Please note the information below is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the receipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of the information provided below should not be acted upon without specific professional guidance. Please call us if you have any questions.
In 2017, if a company sponsors a profit-sharing plan, the company could make a contribution on behalf of the business owner of as much as $54,000. With a SIMPLE IRA, the maximum amount this year is $31,000. If that’s the case, why would you consider the latter choice?
One reason can be found in the plan’s name; a SIMPLE (savings incentive match plan for employees) IRA has less paperwork as well as lower start-up and operating costs, compared with many other types of retirement plans. As long as your company is eligible (it must have no more than 100 employees and must not sponsor another retirement plan), you can set up the plan by filling out IRS Form 5304-SIMPLE or 5305-SIMPLE.
Subsequently, there is no annual filing requirement and no testing for discrimination in favor of highly-compensated employees. The only other requirement is annual notification, which you can meet by sending each employee a copy of the original 5304-SIMPLE or 5305-SIMPLE.
A SIMPLE IRA also can work if you are just starting a company and have no employees. With other retirement plans, adding workers may require some extensive paperwork. With a SIMPLE IRA, the company just sets up an IRA for each employee who joins the plan. A SIMPLE IRA must be offered to all employees who were paid at least $5,000 in any prior two years and who are expected to earn that much in the current year.
Contribution considerations
Eligible employees can defer up to $12,500 of their compensation in 2017, deferring the income tax as well. Those 50 or older can defer up to $15,500.
With a SIMPLE IRA, employers must make certain contributions to employees’ accounts. All money that goes into a SIMPLE IRA is totally vested for the employee.
One option is to match each employee’s contribution, up to 3% of pay. (An employer may choose to match as little as 1% of employees’ contributions, for one or two years during the five-year period that ends with the year for which the employer chooses the lower match percentage.)
Example 1: Sue Taylor, who works for ABC Corp., earns $60,000 a year. She contributes $6,000 to her SIMPLE IRA in 2017. ABC, which chose the matching option, contributes $1,800 (3% of $60,000). Therefore, the total amount moving into Sue’s account in 2017 is $7,800.
Continuing with the ABC Corp. example, suppose that Richard Palmer, the chief shareholder, is 54 years old. Richard defers the maximum $15,500 of his salary to his SIMPLE IRA. If he earns more than $516,667 in 2017, a 3% match would be another $15,500, bringing Richard the maximum $31,000 SIMPLE IRA contribution this year.
Instead of matching, a company sponsoring a SIMPLE IRA can make non-elective contributions of 2% of pay for each eligible employee, even for those who don’t contribute.
Example 2: Walt Vincent works for XYZ Corp., where he earns $50,000 a year. XYZ has chosen to make non-elective contributions to its employees’ SIMPLE IRA. Even though Walt does not contribute this year, XYZ must make a contribution of $1,000 (2% of $50,000) to Walt’s SIMPLE IRA. These non-elective contributions are capped by an annual compensation limit, which is $270,000 in 2017. As a result, with this method a company’s contribution to any employee’s SIMPLE IRA can’t exceed $5,400 this year (2% of $270,000).
Fine points
During the first two years they are in the plan, SIMPLE IRA participants owe a 25% penalty for in-service withdrawals before age 59½. After two years have passed, the regular 10% early withdrawal penalty applies. During those first two years, rollovers from a SIMPLE IRA to a traditional IRA are prohibited. Eligible companies generally must establish a SIMPLE IRA by October 1 in order to have the plan in effect for the current year. However, different rules apply to new companies that came into existence after October 1 in a year, and existing companies that previously maintained a SIMPLE IRA plan.