Simple IRAs – Are They as Simple as They Seem?
We have talked about Simplified Employee Pension Plans (SEP IRAs) and how they can benefit your business and your employees, but what about Simple IRAs? What benefits do they have over a SEP IRA, and where do they fall short in comparison?
Simple Individual Retirement Accounts, designed for small businesses, are remarkably easy to set up, unlike the more complex 401(k). They are also cost-effective to maintain. However, it is important to note that employers are not allowed to have any other retirement plans set up. When deciding to set up a Simple IRA, remember that there are limits on when you can set one up.
Getting Your Future Set Up
You can set up a Simple IRA plan to have an effective date on any date from January 1 through October 1 of any given year so long as you have not previously maintained a Simple IRA plan. If you have previously set up a Simple IRA, you may only set it up with an effective date of January 1. The only time this is optional is if you are a new employer that comes into existence after October 1, though you must set up the Simple IRA as soon as administratively possible after coming into existence.
While 401(k)s come with many regulations and management fees due to using a third-party administrator, Simple IRAs are relatively easy for businesses to set up independently. You have two options when taking the path of a Simple IRA. Your first option is to do a single investment firm for the entire company.
Investment Options: Which retirement plan is for your company?
You will want to sit down with an investment advisor and discuss investment options to ensure you make the best choice for yourself and your employees. The investor will help you choose a financial institution to serve as trustee to hold each participant’s retirement plan assets. The second option is to let your employees know that you will be setting up a Simple IRA and have them choose a financial institution where they would like their investments to be set up.
Once the decision has been made to either do a single company investment or individual employee investments, you will need to take the first step toward establishing your Simple IRA. First, complete one of two forms that you can find on the IRS website.
For single-company investments, you will use Form 5305-SIMPLE , and if deciding to go the route of having your employees choose their own investments, you will complete Form 5304-SIMPLE . Keep the original form once completed; do not file it with the IRS.
Second, you must provide your eligible employees with an annual notice before the beginning of the election period. A list of items that need to be included on your annual notice is listed here . Once your employees are enrolled, this is all the paperwork you will have to do outside of filing a simple annual report to ensure that you have given the proper contribution you are required to.
Eligibility for the Simple IRA: Do your employees qualify?
Now, what makes an employee eligible for a company Simple IRA? First, they must have been a W-2 employee with you for the last two years. They cannot be a contractor, salesperson, or subcontractor. They must be a physical W2 employee of the company and have worked for you for at least two years.
In addition, they must have made at least $5,000 while working with you or expect to receive at least $5,000 during the current calendar year. If they meet those three simple requirements, then they are eligible and are required to have a Simple IRA account. An employee must meet all those requirements to be eligible to participate.
When it comes to the limits on the requirements, you can always make it shorter so that more employees are eligible to participate, such as changing the two-year requirement to one year or six months, or an employer can reduce or eliminate the compensation requirement. You cannot exceed the two years or $5,000 set in place by the IRS.
An employee can exclude employees from a Simple IRA plan if the employees are covered by a union agreement whose retirement benefits were bargained for in good faith by the employees’ union and the employer or if the employees are nonresident aliens who do not have US wages, salaries, or other personal services compensation from the employer.
Flexibility is a Possibility
A Simple IRA does not have quite the flexibility a SEP IRA allows, but it is still more flexible than other retirement plans offer. Unlike with a SEP, an employer is required to make contributions to the plan even when an employee does not, but there are a couple of different options that you have for these contributions.
This provides two options that are given to employers by the IRS. Either you are providing contributions matching up to 3% of employee yearly compensation, or you are providing a 2% nonelective contribution for each eligible employee. With the matching option, employers may choose to go as low as 1% but can only do so for two calendar years within a five-year period.
The most significant difference between these two options is that if an employer chooses the 2% nonelective contribution, then the employer will be contributing 2% to the employee’s retirement account even if the employee themselves is not contributing, while the matching options mean that if an employee is not contributing then the company, then the company is still contributing the matching amount for the employee’s yearly salary.
When deciding which contribution type to go with, remember that you cannot modify the type of contribution you are making. You will have to wait for the renewal period to make any changes or terminate your Simple IRA plan.
Limits on Contributions
How much can be deposited into an employee’s Simple IRA each year is limited. The amount that can be deposited is higher than that of other types of accounts but lower than that of others. As of 2024, employees are limited to depositing up to $16,000 into their accounts.
The IRS updates this number every year, so you should watch this. In addition to the normal elective deferrals, employees over the age of 50 can make catch-up contributions which allows them to deposit an additional $3,500 each year. Employees will need to consider that if they want to maximize their contributions each year, they’ll need to contribute through their employer, as employees cannot go to the bank or investor and provide them with funds for the account – the employer must deposit them.
Once contributed, all funds in an account are 100% vested in the employee, meaning that the balance is owned entirely by the employee. Despite the employees owning 100% of the funds, Simple IRA accounts don’t allow participant loans, and the assets may not be used as collateral.
However, they are eligible for in-service withdrawals, though they are includible on income and will be subject to a 10% additional tax if the employee withdrawing the funds is under 59 ½. This additional tax is increased to 25% if the funds are withdrawn from the account within the first two years of participation. Employees are also only able to roll over the balance of their account to another Simple IRA within the first two years.
Following those two years, they will be able to transfer the money to any other retirement other than a Designated Roth Account (401(k), 403(b), 457(b)). For a list of what retirement accounts can roll over where you can check out this chart
Ensuring Employee Money is Where It Should be
Reviewing your retirement accounts at the end of the year to ensure proper contributions have been made is always recommended. The IRS provides an easy checklist to help you ensure that you are staying in compliance.
If you ever decide to terminate your Simple IRA plan, you will need to consult with your financial advisor or institution to determine if another type of retirement will be a better fit for your company. There are two steps involved with cancelling your Simple IRA plan.
First, you will need to inform your employees of this decision within a reasonable time frame prior to November 2, including that the change will be effective on January 1. Second, notify the financial institution and payroll provider so that they can terminate your contributions. You will not need to notify the IRS. You should keep records of the steps you take for the cancellation.
Simple IRAs are a great retirement solution for small companies wanting to ensure that their employees are set up for the future while also keeping management fees low or if you are looking to incentivize employees to stay with you longer despite the restrictions on contributions and the employee’s ability to manage the account itself.
Check out our youtube video How Simple IRAs Work: A Guide For Small Business Owners with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.
It is up to you to decide which retirement account best suits the needs of you and your employees, but if you ever need assistance with learning what the tax implications of this could be, the team here at Waterford Business Solutions is here to talk you through it. Give us a call today at 864-351-0852 for a free consultation!
