SIMPLE IRA Plans

A SIMPLE IRA is a type of Savings Incentive Match Plan for Employees (SIMPLE plan) that provides for contributions to be deposited into individual retirement accounts or annuities on behalf of employees. A SIMPLE IRA is created after the employer and employee complete IRS Form 5304-SIMPLE or Form 5305-SIMPLE. Form 5304 is used if an employer allows each plan participant to select the financial institution that will receive contributions under the plan. Form 5305 is used if an employer requires that all contributions under the plan be deposited initially at a designated financial institution.

A SIMPLE IRA account can be set up as either a trust account or a custodial account. A trust account is set up by filling out IRS Form 5305-S, SIMPLE Individual Retirement Trust Account. A custodial account is established by completing IRS Form 5305-SA, SIMPLE Individual Retirement Custodial Account.

If an employer has never had one before, a SIMPLE IRA plan can be set up any time between January 1 and October 1 of a year. For employers who previously maintained a SIMPLE IRA plan, a new plan can only be set up on January 1 of a year. This restriction, however, generally does not apply to a new employer who establishes a new SIMPLE IRA plan as soon as administratively possible.

Planning Tools You can download various IRS forms for SIMPLE IRAs to aid in your financial planning.

Contributions. An employee may elect to defer a part of each salary payment to a SIMPLE IRA. The maximum amount an employee can defer annually in 2013 and 2014 is $12,000. This limit is reviewed annually to determine whether it should be adjusted upward for inflation.

A participant who is at least 50 years old can elect to defer additional "catch-up" contributions each year to the SIMPLE IRA to help save more for retirement. Although the maximum amount is subject to annual adjustment for inflation, the annual maximum catch-up contribution amount has held steady at $2,500 from 2006 through 2014.

An employee's contributions must be expressed as a percentage of the employee's compensation unless the employer permits a specific dollar amount. No matter how it is expressed, though, an employer cannot restrict an employee's contribution amount except to comply with the maximum allowed limits.

An employer is required to make contributions to the plan, but there are two basic options for the employer to choose from. The employer can make nonelective (mandatory) contributions of an amount equal to 2 percent of an employee's compensation, which are deposited to the employee's account even if the employee doesn't otherwise participate in the plan. The other option is for the employer to match an employee's contributions dollar for dollar up to 3 percent of the employee's compensation. An employer can contribute a lower percentage, as low as 1 percent, for any year, but can't do so for more than two years during a five-year period ending the year for which a choice is effective.

When figuring out the maximum an employer can contribute annually, the annual maximum compensation amount that can be taken into account for any employee in 2013 is $255,000. The amount increases to $260,000 in 2014.

Example Paul Bunyan, a 52 year-old lumberjack, earns $60,000 in 2013. Although his lifestyle is not extravagant, he wants to contribute as much as possible to his SIMPLE IRA to make sure he stays well fed after he retires. His employer, Red River Lumber Company, matches employee contributions up to 3 percent of an employee's compensation. The maximum that can be added to Paul's SIMPLE IRA account in 2013 is: Employee salary reduction contribution (about 14% of income): 2013 Regular contribution limit $12,000 2011 Catch-up contribution $2,500 Employer matching contribution ($60,000 x .03) $1,800 Total contributions $16,300 Paul's co-worker, Babe B. Ox, is not interested in contributing to her employer's SIMPLE IRA plan and makes no elective contributions to the plan in 2013. Because Babe makes no contributions to the plan in 2013, Red River Lumber Company does not have to make any matching contributions on Babe's behalf.

Distributions. A distribution from a SIMPLE IRA is subject to the same rules as a distribution from a regular IRA. Distributions are generally included in income and taxed in the year received.

A SIMPLE IRA can be rolled over to another SIMPLE IRA on a tax-free basis. If you are rolling over a SIMPLE IRA to a non-SIMPLE IRA, however, the rollover is tax-free only after you participate in the SIMPLE IRA for two years. Also, distributions from a SIMPLE IRA cannot be rolled over tax-free to another qualified retirement plan.

Early withdrawals are generally subject to a 10 percent penalty tax. However, if funds are withdrawn within the first two years of plan participation, the penalty tax increases to 25 percent.

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