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SIMPLE IRA Plan – Deadline Fast Approaching

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Deadline to start up a 2015 SIMPLE IRA Fast Approaching

If you own a business and you’re thinking about starting a retirement plan for 2014, you may want to look at a SIMPLE IRA Plan (Savings Incentive Match Plan for Employees).

A SIMPLE IRA plan can give you a good source of income when you retire by allowing you and your employees to save money. A SIMPLE IRA Plan is a special type of IRA that operates a lot like a 401(k) plan without the complications and operating costs of a conventional 401(k) plan.

SIMPLEs are available to any small business – generally a business with 100 employees or less. Generally you and your employees can choose to make a pre-tax deferral from your salary (or compensation) and then the employer matches that contribution, dollar-for-dollar, up to 3% of each person’s compensation. The maximum salary deferral contribution that can be made for 2014 is $12,000 for those under age 50, or $14,500 for those ages 50 or older. There are special contribution rules for determining your compensation if you’re a self-employed business owner, such as a sole proprietor. Check with a tax advisor or see IRS Publication 560 for more information.

But don’t wait too long to set-up a SIMPLE IRA Plan because there’s a deadline that’s fast approaching. If you’ve owned an existing business, you must establish a SIMPLE IRA plan by October 1, 2014 for this year. However, if you start a new business this year after October 1st, then you can establish SIMPLE IRA Plan for this year after October 1st (but no later than December 31, 2014) as long as you establish it as soon as it’s administratively feasible. If you previously had a SIMPLE IRA Plan for your business, it’s too late to start one for 2014, but you could re-establish one for next year, effective January 1, 2015.

How does a SIMPLE IRA Work?

If you’re self-employed or own a small business, you may be able to establish a savings incentive match plan for employees (SIMPLE) IRA plan. A SIMPLE IRA plan is a salary reduction retirement plan for certain small businesses that is established in the form of employee-owned traditional individual retirement accounts (but with a higher contribution level). To qualify, you can’t maintain another employer-sponsored retirement plan and must have no more than 100 employees who were employed in the past year and who earned at least $5,000. The SIMPLE IRA plan is funded with voluntary employee contributions and mandatory matching or nonelective contributions by the employer. Establishing such a retirement plan can provide you with a tax-advantaged way to save funds for your retirement; it may also help you attract and retain qualified employees.

Tip: The SIMPLE IRA effectively replaces the SAR-SEP, which can only be used by employers who established a SAR-SEP before 1997.

Tip: Even though government employers generally can’t sponsor 401(k) plans they (along with tax-exempt employers) can sponsor SIMPLE IRA plans, as long as they meet the 100-employee test described above.

How much can an employee defer?

Eligible employees may defer up to $12,000 of their wages to the plan in 2014 ((unchanged from 2013). In addition, employees age 50 and older can make an additional “catch-up” contribution of $2,500 in 2013 and 2014. These limits are indexed for inflation. The employee contributions are excludable from the employees’ income, although they are subject to payroll taxes under the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and Railroad Retirement Act (RRA).

Definition of eligible employees

Employees (including self-employed individuals) are eligible if they have earned at least $5,000 from the employer during any two preceding years (whether or not consecutive) and are expected to earn at least $5,000 in the current year. Eligibility does not depend upon an employee’s age or how many hours the employee worked for the employer. However, employees don’t have to be included if they are under a collectively bargained agreement where retirement benefits were the subject of good-faith bargaining. Nonresident aliens who receive no earned income from the employer from sources within the United States can be excluded as well.

Tip: An employer may, at its discretion, lower the $5,000 threshold to include more employees.

Must the employer contribute to the plan?

As an employer, you must make either a matching contribution or a nonelective contribution every year that you maintain the plan using one of two contribution formulas. (No other employer contributions to the SIMPLE IRA plan are permitted.)

A matching contribution must equal the amount (if any) that each employee chooses to contribute up to a maximum of 3 percent of the employee’s annual compensation. Because the maximum employee deferral for 2014 is $12,000 ($14,500 if age 50 or older), your maximum employer matching contribution effectively is the lesser of $12,000 ($14,500 if age 50 or older) or 3 percent of the employee’s compensation. You may reduce the 3 percent match to as little as 1 percent in any two of five consecutive years. (There are special employee notification requirements if you reduce the 3 percent contribution level.) There is no limit on the amount of employee compensation taken into account when applying this matching contribution formula.

If you choose to make a nonelective contribution, you must make a contribution of 2 percent of annual compensation for each eligible employee, even for those employees who choose not to contribute to the plan. For this purpose, no more than $260,000 (in 2014, $255,000 in 2013) of an employee’s annual compensation is taken into account. So the maximum nonelective contribution for any employee in 2014 is $5,200 (2 percent times $260,000).

Example(s): Assume Joe’s Meat Market employs three employees: Mary, Kelly, and Sally. Each employee earns a different salary and contributes a different amount to the SIMPLE IRA plan. The following table demonstrates how much Joe’s Meat Market would be required to pay under the matching and nonelective options.

 

Employee Compensation

Deferral Percentage

Amount Deferred

Match up to 3% of Pay

Nonelective 2% of Pay

Mary

$65,000

10%

$6,500

$1,950

$1,300

Kelly

$10,000

0%

$0

$0

$200

Sally

$30,000

3%

$900

$900

$600

Joe’s Meat Market Total Contribution

     

$2,850

$2,100

 

Tip: For more detailed information about SIMPLE IRAs, see IRS Publication 560.

Who can establish a SIMPLE IRA?

If you have 100 or fewer employees and don’t maintain another employer-sponsored retirement plan, you can establish a SIMPLE IRA whether you’re self-employed or have a qualified small business.

Self-employed

If you are self-employed, with or without employees, you can set up a SIMPLE IRA for yourself and make contributions to the plan. You are considered to be self-employed if you are in business for yourself or you are a sole proprietor or partner. Self-employment income can include part-time work. If you receive a Form 1099-MISC for work you performed as an independent contractor, you probably have self-employment income.

Qualified small business

You may also set up a SIMPLE IRA if you have 100 or fewer employees who were employed at any time in the past year and who earned at least $5,000. The number of employees is figured on an aggregate calendar-year basis, rather than on an average daily basis. For instance, say you employed 97 employees earning over $5,000 in January. Two months later, 7 employees left and were replaced by 7 other employees receiving over $5,000. You would not qualify as a small employer. That’s because you would have employed a total of 104 employees during the year who earned $5,000 or more.

Tip: See Questions & Answers for more information about the 100-employee limit.

Technical Note: The term “employer” includes corporations, partnerships, sole proprietorships, and other trades or businesses under common control (whether incorporated or not). For instance, if you operate both a computer rental agency and a computer repair business as sole proprietorships, the employees from both businesses would be counted together to determine if you have more than 100 employees.

What are some advantages of a SIMPLE IRA?

The SIMPLE IRA plan is exempt from the nondiscrimination rules that usually govern qualified plans

The SIMPLE IRA plan is not required to follow certain Internal Revenue Code rules that prohibit discrimination in favor of higher-paid workers. As a result, the following are true:

  • A minimum number of employees is not required to participate in the plan
  • The plan does not have to maintain a specific ratio of contributions by non-highly-compensated employees to contributions by highly compensated employees
  • Top-heavy plan requirements do not apply
  • The employee has made an affirmative election on how to invest the contributions (i.e., the employee has selected the financial institution for his or her SIMPLE IRA)
  • The employee has rolled over the account to another SIMPLE IRA (for more details on when and how this can be done, see Questions & Answers), or
  • The employee’s SIMPLE IRA has been established for one year
  • If you’re an existing employer who did not previously maintain a SIMPLE IRA plan, you may establish a plan effective on any date between January 1 and October 1.
  • If you previously maintained a SIMPLE plan, you may establish a new plan effective only on January 1. You don’t need to establish a new plan every year–only when you want to change your plan (for example, when you decide to change your designated financial institution or change employee participant requirements).
  • If you are a new employer and you came into existence after October 1, you may establish a plan as long as you do it as soon as “administratively possible” after the start of the business.

Therefore, even if no employees want to contribute, you may establish a plan, contribute on your own behalf, and provide an employer matching contribution.

You aren’t required to file reports with the government

Only the financial institution holding the IRAs is required to file reports with the government. You are required only to report employees’ contributions on their W-2 forms. In addition, you must check the pension plan box on the employee’s W-2.

You have limited fiduciary responsibility

Once your employees exercise control over the assets in their accounts, you are relieved of any fiduciary responsibility.

An employee is considered to have exercised control when:

The contribution limit for a SIMPLE IRA is more than the amount allowed for a traditional IRA

In 2014, an employee may make an elective contribution (expressed as a percentage of compensation unless you permit employees to express the contribution as a dollar amount) of up to $12,000 (unchanged from 2013). For instance, an employee who earned only $12,000 in 2014 may contribute 100 percent of his or her income ($12,000) to the plan. This amount is significantly higher than the contribution limit for a traditional IRA. Employees age 50 or older may also make additional catch-up contributions of $2,500 in 2013 and 2014.

Caution: An employee who has several jobs with different employers and participates in several plans can’t make total elective deferrals in excess of $17,500 in 2013 and 2014 (plus allowable catch-up contributions). Elective deferrals to 401(k) plans, 403(b) plans, SIMPLEs, and SAR-SEPs are included in this overall limit, but deferrals to Section 457(b) plans are not.

Employer contributions can be flexible

You can change your employer contribution annually. That is, each year, you can decide whether you want to provide a matching contribution or a nonelective contribution.

The plan requires minimal paperwork

The IRS has developed Forms 5304-SIMPLE and 5305-SIMPLE, which are model forms for setting up plans. These forms can also satisfy employer notification requirements (i.e., they can provide necessary information about the plan to your employees).

Pretax dollars are contributed and grow tax deferred

Whether you’re making contributions for only yourself, or for yourself and your employees, your business can deduct contributions made to a SIMPLE IRA. The dollars invested are pretax dollars and accrue tax deferred. That means that your employees can exclude the contributions from their gross income.

Rollovers are permitted

Income-tax-free rollovers or direct trustee-to-trustee transfers can be made from one SIMPLE IRA to another SIMPLE IRA.

Caution: A rollover from a SIMPLE IRA to a traditional IRA, another qualified plan, or a 403(b) plan or Section 457 plan can be made tax free only after you’ve participated in the SIMPLE IRA for at least two years.

What are some drawbacks of establishing a SIMPLE IRA?

You’re required to make a contribution every year

Even if your business is doing poorly in a given year, you must make a contribution (either matching or nonelective) to the plan. In contrast, some other retirement plans (e.g., a profit-sharing plan) can give you year-to-year discretion regarding whether you want to contribute and how much.

Your employees are vested immediately

Your employees do not have to be employed for a certain number of years before they have full ownership of employer contributions. In other words, employees are immediately 100 percent vested in employer contributions. Conversely, with a 401(k), you can require employees to remain employed for a certain period of time before they are fully vested in employer contributions.

Tip: The SIMPLE IRA might not be a good choice if your goal is to induce employees to remain with your company. Furthermore, immediate vesting can be extremely costly if you have high turnover.

You’re not allowed to maintain any other employer-sponsored retirement plans

In general, you can’t maintain a SIMPLE plan if you maintain any other plan for which contributions are made or benefits are accrued for your employees during any part of the calendar year. Consequently, the SIMPLE IRA will not be the appropriate plan if you want to maintain two or more benefit plans, especially when you have groups of employees with different plan needs.

How do you establish a SIMPLE IRA?

Establish a SIMPLE IRA at the appropriate time of the year

Set up a plan document and give eligible employees notice of the plan before the beginning of the annual enrollment period

Although you can establish a SIMPLE IRA by using any document that satisfies the statutory requirements, you’ll probably find it easier to use one of the model forms created by the IRS. If you want to allow employees to choose the financial institution that will receive their contributions to their SIMPLE IRAs, you can use IRS Form 5304-SIMPLE. If you’re setting up all of the IRAs in the same place, you can use IRS Form 5305-SIMPLE. Both forms contain a model plan, employee notification information, and a salary reduction agreement. The notice also must include a summary plan description prepared by the SIMPLE IRA trustee.

Provide employees at least 60 days to elect whether or not to contribute to the plan

Every eligible employee must have the right to elect to make a salary reduction contribution for a year or modify a previous election during the 60-day period before the start of each calendar year (i.e., November 2 to December 31 of the preceding year). For the first year an employee becomes eligible to make contributions, the election can be made during the 60-day period that includes either the date the employee becomes eligible or the day before the date.

Your business may qualify for the small employer pension plan start-up tax credit

If you establish a new SIMPLE IRA plan, you may be eligible to receive a business tax credit of up to $500 (50 percent of the first $1,000 of qualified start-up costs to create or maintain the plan) in three tax years. The credit may be claimed for qualified costs incurred in each of the three years starting with the tax year when the plan became effective.

You or your employees may qualify for the tax credit for IRAs and retirement plans

Some low- and middle-income taxpayers may claim a federal income tax credit (“Saver’s Credit”) for elective deferrals made to SIMPLE IRAs and certain other employer-sponsored retirement plans.

IMPORTANT DISCLOSURES

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor.

STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

As always, a copy of our current written disclosure statement discussing our services and fees continues to be available for your review upon request.

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