Sep 28, 2009

SIMPLEs | 401(k) and Other Salary Savings Plans

In an attempt to increase coverage of employer-sponsored plans, Congress has provided certain simplified arrangements that are not qualified plans but provide employers and employees some of the same benefits as qualified plans. One such arrangement, structured as a salary savings plan somewhat similar to a 401(k) plan, is the SIMPLEs (savings incentive match plans for employees). SIMPLEs are employer-sponsored plans under which plan contributions are made to the participating employees' IRA's. SIMPLEs also can be part of a 401(k) plan, but this arrangement is somewhat more complicated than a SIMPLE/IRA. Tax-deferred contribution levels are generally significantly higher than the $2,000/$4,000 deductible limit for individual IRAs. SIMPLEs feature employee salary reduction contributions (elective deferrals) coupled with employer matching contributions.

SIMPLEs are easy to adopt and generally simple to administer, while providing employees with the tax-deferred retirement savings benefits of a qualified plan. However, qualified plans potentially can provide higher contribution levels. An employee's salary reductions under a SIMPLE can be no greater than $6,000 annually.

Eligible Employers

Any employer may adopt a SIMPLE if it meets the following requirements:

  • The employer has 100 or fewer employees.

  • The employer does not maintain a qualified plan, 403(b) plan, or SEP except for a collectively bargained plan.

Advantages and Disadvantages

SIMPLEs can be adopted by completing a simple IRS form (Form 5304-SIMPLE or 5305-SIMPLE) rather than by the complex procedure required for qualified plans. Benefits of a SIMPLE/IRA are totally portable by employees because funding consists entirely of IRAs for each employee and employees are always 100 percent vested in their benefits. Employees own and control their accounts, even after they terminate employment with the original employer. Individual IRA accounts allow participants to benefit from good investment results, as well as run the risk of bad results. As with a 401(k) plan, a SIMPLE can be funded in part through salary reductions by employees.

However, SIMPLEs have some disadvantages. As with profit-sharing or salary savings plans in general, employees cannot rely on a SIMPLE to provide an adequate retirement benefit. First, benefits are not significant unless the employee makes significant regular salary reduction contributions. Such regular contributions are not a requirement of the plan. Furthermore, employees who enter the plan at older ages have only a limited number of years remaining prior to retirement to build up their SIMPLE accounts. Also, annual contributions generally are restricted to lesser amounts than would be available in a qualified plan. SIMPLE contributions are limited by the maximum $6,000 (as indexed; 2000: $6,000) salary reduction permitted for each participant (plus the employer's matching contribution). This contrasts with the $9,500 (as indexed; 2000: $10,500) annual salary reduction permitted for 401(k) or 403(b) plans. Distributions from SIMPLEs/IRAs are not eligible for the 5-year (or 10-year) averaging provisions available for certain qualified plan distributions. (Five-year averaging is repealed for years after 1999, but 10-year averaging is available even after 1999.)

Design Features of SIMPLEs

The following are the most significant Internal Revenue Code requirements for SIMPLEs (Section 408(p):

  • The employer must have 100 or fewer employees (only employees with at least $5,000 in compensation for the prior year are counted) on any day in the year.

  • The employer may not sponsor another qualified plan, 403(b) plan, or SEP under which service is accrued or contributions made for the same year the SIMPLE is in effect, except for a plan covering exclusively collective bargaining employees.

  • Contributions may be made to each employee's IRA or to the employee's 401(k) account. In effect, there are thus two types of SIMPLEs—those that include the 401(k) requirements and those funded through IRAs. SIMPLEs meeting the 401(k) requirements are rarely adopted and will not be discussed further here.

  • Employees who earned at least $5,000 from the employer in the preceding two years and are reasonably expected to earn at least $5,000 in the current year can contribute (through salary reductions) up to $6,000 (as indexed; 2000: $6,000) annually.

  • The employer is required to make a contribution equal to either

    1. a dollar-for-dollar matching contribution up to 3 percent of the employee's contribution (the employer can elect a lower percentage, not less than 1 percent, in not more than two out of the past five years) or

    2. 2 percent of compensation for all eligible employees earning at least $5,000 (whether or not they elect salary reductions).

In a SIMPLE/IRA plan, each participating employee maintains an IRA. Employer contributions are made directly to the employee's IRA, as are any employee salary reduction contributions. Employer contributions and employee salary reductions, with the limits discussed above, are not included in the employee's taxable income.

Direct employer contributions to a SIMPLE are not subject to Social Security (FICA) or federal unemployment (FUTA) taxes. However, as with 401(k) plans, employee salary reduction contributions are subject to FICA and FUTA. The impact of state payroll taxes depends on the particular state's laws. Both salary reductions and employer contributions may be exempt from state payroll taxes in some states.

Distributions to employees from a SIMPLE/IRA plan are treated as distributions from an IRA. All the restrictions on IRA distributions apply and the distributions are taxed the same.

Installation of a SIMPLE

Installation of a SIMPLE can be very easy. The employer merely completes IRS Form 5304-SIMPLE or Form 5305-SIMPLE. Form 5305-SIMPLE provides for a "designated financial institution" for participant investments, while Form 5304-SIMPLE does not have this provision, which some plan sponsors and participants may find restrictive. Under a SIMPLE, salary reduction elections must be made by employees during a 60-day period prior to January 1 of the year for which the elections are made. The form does not have to be sent to the IRS or other government agency.

The reporting and disclosure requirements for SIMPLEs are simplified if the employer uses Form 5304-SIMPLE or 5305-SIMPLE. The annual report form (5500 series) need not be filed if these forms are used. In other cases, reporting and disclosure requirements are similar to those for a qualified profit-sharing plan.


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