are a number of ways for individuals to save for retirement on a tax-favored basis. These include employer-sponsored retirement plans such as qualified plans and SEPs. However, in order to receive tax-favored treatment, such plans must comply with many rules, including (in some cases) complex nondiscrimination and administrative rules. In addition, top-heavy rules may require the employer to make a minimum contribution (generally 3% of every non-highly compensated participant's compensation). SIMPLE plans are less complex and easier to administer.
Amounts elected to be contributed to a SIMPLE, as well as employer contributions, are not currently includible in the participant's income. Within limits, an employer must match elective (salary reduction) contributions or, alternatively, make a 2% nonelective contribution under the plan. Under a SIMPLE, there are none of the discrimination or complex administrative burdens associated with a qualified plan. Thus, a SIMPLE IRA plan may be a less burdensome alternative for some employers than other types of deferred compensation agreements.
Contributions under a SIMPLE IRA plan may be made only to a SIMPLE IRA and not to any other type of IRA. A SIMPLE IRA is an individual retirement account described in Code Section 408(a) or an individual retirement annuity described in Code Section 408(b), to which the only contributions that can be made are contributions under a SIMPLE and rollovers or transfers from another SIMPLE IRA. All excess contributions must be removed to avoid a 6% cumulative penalty tax (and cannot be "used up" because traditional IRA contributions [e.g., $2,000] cannot be made to a SIMPLE IRA).
Exclusive plan requirement
An employer cannot make contributions under a SIMPLE plan for a calendar year if the employer, or a previous employer, maintains a "qualified plan" under which any of its employees receives an allocation of contributions (in the case of a defined contribution plan) or has an increase in a benefit accrued or treated as an accrued benefit under Code Section 411(d)(6) (in the case of a defined benefit plan) for any plan year beginning or ending in that calendar year. For this purpose, a qualified plan means a plan, contract, pension or trust described in Code Section 219(g)(5) and includes:
* A qualified pension, profit-sharing, or stock bonus plan under Code Section 401(a) which includes a tax-exempt trust;
* An annuity plan under Code Section 403(b);
* A governmental plan (a plan established by the United States, a state, or political subdivision, or agency of a state or political subdivision) other than an eligible deferred compensation plan under Code Section 457(b);
* Certain trusts funded solely with employee contributions under Code Section 501(c)(18); and
* A SEP or SARSEP plan.
* Another SIMPLE--thus, an employer may only have one SIMPLE.
Except to the extent that forfeitures replace otherwise required contributions--transfers, rollovers, and forfeitures are disregarded in determining whether a contribution has been made to a qualified plan.
SIMPLE IRAs
A SIMPLE is an individual retirement account or an individual retirement annuity IRA that satisfies several additional rules and also includes a qualified salary reduction arrangement. A SIMPLE is a written plan established by an employer. The major features for a SIMPLE established in the form of an IRA are:
1. The employer must be an eligible employer for the year;
Although a tax-exempt employer may not maintain a SARSEP, it may establish a SIMPLE plan. A governmental employer also may establish a SIMPLE plan (if allowed by their enabling statutes).
2. The only contributions permitted are the employee's elective deferrals and the employer's matching (or, alternatively, the nonelective contribution).
3. All contributions are fully vested.
4. Eligible employees must have the option to participate.
5. Special administrative requirements must be satisfied.
6. The plan year is the calendar year.
Eligible employer
An eligible employer is any employer that employed 100 or fewer employees (on a controlled group or related employer basis) with at least $5,000 in compensation for the preceding year and does not maintain a qualified plan to which contributions were made, or under which benefits were accrued, for any year after the adoption of the SIMPLE. There is a two-year grace period if an employer, after establishing a SIMPLE, exceeds the maximum number of employees. A special transition rule applies if the failure to satisfy the 100-employee limitation is due to an acquisition, disposition, or similar transaction involving the employer.
Example: Clock Company employed 90 individuals during 1998 and 1999. It establishes a SIMPLE plan for 2000 for employees earning at least $5,000 from Clock during any two prior years. During 2000, Clock hires 50 additional employees. All employees earn at least $5,000. If it were not for the grace period, Clock would not be eligible to maintain a SIMPLE for 2001 because it employed over 100 employees earning at least $5,000 in 2000 (the preceding year).
Example: Fence Company employed 90 individuals during 1998 and 1999. All employees earn at least $5,000. It establishes a SIMPLE plan for 2000 for employees earning at least $5,000 from Fence during any two prior years. During 2000, Fence hires 50 new employees. Although Fence would be ineligible to initially establish a SIMPLE for 2001 because it had over 100 employees earning at least $5,000 during 2000, it may continue to maintain its existing SIMPLE during the two-year grace period, that is, for 2001 and 2002.
For purposes of the 100-employee limitation, all employees working at any time during the calendar year are taken into account, regardless of whether they are eligible to participate in the SIMPLE. Thus, employees who are excludable under the rules of Code Section 410(b)(3) relating to the exclusion for certain unionized employees, and nonresident alien employees, or employees who have not met the plan's minimum eligibility requirements must be taken into account. Employees also include self-employed individuals who received earned income from the employer during the year.
Generally, the employer that adopts the plan is the employer. However, certain related employers (trades or businesses under common control) must be treated as a single employer. Thus, individuals working for related employers are treated as if employed by a single employer for purposes of satisfying SIMPLE requirements. Related employers include trades or businesses under common control whether or not they are incorporated. These are:
--Controlled groups of corporations under Code Section 414(b)
--A partnership or sole proprietorship under common control under Code Section 414(c)
--An affiliated service group under Code Section 414(n)
In addition, if an employer has leased employees required to be treated as its own employees under Code Section 414(n), the leased employees must be treated as employees of the employer for purposes of the employer's eligibility to establish the program.
A new employer would qualify as an eligible employer. However, the employer would have to adopt very liberal eligibility requirements; otherwise, the plan would have no participants. In the case of a new employer, it is unclear whether the IRS may require that the "no more than 100 employee" rule be satisfied during the first 30 days that the business was in existence (as it does for the "fewer than 25" rule for SARSEPs). Arguably, a new employer qualifies because it had no employees in the prior year.
The IRS model and prototype SIMPLE plans do not allow for an adoption date later than October 1 (inclusive of the applicable year) to lessen the likelihood of overlapping election periods and to prevent possible abuses when the plan is adopted late in the year.
In next month's Rough Notes, Part 2 of this article will address compensation issues, employee and employer contributions, and the employer election to make a nonelective or alternate matching contribution under a SIMPLE plan in IRA form. The article will conclude in the May issue. *
©COPYRIGHT: The Rough Notes Magazine, 2000