In the world of small business retirement plans, there are many options. Some plans give the employer sole authority to make contributions, others are contributed to by employees only, and some are a hybrid of the two in which employees make contributions and employers can make matching payments or make random contributions to the plan. The SIMPLE IRA is an interesting option for small and mid-sized businesses (up to 100 employees) which allows a mix of employer and employee contributions. Some would say IRA plans like the SIMPLE are becoming obsolete as the 401k vehicle has become more flexible but that’s not entirely true. 401k plans still have more onerous rules on business owners in terms of tax reporting requirements and the fairness surrounding contribution levels. For that reason many people stick with plans like the SIMPLE IRA which have lower contributions limits but are easy to administer and achieve the goal of socking away tax-deferred funds for retirement.
In a nutshell, SIMPLE IRA plans allow employees to make salary reduction contributions (if they wish) and employers have the option of making matching contributions OR a non-elective contribution. All of the contributions are made directly into the plan.
The SIMPLE IRA is established by filling out the appropriate form, generally Form 5305-SIMPLE or Form 5304-SIMPLE. The difference between these two forms is that the 5305 limits the employees to one financial institution whereas the 5304 allows each employee to use a different financial institution if they so desire. In most cases, even when the 5304 is selected, the same financial institution is used for most employees, the reason being that it makes life easier for the person who has to do payroll and send matching or non-elective contributions to that firm. Sending checks to 10 different places presents operational difficulty and probably wouldn’t achieve all that much since most fund companies offer at least a basic lineup of stock and bond funds.
In terms of the employer contribution portion, the employer must choose one of two options: the first is to match employee contributions up to 3% of compensation. The other option is to make a 2% non-elective contribution for each eligible employee. If the employer chooses the second option, they must make the contribution even if the employee isn’t make salary deferral contributions. Also of interest is the fact that the employee is always 100% vested. This is an IRA plan and once the money goes in, it belongs to the employee.
Contribution Limits
In 2012, the employee portion cannot exceed $11,500. If the employee is over age 50, they can contribute an additional $2,500, capping the employee portion at $14,000. The employer portion works according to the paragraph above. As mentioned above, these ‘low’ contribution limits are one of the downsides to SIMPLE IRA plans. 401k limits are $16,500/year with a $5,500 catch-up allowed for those participants over age 50.*
All things considered, I think the SIMPLE IRA presents a nice product for small and mid-size business owners in that they are very easy to administer and allow the participants to sock away a decent amount of money for retirement. Employees should particularly like these plans because of the mandatory employer contribution portion. This could help you even if you aren’t actively deferring your own salary into the plan. Once your business gets to a place in which you need to defer more dollars and set more limits about who can contribute and when, consider a switch to the 401k plan.
If you have questions about which retirement plan is right for you or your business, please don’t hesitate to e-mail or call me.
Russell Bailyn
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Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net
*Note: Withdrawals prior to age 59 1/2 may be subject to a 10 percent federal income tax penalty. Upon withdrawal, earnings are taxed as ordinary income.
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.