Retirement questions: what is a simple ira? – Simple IRA plans explanation for small employers and employees
A Simple IRA plan is a retirement savings plan that can be offered by employers having 100 or fewer employees who earned at least $5,000 in total compensation during the previous calendar year. The employer also must not offer any other qualified retirement plans, such as a 401(k). Self-employed persons are also eligible to establish simple IRA plans, even if they have no other employees other than themselves. However, in this case, the self-employed person is responsible for both the employee and the employer contributions.
In the event that the company employs more than 100 employees after establishing the plan, it has a two-year grace period to return to having no more than 100 employees. In the event it does not, the plan must be discontinued. If the 100 or fewer employee limitation is exceeded because the firm is involved in an acquisition or merger, the grace period exists for the rest of the year in which the acquisition or merger occurred and, under certain circumstances, for the following year.
Employers can exclude employees from participating if they have not earned $5,000 or more in any two calendar years preceding adoption of the plan, are expected to earn less than $5,000 in the current year, or are covered by collective bargaining agreements. However, such exclusions are optional.
Employers are required to choose one of two contribution methods to a Simple IRA plan. Under the matching option, the employer matches employee contributions dollar for dollar up to 3% of each eligible employee’s compensation. The company can contribute less than 3% (between 1% and 3%) during two years of any five-year period. Under the nonmatching option, the employer must make a contribution of 2% of compensation up to a maximum of $4000, based on the maximum eligible compensation limit of $200,000, for every eligible employee. The employer contribution is made regardless of the amount of salary reduction contributions, if any, made by the employee. The employer contribution method can be changed once per year, and employees must be notified of any changes at least 60 days before the start of the new plan year.
Employees can contribute from 0% to 100% of their compensation, although annual dollar limits apply. They are not required to contribute every year. Employees can typically change their contribution election during a 60-day period preceding each plan year. However, employers may allow more frequent changes. Those becoming newly eligible to participate in the plan start their 60-day election period on the day they become eligible. Employees can stop their contributions at any time, but employers can then prohibit them from resuming contributions until the following calendar year. Both the employee and the employer’s contributions are fully vested at all times, meaning that the employee retains the full balance of their account even if they change employers. Employees may have the option of investing their account balances in a variety of financial instruments, although life insurance contracts and most collectibles are prohibited.
Both employee and employer contributions are federal (and often state) tax deferred until they are withdrawn from the account. Once the employee’s account has been established for two years, he or she can roll over or transfer the account balance to any IRA. Withdrawals from the account prior to age 59 1/2 may be subject to an additional 10% penalty tax in addition to ordinary income taxes. In the event the account has not been established for two years prior to the early withdrawal, the penalty tax is 25% instead of 10%. Minimum distributions from the account are required once the employee reaches age 70 1/2.