SIMPLE IRA Eligibility Requirements — Individual Retirement Accounts

Employer Eligibility

Unlike other qualified plans, SIMPLE plans are not available to all employers. Two requirements must be met:

The employer must not have any other qualified retirement plan in effect
The employer must have 100 or fewer employees who received at least $5,000 in compensation during the preceding year

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 — employees of two businesses under the control of a sole proprietor would be combined to determine eligibility.

Establishing Date

Existing employers establishing a first-time SIMPLE plan may do so on any date between January 1 and October 1
New employers that come into existence after October 1 may set up a SIMPLE plan for that year, provided it is established as soon as administratively feasible
Employers that previously maintained a SIMPLE plan may re-establish one effective only on January 1 of a year

Two-Year Grace Period

Employers who maintained a SIMPLE plan for at least one year, but later become ineligible, may continue to maintain the plan for an additional two-year grace period following the last year of employer eligibility. If the employer remains ineligible after the two-year grace period, the SIMPLE plan may no longer be maintained.

Example — Grace Period: Stellar Corporation established a SIMPLE plan when it had 95 employees. It later hired its 101st employee and is no longer eligible for a SIMPLE plan. However, it may maintain the plan for the next two years under the grace period. If at the end of the grace period its payroll drops below 100 employees, it may continue to operate the plan. If not, no SIMPLE plan contributions may be made in future years.

Mergers and Acquisitions

A special rule applies to mergers and acquisitions. If an employer becomes ineligible for a SIMPLE plan due to a merger, acquisition, or similar restructuring, the SIMPLE may be maintained for the rest of the year and the year following the restructuring.

Example — Merger: ABC Corporation operates a SIMPLE IRA plan for its 35 employees. XYZ, Inc. maintains a defined benefit plan for 47 employees. ABC merges with XYZ in August. Since the combined enterprise has another type of qualified plan, it is no longer eligible for a SIMPLE plan (even though it has fewer than 100 employees). The tax code allows ABC to continue operation of the SIMPLE IRA for the rest of the current year and the following year. During this time, XYZ’s employees may not participate in the SIMPLE IRA, and ABC’s SIMPLE participants are not eligible for the pension plan.

SIMPLE IRAs and SIMPLE 401(k) Plans

Employers may adopt a SIMPLE plan as part of a 401(k) arrangement or establish the SIMPLE plan using employee IRAs. They are similar in concept but differ in some operational aspects. The following discussion focuses on SIMPLE IRA plans, with differences between SIMPLE IRAs and SIMPLE 401(k)s noted where applicable.

The SIMPLE IRA is easier to establish. The IRS provides a model document, Form 5305-SIMPLE, a two-page document that employers may use to set up the program. (View IRS Form 5305-SIMPLE →) The employer must notify eligible employees of their coverage and ensure that each eligible employee has established an IRA account. Contributions are deposited directly into employees’ IRAs.

The employer claims a tax deduction for contributions. All IRAs established under a SIMPLE arrangement must be traditional IRAs, not Roth IRAs. All eventual distributions will be fully taxable to the employee.

§ SIMPLE 401(k) difference: SIMPLE 401(k) plans allow a Roth account to accept employee after-tax deferrals; however, employer contributions must be placed in a regular non-Roth account.

To establish a SIMPLE 401(k) plan, the employer must conform to the requirements of a regular 401(k) plan — more complicated than a SIMPLE IRA. The advantage is that the complex nondiscrimination tests for “regular” 401(k)s are satisfied if the plan meets the SIMPLE contribution and vesting requirements. SIMPLE 401(k) plans, however, must still satisfy all other 401(k) rules.

§ SIMPLE 401(k) difference: SIMPLE 401(k) plans may permit loans to participants and hardship withdrawals. SIMPLE IRAs may not.

All SIMPLE plans — 401(k) or IRA — must be maintained on a calendar year basis. If an employer converts an existing fiscal-year 401(k) into a SIMPLE 401(k), the plan must be converted to a calendar year.

Employee Participation Requirements

The tax code requires an employer’s SIMPLE plan to be available to every eligible employee who:

Received at least $5,000 in compensation from the employer during any two preceding years, and
Is reasonably expected to receive at least $5,000 in compensation during the current year

The two preceding years do not need to be consecutive, and need not be the immediately preceding years. An employer may establish a SIMPLE plan even if none of its employees wish to participate, though the employer must notify employees of their right to do so.

Self-employed individuals are eligible to participate. Employees who already participate in a retirement plan of a different employer for the same year may also participate in a SIMPLE plan.

Employers may make participation requirements less restrictive — including waiving the compensation rule altogether and simply covering all employees. The employer’s election is indicated on Form 5305-SIMPLE.

§ SIMPLE 401(k) difference: SIMPLE 401(k) plans may limit participation to employees age 21 and older. SIMPLE IRAs may not impose an age restriction.

Employers may exclude nonresident aliens and employees covered under a collective bargaining agreement from SIMPLE plan participation (though these employees are still counted toward the 100-employee eligibility test).

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