Contributions to a SIMPLE IRA Plan
Contributions to a SIMPLE IRA are made up of salary reduction contributions and employer contributions. You, as the employer, must make either matching contributions or nonelective contributions. The employer may choose either method of making employer contributions on a yearly basis. Eligible employees must be told during the election period what method will be used for that year.
The SIMPLE IRA plan employer contribution is dependent upon which contribution formula chosen by the employer on a year by year basis:
- If you decide to make a 2% non-elective contribution, then each eligible employee must receive a contribution equal to 2% of their compensation regardless of whether the employee makes elective deferrals.
- However, if you decide to do the dollar-for-dollar match up to 3% of pay, then only the eligible employees who have elected to make contributions will receive an employer contribution, i.e., the matching contribution.
You may reduce this 3% limit to a lower percentage, but in any event, not lower than 1%. You may not lower the 3% limit for more than 2 calendar years out of the 5-year period ending with the calendar year the reduction is effective.
No other employer contributions can be made to a SIMPLE IRA plan.
The definition of compensation stated in the document must be followed in the operation of the plan. Compensation generally includes the pay a participant received from you for personal services for a year.
Employees can make salary reduction
contributions in any amount to a SIMPLE IRA plan up to the legal limits. The maximum amount that an employee can contribute is $10,000 (starting in 2005). This amount may be subject to adjustments for years after 2005.
Each year employees can change their contribution levels during the plan’s election period. This election period must be at least 60 days long, and employees must receive prior notice about an upcoming election opportunity. SIMPLE IRA plans that have already been established must have an annual election period that extends from November 2 to December 31. A plan can have more election periods each year in addition to this 60-day election period.
Employee Catch-up Contributions
Additional employee contributions (known as catch-up contributions) are allowed for employees age 50 or over. An employee who will turn 50 at any time during the year may make catch-up contributions for that whole year. The additional contribution limit is $2,000 in 2005 and $2,500 in 2006. This amount may be subject to adjustments for years after 2006.
Catch-up contributions also may not exceed the lesser of the following amounts:
- The catch-up contribution limit.
- The excess of the participant’s compensation over the elective deferrals that are not catch-up contributions.
When Employees Want to Stop Contributions
Employees may elect to terminate their salary reduction contributions to a SIMPLE IRA plan at any time. If they do so, the SIMPLE IRA plan may preclude them from resuming salary reduction contributions until the beginning of the next calendar year. Employers that are making nonelective employer contributions must continue to make them on behalf of these employees.
When and where to Make Contributions
Salary reduction contributions must be made within 30 days after the end of the month in which the amounts would otherwise have been payable to the employee in cash. Matching contributions or non-elective contributions must be made by the due date (including extensions) for filing your federal income tax return for the year.
After you send the SIMPLE IRA plan contributions to the financial institution you selected, that institution will manage the funds. It’s worth noting that employees can move their SIMPLE IRA assets from one SIMPLE IRA to another. SIMPLE IRA plan contributions can be put into stocks, mutual funds, and other similar types of investments. The IRA owner decides how the assets in the account will be invested.
You will need to give each participating employee an annual statement indicating the amount contributed to their account for the year.
Communicating with Employees
There are two key disclosure documents that keep participants informed about the basics of how the plan operates, inform them of changes in the plan’s structure and operation, and provide them a chance to make decisions and take timely action with respect to their accounts.
- The summary description is a plain-language explanation of the plan and is comprehensive enough to inform participants of their rights and responsibilities under the plan. It also informs participants about the features of the plan.
This document is usually provided by the financial institution and is given to participants at the plan’s inception, when employees first join the plan, and annually thereafter.
Employers can satisfy the summary description requirement by providing employees with the most recent copy of IRS Form 5304-SIMPLE or 5305-SIMPLE provided by the Financial Institution (if one of these model forms is used to establish the SIMPLE IRA plan), along with the financial institution’s procedures for withdrawals and transfers.
- Each year, in addition to the information above, employees must receive an annual election notice describing their right to make salary reduction contributions and the employer’s decision to make either matching or nonelective contributions for the following year. For employers that use one of the model forms, page 3 of Form 5304-SIMPLE and page 3 of Form 5305-SIMPLE contain a Model Notification to Eligible Employees that can be used to provide this information to employees.
Every year, during the 60-day election period at the end of the year, employees must be given the opportunity to enter into a salary reduction agreement or to modify an existing agreement.
How Does a SIMPLE IRA Plan Work?
Elizabeth works for the Rockland Quarry Company, a small business with 50 employees. Rockland has decided to establish a SIMPLE IRA Plan for its employees and will match its employees’ contributions dollar-for-dollar up to 3% of each employee’s salary. Under this option, if a Rockland employee does not contribute to his or her SIMPLE IRA then that employee does not receive any matching employer contribution from Rockland.
Elizabeth has a yearly salary of $50,000 and decides to contribute 5% of her salary to her SIMPLE IRA. Elizabeth’s yearly contribution is $2,500 (5% of $50,000). The Rockland matching contribution is $1,500 (3% of $50,000). Therefore, the total contribution to Elizabeth’s SIMPLE IRA that year was $4,000 (her $2,500 contribution plus the $1,500 contribution from Rockland). The financial institution partnering with Rockland on the SIMPLE IRA Plan has several investment choices and Elizabeth is free to pick and choose which ones suit her best.
Austin has worked five years for the Skidmore Tire Company, a small business with 75 employees. Skidmore has decided to establish a SIMPLE IRA Plan for its employees and will make a 2% non-elective contribution for each of its eligible employees. Under this option, even if an eligible Skidmore employee does not contribute to his or her SIMPLE IRA then that employee would still receive an employer contribution to his or her SIMPLE IRA equal to 2% of salary.
Austin has a yearly salary of $40,000 and has decided that this year, he simply cannot make a contribution to his SIMPLE IRA. Even though Austin does not make a contribution this year, Skidmore must make a contribution of $800 (2% of $40,000). The financial institution partnering with Skidmore on the SIMPLE IRA Plan has several investment choices and Austin has the same investment options as the other plan participants.
Tax Treatment of Contributions
You can deduct your contributions and your employees can exclude these contributions from their gross income. For example, sole proprietors may deduct them on Schedule C (Form 1040), Profit or Loss From Business, or Schedule F (Form 1040), Profit or Loss From Farming, partnerships deduct them on Form1065, U.S. Return of Partnership Income, and corporations may deduct them on Form 1120, U.S. Corporation Income Tax Return, Form 1120-A, U.S. Corporation Short-Form Income Tax Return, or Form 1120S, U.S. Income Tax Return for an S Corporation.
Sole proprietors and partners may deduct contributions for themselves on Form 1040, U.S. Individual Income Tax Return. (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065), Partner’s Share of Income, Credits, Deductions, etc., you get from the partnership.)
SIMPLE IRA contributions are not subject to federal income tax withholding. However, salary reduction contributions are subject to social security, Medicare, and federal unemployment (FUTA) taxes. Matching and nonelective contributions are not subject to these taxes.
Additional Operating Resources
The latest information on SIMPLE IRAs and other retirement plan topics is available on the IRS Retirement Plans web page at http://www.irs.gov/ep:
- Notice 1998-4
- Publication 560
- Publication 590