SIMPLE Plans

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Small employers are permitted to offer Savings Incentive Match Plan for Employees (SIMPLE plan), if they do not currently maintain another qualified plan. SIMPLE plans may be structured as an IRA or 401k plan. (This discussion focuses on SIMPLE 401k plans.) The primary attraction of a SIMPLE plans over a "regular" 401k plan is that they relieve smaller employers of the need to perform complex nondiscrimination testing and to comply with burdensome top-heavy plan and reporting rules. The primary disadvantage of a SIMPLE 401k plan is a lower level of allowable annual contributions.

Please note: An employer that maintains a qualified plan as a result of a collective bargaining agreement may set up a SIMPLE plan to cover those employees not covered under the other plan.

Unlike other qualified plans, SIMPLE plans are not available to all employers. First, only employers who do not have any other qualified retirement plan may set up a SIMPLE plan. Secondly, only employers who have 100 or fewer employees may establish a SIMPLE plan. When counting employees, the employer must include all employees employed at any time during the year, regardless of whether those employees were eligible to participate in the plan. Businesses that operate under common control are treated as a single employer. Thus, the employees of two businesses under the control of a sole proprietor would be combined for purposes of determining whether either business could establish a SIMPLE plan. Likewise all employees of a parent company and subsidiary must be counted to determine if a SIMPLE plan can be established.

Please note: An employer who establishes a SIMPLE plan while maintaining another plan under a collective bargaining agreement must count all employees, including those covered by the collective bargaining agreement, even if those employees are not eligible for participate in the SIMPLE plan.

To establish a SIMPLE 401k plan, the employer must conform to the requirements of a regular 401k plan in its plan documents. The employer may establish a new 401k plan and elect to treat it under the SIMPLE rules, or the employer may "convert" an existing 401k plan into a SIMPLE 401k by agreeing to operate under the SIMPLE rules. The IRS offers employers a model amendment for those wishing to convert an existing 401k plan to the SIMPLE rules. The advantage of a SIMPLE 401k plan is that the complex nondiscrimination tests for "regular" 401ks, are satisfied if the plan meets the SIMPLE contribution and vesting requirements. However, SIMPLE 401k plans the must satisfy all of the other requirements applicable to "regular" 401k plans.

All SIMPLE plans are maintained on a calendar year basis. If an employer "converts" an existing 401k plan that is maintained on a fiscal year basis into a SIMPLE 401k, the plan must be converted to a calendar year in order to adopt the SIMPLE arrangement.

Eligible employees need only have earned $5,000 in compensation in any two preceding years and not in the immediately preceding two years. Nor must the two years be consecutive. In addition, an employer may establish a SIMPLE plan even if none of its employees wish to participate. However, the employer must notify all eligible employees of their right to participate in the plan. Self-employed individuals are eligible to participate in a SIMPLE plan. Employers may exclude nonresident aliens and employees who are covered under a collective bargaining agreement from participation the SIMPLE plan. (Although all of these employees are counted for purposes of qualifying "under the 100 employee" rule.)

Employers may choose to make the participation requirements of their SIMPLE plan less restrictive. In fact, employers may waive the compensation rules altogether and simply cover all eligible employees.

In traditional 401k plans, only employee elective deferrals are required. Employer contributions -- matching or non-elective -- are optional. The rules governing SIMPLE plans require employers to make some type of contribution to employee accounts. SIMPLE rules also prohibit employees from making additional, after-tax voluntary contributions. In short, SIMPLE plans allow:

Under the SIMPLE plan, an employee can elect to contribute up to "$6,000" per year (adjusted for inflation). The inflation-adjusted limit is $10,500 in 2007. This is considerable less than the $15,500 allowed in a "regular" 401k in 2007. A "catch-up" provision of $2,500 per year is available for SIMPLE participants age 50 or older -- please note is also less than allowed in "regular" 401ks. The contribution formula in a SIMPLE plan is expressed as a percentage of compensation, not as flat dollar amount, so not every employee may be able to contribute the maximum dollar amount.

Unlike traditional 401k plans in which an employer may choose to contribute or not, in a SIMPLE plan, the employer must contribute. Employers may select one of two contribution formulas: "matching contributions" or "nonelective contributions".

Under the matching contribution formula, employers match an eligible employee's contributions on a dollar-for-dollar basis, up to a maximum of 3% of the employee's compensation for the year. As with traditional 401k plans, employee compensation for this purpose is limited to the employee's first $150,000 of earnings adjusted for inflation ($225,000 for 2007). This means that for 2007, the maximum employer matching contribution in a SIMPLE 401k plan is $6,750 (3% of $225,000) regardless of the the employee's actual compensation, or contribution. So, employees deferring the maximum of $10,500 in 2007, will not receive a true dollar-for dollar match due to this limitation.

A matching contribution formula requires a contribution each year. Employers may not simply choose to not to contribute in some years due to financial difficulties or other reasons. If the employee defers income, the employer must match it.

Under the nonelective formula, an employer simply contributes 2% of the compensation for each eligible employee that year. When calculating nonelective contributions, compensation is limited to the first $150,000 of income -- adjusted for inflation ($225,000 for 2007). Whether the employee chooses to make an elective deferral for the year is irrelevant under this funding method. The employer will contribute 2% of compensation to the SIMPLE plan for all eligible employees.

The employer must notify each eligible employee of the nonelective contributions before the 60-day election period during which an employee decides whether to participate in the SIMPLE plan.

The annual contribution limit and the requirement of an annual contribution may make SIMPLE plans less attractive to small employers. For example, the owner of a small business whose income is much higher than that of her employees and who is interested in compiling retirement assets for herself as quickly as possible, may prefer to adopt a more traditional qualified plan (such as a profit-sharing plan) that allows higher annual contributions. In addition, small businesses that have fluctuating profits should be aware that they must continue to make contributions to the SIMPLE plan even if the business is not performing well in that year. Even in lean years, an employer will be required to contribute something on behalf of the employees.

In addition to the dollar limits on elective deferrals, the "100%/$40,000" limit applies to total contributions to an employee's account in a 401k plan, including a SIMPLE 401k plan. The inflation-adjusted limit is $45,000 in 2007.

For example, Samantha's unincorporated catering business, Goodies on the Go, employs Hannah, Chris and Jack as employees - each is paid $50,000. Samantha's net business income is $250,000. Assume Goodies on the Go sets up a SIMPLE 401k. Hannah elects to defer 5% of her compensation, Chris elects 1%, Jack chooses not to defer anything in 2007, while Samantha elects to defer 4% of her business income. Matching contributions to the participants' 401k would be:

For Hannah: Elective deferral Matching contribution	5% of $50,000 or 3% of $50,000 or	$2,500 $1,500	$4,000
For Chris: Elective deferral Matching contribution	1% of $50,000 or dollar-for-dollar or	$ 500 $ 500	$1,000
For Jack Elective deferral Matching contribution	0% of $50,000 or dollar-for-dollar or	$ 0 $ 0	$ 0
For Samantha: Elective deferral Matching contribution	4% of $250,000 or 3% of $225,000 or	$10,000 $ 6,750	$16,750

If Samantha's income had been $300,000, a 4% elective deferral would exceed the maximum of annual amount ($10,500 in 2007), so her elective deferral would be capped at $10,500 and the matching contribution would be $6,750 (3% of $225,000)

Assume the same facts as the previous example: In 2007, Hannah, Chris and Jack are each paid $50,000. Samantha's net business income is $250,000. Hannah elects to defer 5% of her compensation, Chris elects 1%, Jack chooses not to defer anything in 2007, while Samantha elects to defer 4% of her business income. Goodies on the Go chooses the non-elective method in 2007. The non-elective contributions to the participants' SIMPLE 401k would be:

For Hannah: Elective deferral Non-Elective contribution	5% of $50,000 or 2% of $50,000 or	$2,500 $1,000	$3,500
For Chris: Elective deferral Non-Elective contribution	1% of $50,000 or 2% of $50,000 or	$ 500 $1,000	$1,500
For Jack Elective deferral Non-Elective contribution	0% of $50,000 or 2% of $50,000 or	$ 0 $1,000	$1,000
For Samantha: Elective deferral Non-Elective contribution	4% of $250,000 or 2% of $225,000 or	$10,000 $ 4,500	$14,500

Please note that Goodies on the Go must contribute for Jack even though he did not elect to defer, and Chris receives more than under the matching contribution formula.

Employers may deduct any contributions they make to the SIMPLE account for the year in which they are made. This includes a deduction for the employee's compensation that was "deferred into the account", i.e., the employee's elective contributions. Employers may take a deduction for matching contributions to a SIMPLE plan for the tax year, provided the contributions are made by the date that the employer's tax return is due (including extensions).

All contributions (elective employee deferrals or employer contributions) to the SIMPLE account are excluded from an employee's income -- for federal income tax purposes. As with any 401k, employee contributions to a SIMPLE IRA are subject to Social Security (FICA) and federal unemployment (FUTA). However, employer contributions to a SIMPLE IRA are not subject to FICA or FUTA.

The IRS requires a minimum 60-day window in which employees may elect to contribute to a SIMPLE plan. Typically the "window" is the 60-day period before January 1st. SIMPLE plans may expand this "window" -- some plans offer up to 90 days in which to decide, others may offer a 30-day window each quarter. Employees must decide if they will contribute to the plan during that "window" of opportunity -- or if they wish to modify the amount they previously elected.

The employer notifies employees of their eligibility to contribute to the SIMPLE plan. The notice indicates what type of employer contributions will be made for the upcoming year (matching or non-elective). All notices must be provided within a reasonable period of time before the start of the period in which employees choose to contribute. Employees respond to the notice indicating if they wish to contribute elective deferrals, and if so, how much. The notice must also include a copy of the plan's "summary statement" prepared by the plan's trustee.

Employees may terminate their participation in the SIMPLE plan by discontinuing their contributions -- at any time during the calendar year. However, the employer can restrict such employees from resuming participation until the beginning of the following year.

The monies contributed by employees to a SIMPLE must be segregated from the employer's assets as quickly as possible. As with all qualified plans, ERISA regulations require employers to deposit employee contributions into the employee's SIMPLE 401k account no later than 15 days after the end of the month in which the employee would otherwise have been paid in cash. Employers must make their matching or nonelective contributions to a SIMPLE plan by the date that its tax return for the tax year is due, including extensions.

the employer makes matching contributions up to 3% of the employee's compensation for the year, or alternatively, makes a nonelective contribution of 2% of compensation for each eligible employee, and

SIMPLE 401k plans that satisfy these requirements of are exempt from treatment as a "top-heavy" 401k plan. This exemption applies only to SIMPLE 401k plans, and not to other 401k arrangements maintained by the employer.

All contributions to an employee's SIMPLE account must be nonforfeitable, That is, every contribution to the SIMPLE account -- employee and employer -- is immediately, 100% vested.

A SIMPLE 401k is subject to same general restrictions on withdrawals that apply to all 401k plans, this includes withdrawals due to financial hardship. Contributions to a SIMPLE 401k, and the earnings on those contributions, accumulate tax-free until the funds are withdrawn. Withdrawn funds are taxed at ordinary income tax rates. Early distributions from a SIMPLE 401k plan are subject to a 10% penalty tax, as with all other 401k plans. An employee who receives a distribution from a SIMPLE 401k plan may defer tax on the distribution by rolling over all or part of the distribution within 60 days of receipt to another qualified employer-sponsored plan or to an IRA, including a SIMPLE IRA.

Regarding distributions due to economic hardship, the participant may withdraw funds from the 401k if other financial resources are not readily available. The IRS recognizes medical expenses and the purchase of a principal residence as examples of the "immediate and heavy financial need" that qualify as a hardship. Persons taking a distribution due to "hardship", may not contribute any elective deferrals to the 401k plan or other qualified plans for the next 6 months.

SIMPLE 401k plans may also offer participants the ability to borrow funds up to one-half of the vested account value, to a maximum of $50,000. These loans are not treated as taxable distributions if:

If the loan does not meet these requirements, the amount "borrowed" is taxed as a distribution -- and possibly subject to the 10% penalty tax on premature distributions.