SIMPLE IRA Plans – Are They Really Simple?

SIMPLE IRA Plan

SIMPLE IRA Plan

SIMPLE IRA plans can be a great way for a small company to provide a low cost retirement benefit as an alternative to a qualified retirement plan like a 401(k) and profit sharing plan. SIMPLE IRA stands for Savings Incentive Match Plan for Employees. However, calling it simple is probably a misnomer.

To be fair, when compared to a 401(k) plan, it is simple. 401(k) plans require special compliance that involves complex testing and requires annual tax filings. With SIMPLE IRAs there are no annual tax filings so this keeps costs low. In addition, most large financial institutions have a streamlined process of establishing these plans.

When a company provides a SIMPLE IRA as retirement benefit to employees, it can fund employee retirement accounts according to two methods. One method is a 2% non-elective contribution based on the salary of the employee. This means every employee would receive a contribution of 2% of their salary regardless of whether the employee contributes to the plan. The other method involves the company matching dollar for dollar the employee’s contributions up to 3% of the employee’s salary. In this scenario, the employee only receives a benefit if they contribute a portion of their salary to their account.

How SIMPLE IRA matching works:

There are two methods of matching for a SIMPLE IRA plan:

  • 2% Non-elective: This means every employee gets a company contribution regardless of whether they contribute or not. See examples below:
    • Employee Salary $100,000: Employee contributes $5,000. Company must contribute $2,000.
    • Employee Salary $100,000: Employee contributes $2,000. Company must contribute $2,000.
    • Employee Salary $100,000: Employee contributes $0. Company must contribute $2,000.
  • 3% Elective: This means the business MUST match employee contributions (dollar for dollar) up to 3% of the employee’s compensation. See examples below:
    • Employee Salary $100,000: Employee contributes $5,000. Company must contribute $3,000.
    • Employee Salary $100,000: Employee contributes $2,000. Company must contribute $2,000.
    • Employee Salary $100,000: Employee contributes $0. Company must contribute $0.

SIMPLE IRA Contribution Comparison:

Employee contributions to a SIMPLE IRA are made with pre-tax dollars. This means your salary is reduced and this results in a reduction of taxable income. The more you contribute to the plan, the more you’ll save in taxes. For more detail on taxation of various retirement accounts, please visit this article titled Tax-deferred vs Tax-free Investment Accounts.

SIMPLE IRA Plans - Contribution Comparison

SIMPLE IRA Plans – Contribution Comparison

While SIMPLE IRA plans are easier to establish and administer than 401(k) plans, calling them simple can give a false impression on what is required of the employer. When operating a 401(k), there is often a plan administrator that helps the employer stay in compliance and provide advice on changing rules and regulations. With a SIMPLE IRA, the employer often has to do a little more digging to find the answer. Because a third party administrator is not reviewing the plan annually for compliance, the employer must take the initiative to make sure they are following the rules.

The employer has many responsibilities when dealing with retirement plans and the SIMPLE IRA is no exception.

The employer is required to:

SIMPLE IRA Plans - Are They Really Simple?

SIMPLE IRA Plans – Are They Really Simple?

  • Monitor the financial institution to assure they are doing what they are required to do
  • Deduct the proper amounts from employee paychecks and make the appropriate matching contributions if applicable
  • Promptly forward employees withheld salary deferrals to the financial institution
  • Provide a summary plan description and annual election notice to employees
  • Make a determination regarding the automatic enrollment option

From the employee’s perspective there are several questions to ask as well:

  • How should I invest these funds?
  • What impact does this have on my other retirement accounts?
  • Can I roll this over to another employer plan?
  • Can I access my funds before retirement?
  • Are there penalties for withdrawing my funds?

This is not a comprehensive explanation of SIMPLE IRA plans, but rather an explanation that there is more to these plans than the name implies. SIMPLE IRA plans can be a great way to provide benefits to employees in a cost effective way, but simple is not a word I would use to describe them. The Department of Labor and IRS have plenty of information about establishing and maintaining SIMPLE IRAs. Both sites make mention that these plans are “easy” and “hassle free.” You be the judge.

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