A column on personal finance prepared by the Virginia Society of Certified Public Accountants
A SIMPLE RETIREMENT PLAN FIX FOR SMALL BUSINESSES
(April 24, 2003) - According to the Virginia Society of CPAs, SIMPLE IRAs are an excellent choice for a small business owner wanting to offer an employee retirement plan without the administrative burden and expense of a 401(k) plan.
SIMPLE stands for "savings incentive match plan for employees." Created by the Small Business Protection Act of 1996, the SIMPLE IRA lives up to its acronym. It's free of the complicated reporting requirements associated with most other retirement plans designed for businesses and costs significantly less to establish and maintain.
Who Is Eligible?
A SIMPLE IRA is available to an employer that in the previous year had no more than 100 employees who earned $5,000 or more and did not maintain another retirement plan. Certain exceptions apply. For example, if you maintain the SIMPLE IRA plan for at least one year and then cease to meet the 100-employee limit in a later year, you will be treated as meeting the requirement for the two calendar years immediately following the calendar year you last met it.
If you already have another retirement plan, but want to offer a SIMPLE IRA, you must terminate your current plan before establishing a new SIMPLE IRA plan, unless the plan is part of a collective bargaining agreement.
To qualify for participation in a SIMPLE IRA, an employee must have earned at least $5,000 in compensation in any two prior years and expect to earn at least $5,000 in compensation during the current plan year.
A self-employed worker may also open a SIMPLE IRA. The same holds true for a person who has a job offering a retirement plan, but also earns income from self-employment. Another important point: employees with a SIMPLE IRA may also invest in a regular IRA.
How Much Can You Contribute?
The SIMPLE IRA allows both employer and employee contributions. For 2003, employees may contribute up to $8,000. That amount increases to $9,000 in 2004 and to $10,000 in 2005 and 2006. If the plan permits and you are age 50 or older, you may make a "catch-up" contribution of $1,000 in 2003. Catch-up contributions for subsequent years are $1,500 in 2004, $2,000 in 2005, and $2,500 in 2006 and beyond.
Employers may choose between two matching contribution methods, both requiring employer participation. In the first method, the employer matches dollar-for-dollar the amount each eligible employee puts into his or her SIMPLE IRA, up to 3 percent of the employee's salary.
The second option is a fixed contribution plan. Employers who select this method must contribute a flat 2 percent of compensation to the account of each eligible employee. The employer contribution is required for all employees, including those workers choosing not to contribute on their own behalf.
Employer contributions may be deducted in full by the employer as a business expense and are excluded from the gross income of the employee. As is the case with other retirement plans, the employee pays no federal taxes on earnings until withdrawn. All contributions, both those made by the employer and employee, into a SIMPLE plan are fully vested immediately.
SIMPLE IRA plans are offered by banks, brokerage firms and mutual funds. Plan participants choose how to invest their money among the plan's choices.
What About Making Withdrawals?
Generally, an employee who withdraws funds from a SIMPLE IRA before reaching age 59 1/2 pays a 10 percent tax penalty in addition to any income tax due on the withdrawal (assuming no penalty exception applies). But there is one key difference from most other retirement plans: if the withdrawal occurs during the employee's first two years of participation in the plan, the penalty tax increases to 25 percent - that's on top of state and federal taxes.
In the initial two-year period, a tax-free rollover of a SIMPLE IRA can be made to another SIMPLE IRA. After the two years of participation, a tax-free rollover may be made to a traditional IRA, qualified plan, or another SIMPLE IRA.
How Does the SIMPLE IRA Compare to a 401(k)?
While SIMPLE IRAs are more cost effective and easier to open and maintain, there are some limitations when compared to 401(k) plans. In addition to the higher penalty that occurs on withdrawals in the first two years of participation, the annual contribution limit is less than the amount that can be stashed in a 401(k). And, unlike most 401(k) plans, you cannot take a loan on the funds in your SIMPLE IRA, a limitation that may hinder employee participation. One final consideration is that the 401(k) allows the employer some discretion with respect to the vesting of contributions whereas, with a SIMPLE IRA, both employer and employee contributions are immediately vested.
If you're not sure which plan to offer your employees, a CPA can help you choose the plan that would best suit your company's objectives and resources.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
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