ULTIMATE GUIDE TO SIMPLE IRA PLANS
In 1978 congressed passed the Revenue Act of 1978, which brought about the existence of 401k plans. Prior to the 401k many employees were covered by pensions that would provide them with retirement income. However, as pensions became more and more expensive, employers looked to find a solution that could provide retirement benefits, but not cost them a small ransom.
Unfortunately, as more and more regulation began to accrue in regards to 401k plans, the cost to a business to run them crept up and up. Administrative fees, set up fees, compliance fees, and testing fees all began to make 401k expensive. Often times so expensive, that small business found them hard to justify. While the owners wanted to do something to provide retirement savings for their employees, the costs simply became too much to bear.
In 1996 congress again came through, this time with the Small Business Job Protection Act. This act brought forth what is known as the Simple IRA (Savings Incentive Match Plan For Employees). With low to no administrative fees, and no fiduciary responsibility of the business owners, these plans opened the floodgates for small business to offer a retirement plan to their workers.
The only problem with simple IRA’s is that they are still somewhat forgotten. 401k plans still earn most of the media attention, and many employers are still unaware of the plan, and what it can offer. If you are a small business owner, or, you work for a small business that currently has no retirement plan, here is what you should know.
SIMPLE IRAS OFTEN HAVE NO ADMINISTRATIVE COSTS
Simple IRA’s really live up to their name. Compared to a 401k they will require little to no up-front investment by the business, and little to no time from the business owner. The reason they are able to be run so simplistically is because they look and operate very similar to regular IRA accounts. What that means in plain English, is that most if not all of the responsibility to run the accounts and manage the investments rests on your employees, not the business owner.
There are two key differences between Simple IRA accounts and regular IRA accounts. Contribution limits, and contribution types.
Regular IRAs are limited to $6,000 of contributions per year ($7,000 for those over 50). Simple IRAs bump that up to $13,500 and $16,500 for those over 50. That gives your employees a chance to really juice their retirement savings.
In a regular IRA, contributions come straight from the account owners in the form of check or electronic deposits right from their bank account. With a simple IRA, deposits must be made in the form of paycheck deferrals. Employees elect either a flat dollar amount, or a percentage to be deducted from their paycheck, which goes into their simple IRA account.
Simple IRAs are tremendously easy to set up and involve very little paperwork. The only part that gets tricky is the timing. For a plan to become effective in the current year, it must be established by 10/1. If an employer misses that deadline for getting the plan established then they will have to wait until 1/1 of the following year to get the plan started. If you want an answer as to why, you will need to get ahold of the IRS because similar to you, this makes very little sense to me.
The time that a business owner will spend administering a Simple IRA plan is the annual distribution of the plan notices. Basically once a year (before November) you need to let your employees know that you intend to continue offering the plan.
THERE ARE TWO OPTIONS FOR MATCHING
While the administrative costs of a Simple IRA are nonexistent, that does not mean they are free to the business owner. While an owner will not be obligated to write a check to the financial institution maintaining the account, they will be obligated to contribute money into their employee’s accounts. There are two options for how you do this.
Contribution matching is the most common of the two options. If this method is elected employers are obligated to match employee contributions up to (at least) 3% of their salary. Employers are of course welcome to offer larger matches, but 3% is the required minimum. The other key consideration with this method is that employers are ONLY obligated to MATCH contributions. Meaning if an employee chooses not to use the plan, they employer does not need to deposit anything into their account.
The second method is the mandatory method. If this choice is elected the employer is obligated to contribute 2% of each employees pay into their simple IRA account whether the employee contributes or not.
A good financial advisor will be able to help a business owner determine which election method would be best for their goals.
EMPLOYEES CAN HAVE ACCOUNTS ANYWHERE
One of the many things that employees like about Simple IRA plans, is that they are not tied to any particular financial institution like they would be with a 401k plan. If they already have a financial advisor they work with, or an online brokerage they keep their accounts at, they can continue to use that platform.
In order to offer this flexibility to employees the right election must be made by the employer when the plan is established. IRS form 5304 will allow employees to open accounts anywhere, while form 5305 will require them to open accounts at a specific institution. If the thought of IRS forms makes you nauseas, then you’d be best off working with a financial advisor to set up the plan. But I would recommend you at least know what forms these are and ask the advisor. Some advisors work for firms that only allow for 5305 plans, so you will want to avoid them.
There are some specific nuances your employees will want to know about when it comes to transferring accounts and the timeframes associated with those moves. The good news to a business owner, is that those nuances are not your problem, but it is a good idea to point your employees towards working with an advisor as the default and them let them ultimately decide what they want to do.
YOU CAN CHANGE SIMPLE IRA PROVIDERS
If you started a plan as a 5305 plan and are stuck working with one firm I have good news, you can change Simple IRA providers! The process to make the switch from a 5305 to a 5304 is pretty darn simple, the only trick is that it has to be done at the right time of year.
You need to let your employees know that you intend to change simple IRA providers by 11/2 of the current year in order to make the switch on 1/1 of the following year. Then you simply file the new form 5304 with the IRS with a plan start date of 1/1. Closing the old plan down is as easy as it comes because there is actually nothing the business owner needs to do. Simply start directing contributions to the new plan, and then let employees decide if they want to move or consolidate their old accounts.
This gives a great layer of flexibility for business that become dissatisfied with a brokerage or financial advisor that currently administers their plan. It also allows businesses to change Simple IRA providers if their financial advisor switches firms and they would like to continue to work with them.
SIMPLE IRA PLANS ARE EXCLUSIVE
Everything up to this point has hopefully been pretty straight forward. This is the point where Simple IRA’s will get a little more nuanced. The good news here is that if you are working with a financial advisor, they will know how to navigate all of this, so you don’t have to worry about it.
Simple IRA’s are exclusive. What that means, is if a business operates a Simple IRA plan it is the ONLY plan they can run. These cannot be offered in conjunction with 401k plans or anything.
While they are exclusive to the business they are NOT exclusive to employees. If employees work multiple jobs, that all offer retirement plans, they can contribute to all of them if they so desire. The only thing employees need to watch for is the aggregate contribution limit. As mentioned earlier, a Simple IRA is limited to $13,500 in contributions for employees under 50. If an employee works three jobs all with Simple IRA plans that might lead one to think they can contribute up to $40,500 between the three. While I wish that was the case the IRS has established aggregation limits that cap overall contributions to ALL retirement plans at $19,000 for those under 50.
SIMPLE IRA PLANS ARE ONLY FOR SMALL BUSINESSES
While in the authors opinion Simple IRA plans offer a much better savings plan than 401ks, the IRS has every intention of only allowing the opportunity to use them to small businesses. Now, being that the IRS is involved, the rules that govern this are anything but simple.
In general, a business must have fewer than 100 employees. BUT, employees earning under $5,000 per year do not count towards that limit. So seasonal and part time workers may not count toward the limit.
The IRS also allows for a grace period for businesses that grow over 100 employees. If you satisfied the requirement last year, but this year went over the limit, the Simple plan can remain open for the current year and will be treated as if the requirement was still satisfied.
RMDS STILL APPLY
Because Simple IRA’s are similar to 401k plans and traditional IRAs in that they are tax deferred, they will also someday be subject to those pesky required minimum distributions. While this is nothing that employers need to be concerned with, employees, will need to be aware that when they turn 72 the IRS will come calling. Beginning in the year in which you turn 72.5 (again nothing can be simple with the IRS) account holders will need to start taking withdrawals from their account and paying the associated income tax.
If an employee works with a financial advisor, they will likely be developing strategies early in order to minimize the overall tax hit of the account. This can take the form of roth conversions, or QCD’s. If you work with an advisor who has never brought either of those items to your attention it may be time to switch btw.
CONCLUSION
Simple IRA plans deserve far more attention than they currently receive. They offer a far more streamlined and less expensive process for business owners, and they give employees complete flexibility in how they want to manage and control their investments.
If a business owner is looking for an inexpensive way to retain valuable employees, and offer a benefit that will help those employees provide for their future, a Simple IRA should be strongly considered.
If you run a business with more than 100 employees, by all means look into starting up 401k plan. If you are truly a small business, (less than 100 employees), then a Simple IRA is quite possibly the best fit for you.