SIMPLE IRA

Introduction
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)

Requirements for establishing a SIMPLE IRA include:
 * Small-business owners (including sole proprietors, partners, and owners of S- or C-corporations) who do not have an existing retirement plan.
 * Employers with 100 or fewer employees.
 * Generally, employers who maintain a SIMPLE IRA cannot contribute to any other employer-sponsored retirement plan.

Contributions to a SIMPLE IRA can be made by:
 * 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.
 * In general, all employees who receive at least $5,000 in compensation for the current calendar year and who received at least $5,000 during any two previous years are eligible.
 * 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.
 * If you choose matching contributions, you must match each employee's contribution up to 3% of eligible compensation. If you choose nonelective contributions, you must contribute 2% of eligible compensation for each eligible employee, even if the employee chooses not to contribute., [source Vanguard]

Taxation
SIMPLE IRA salary contributions are made with pre-tax dollars. Earnings are tax deferred until distributed, at which time they are taxed as ordinary income. A withdrawal during the first two years of a plan's existence are accessed a 25% penalty tax. After two years, an early withdrawal incurs a 10% penalty tax. Withdrawals are not subject to penalty tax when made after age 59 1/2; and minimum withdrawals must begin once an account owner turns 70 1/2.

Contributions
Employees can contribute up to 100% of earned income to the following limits.

SIMPLE IRA Transfers
Although SIMPLE IRA's comprise a small part of the employer-provided qualified plan universe, they are unique in being the sole plan that currently permits the individual employee to execute in-service trustee-to-trustee exchanges to a fiduciary of the employee's choosing. The first consideration in the selection of a SIMPLE-IRA fiduciary is to determine the type of SIMPLE IRA an employer has established, either an IRS Form 5304-SIMPLE or an IRS Form 5305-SIMPLE.


 * IRS Form 5304-SIMPLE : this form of SIMPLE IRA permits each employee to choose the financial institution for receiving contributions. The employer is required to send contributions on behalf of the employee directly to the financial institution of the employee's choice. Most participants are unaware of this option, so the employee should check with the employer to see what form was used to create the plan. Obviously, if the employee has this type of SIMPLE-IRA he can choose Vanguard as the SIMPLE IRA fiduciary and have all salary deferral and employer matches invested in Vanguard Funds. 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.


 * IRS Form 5305-SIMPLE: this form of SIMPLE IRA requires all contributions to be deposited initially at a designated financial institution of the employer's choosing. An employee must execute trustee-to-trustee transfers in order to invest with a fiduciary of choice. During the first two years of SIMPLE IRA participation, a transfer can only be made to another SIMPLE IRA. After two years (dated from the first contribution into the plan) transfers can be made into a Traditional IRA. Using a Traditional IRA avoids 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. Once the two year waiting period has passed, one simply transfers each subsequent year's contributions to the personal Traditional IRA account. This can be done on a quarterly, semiannual, or annual time line, depending mostly on one's tolerance for paperwork and the added risk of more transfer processing errors with more frequent transfers.

With Form 5305-SIMPLE IRAs an employee should always seek to reduce transfer costs by selecting the lowest cost fund in the employer's plan for accumulating assets for transfer. In the case of load fund SIMPLE IRA's this usually is restricted to a no-load share class of a money market fund. Since on-going salary deferrals and employer matches will continue to be deposited with the employer's fiduciary, avoiding front end loads and back end surrender charges is essential in reducing transfer costs.

Links

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