For businesses with 100 or fewer employees, offering competitive benefits packages can be a challenge. Not only do employees’ financial needs vary, but most plans available for fewer than 100 employees require burdensome tax filings and discrimination testing.
Enter the SIMPLE IRA — the Savings Incentive Match PLan for Employees. This relatively new benefit option (launched less than 10 years ago) was born of the demands of small business owners, who found traditional 401(k) plans to be both cumbersome and costly. SIMPLE IRA plans, by contrast, can be easy to establish and may cost employers little to maintain.
As the name implies, SIMPLE IRAs are simplified employer-sponsored retirement plans. Although many employees can establish personal IRAs, employers cannot contribute to them. With SIMPLE IRAs, however, employees may defer up to 6 percent of their pretax income per year and employers may make contributions in several ways.
Contribution options
Employers may choose to contribute a match of 3 percent of participating employees’ compensation, or opt to contribute 2 percent of compensation to every eligible employee, whether the employee contributes to the plan or not.
In the first case, an employee who earns $30,000 per year may contribute up to 6 percent of his or her salary to the SIMPLE IRA, contributing a total of $1,800 by the end of the year. If the employer has decided to match the employee contributions up to the first 3 percent, or $900 in this case, the total contributions in the account for the year would be $2,700.
One significant advantage of a SIMPLE IRA over other employer-match plans is that contributions from highly compensated employees aren’t limited by the size of the overall plan. This allows every employee to contribute up to 6 percent of his or her salary, up to government-determined annual maximums. For the 2005 tax year, employees can accumulate up to $24,000 in deferred salary and matches. The maximum for traditional IRAs is $4,000.
Alternatively, employers may choose to establish their SIMPLE IRA plans with 2 percent profit-sharing formulas that benefit all eligible employees. In that case, an employee who earns $30,000 would receive an employer contribution of $600, regardless of whether he or she defers any income.
Another advantage of SIMPLE IRAs for employers is that they do not require special tax forms, such as IRS Form 5500, which is associated with other defined contribution plans. This reduces internal administrative duties and saves the cost of hiring an accountant to review and distribute documents.
There may be fees for setting up and maintaining SIMPLE IRAs, but they can be as little as $10 per participant. Conventional 401(k) plans may cost up to $10,000 a year to own and operate.
Not completely perfect
There are some drawbacks to a SIMPLE IRA. One is that employees are not allowed to borrow against them. If an employee needs funds, banks may be able to provide the employee with solutions outside of the SIMPLE IRA plan that may not be immediately available from an accountant or tax preparer.
Another drawback of the SIMPLE IRA plan is that the employee must maintain funds in the account for a minimum of two years prior to any distributions being allowed. Furthermore, distributions taken before age 59 1/2 may be subject to a 10 percent IRS penalty.
While these provisions may appear to restrict access to the funds, they are in place to help simplify the retirement plan documents and to help ease the administrative burden common in other types of plans.
There may be very specific reasons for small business owners to maintain their existing retirement benefit plans, but it behooves them to discuss SIMPLE IRAs with their bankers. For cost-effective, easily administered and financially advantageous arrangements, SIMPLE IRAs may be a great solution.
Terry Newman is a financial adviser and North Regional manager with MB Investment Services, a division of MB Financial Bank. Reach him at (312) 633-0331.
Securities and insurance products offered through Vision Investment Services Inc. (VIS), member NASD/SIPC and a licensed insurance agency. VIS is a wholly owned subsidiary of MB Financial Bank.
