SIMPLE IRA

The SIMPLE (Savings Incentive Match Plan for Employees) IRA was established in 1996 by the Small Business Job Protection Act. At year end 2007, SIMPLE IRAs held approximately $61 billion dollars of assets.[see:ICI The U.S. Retirement Market, 2007 (July, 2008)

SIMPLE IRA's may be sponsored by employers (including governmental employers, non-profit employers, self-employed individuals and business owners) with 100 or fewer employees. Employers who maintain a SIMPLE IRA cannot contribute to any other employer-sponsored retirement plan in the same year.

Contributions
Contributions to a SIMPLE IRA can be made by employees (through salary reductions) and by employers.
 * Employees are permitted, but not required, to have a portion of their salary paid to the SIMPLE IRA instead of being paid in cash.
 * Employers may make matching or nonelective contributions to an employee's account.
 * Matching. If you offer matching contributions, only employees who elect to make their own salary deferral will receive an employer contribution. Employers must match the employee contribution dollar for dollar up to 3% of each eligible employee's compensation. Employers may select a limit lower than 3% of compensation (between 1% and 3%), but only in two years out of any five-year period.
 * Nonelective. If you offer nonelective contributions, each eligible employee must receive a contribution totaling 2% of compensation (up to $4,500 for 2007 and $4,600 for 2008), even if the employee chooses not to make any contributions. An employee's maximum compensation that can be included for calculating the nonmatching contribution is $225,000 for 2007 and $230,000 for 2008.
 * Employees who are not expected to receive at least $5,000 in compensation for the current calendar year and who did not receive at least $5,000 during any two previous years can be excluded.
 * Employees covered under collective bargaining agreements for which retirement benefits were the subject of good-faith bargaining can be excluded.
 * Nonresident aliens with no U.S.-source income can be excluded.

The employee contribution can be up to 100% of compensation (earned income, for self-employed individuals), up to the following limits:

The employee contribution counts toward the employee's combined salary deferral limit along with 401(k), 403(b) and SARSEP plans ($15,500 in 2008, excluding catch-up contributions).

Tax Treatment of Contributions
SIMPLE IRA contributions are deductible to the employer (to the extent they would be if paid as salary) and are not included in employees' income, though the contributions out of salary, but not matching or nonelective contributions, are subject to FICA and FUTA taxes. The SIMPLE IRA itself is subject to the same tax rules as other IRA's, including exemption from tax on most investment income.

Withdrawals
SIMPLE IRA's are subject to most of the same rules governing withdrawals, and their tax consequences, as other IRA's. Employees are always fully vested and can withdraw any amount at any time.

As with other IRA's, withdrawals, other than rollovers, are ordinary income (as SIMPLE IRA's never include after-tax contributions), and are subject to a 10% penalty before age 59 1/2, subject to certain exceptions. Until the second anniversary of the first contribution to an employee's account, rollovers are permitted only to other SIMPLE IRA's. During this period, the 10% penalty is increased to 25%. SIMPLE IRA's are subject to the same required minimum distributions, beginning at age 70 1/2, as other IRA's.

Some Simple plans (including those established with the IRS model plan Form 5305-SIMPLE) require the use of a "designated financial institution" as trustee or custodian of the employees' SIMPLE IRA's. In that event, the employees must be given the option of transferring their balances to any other SIMPLE IRA, or, after the 2-year period, any other IRA, without any cost or penalty. The financial institution may require notice prior to the start of a year. Costless transfers may be limited to new contributions; surrender penalties could be imposed on withdrawals of past contributions. Monthly transfers are sufficient for this purpose.

Other Simple plans (including those established with the IRS model plan Form 5304-SIMPLE) permit employees to designate any SIMPLE IRA to which their contributions will be directed.

Vanguard imposes a $25 account fee per fund (waived if Vanguard assets exceed $100,000) on SIMPLE IRAs. If subject to account fees, clients would be best advised to restrict fund selection in order to reduce costs. Vanguard's SIMPLE IRA imposes a five fund maximum limit. Using a traditional IRA (when available, after the expiration of the 2-year period) would avoid the $25 Vanguard SIMPLE IRA account fees. Trustee-to-trustee transfers to Vanguard are executed by: (1) filling out an IRA Transfer Request; (2) including a recent SIMPLE IRA account statement; and (3) having Vanguard execute the transfer. Trustee-to-Trustee transfers do not affect annual contribution limits to personal IRA accounts.

Links

 * IRS SIMPLE IRA Plan
 * IRS Publication 590 Individual Retirement Arrangements (IRAs)