SIMPLE Retirement Plan: 401(k) Version

SIMPLE 401(k) Retirement Plan defined

A new subset of the 401(k) plan is the SIMPLE 401(k) Retirement Plan. SIMPLE 401(k) Retirement Plan is a retirement plan sponsored by employers. Just like the SIMPLE IRA plan, this is a retirement plan that is very much attractive for small business owner with 100 or fewer employees because it avoids some of the administrative fees and paper work which are common on all retirement plans. Employers benefit from the tax-deductible contributions made to the plan, and employees may elect to have salary deferrals in order to contribute to the retirement plan. The employer has the option of matching a certain portion of the employee’s deferrals or making non-elective contributions to all eligible employees (an annual limit applies in both cases). A minimum compensation eligibility requirement exists for employees who want to join this retirement plan, and employees cannot establish any other qualified retirement plans at the same time.

Why would one choose a SIMPLE 401(k) retirement plan instead of a SIMPLE IRA or regular 401(k) retirement plan? The fact is the SIMPLE 401(k) retirement plan is a cross between a SIMPLE IRA and traditional 401(k) retirement plan and offers the best of both plans - for the most part. Following are some review of the features and benefits of the SIMPLE 401(k) plan and compare it to the traditional 401(k) plan.

Advantages

• There is no testing under this type of retirement plan. An employer that adopts a traditional 401(k) retirement plan may be required to perform certain non-discrimination and top-heavy testing to ensure that the plan operates in compliance with regulatory requirements. Generally, such testing must be done by professionals who specialize in that area and can be quite costly. SIMPLE 401(k) retirement plans, on the other hand, do not require these tests. That is why this is very attractive to small business owner with 100 or fewer employees and who likes the features of the 401(k) retirement plans, but can't afford the administration costs of testing.
• Also loans are allowed and this can be an attractive feature of a qualified plan because employees and business owners usually like the idea of being able to borrow their own funds and make loan and interest payments to their own accounts. The loan feature can be made available in both SIMPLE and traditional 401(k) retirement plans.

Disadvantages

• There is an immediate vesting of contributions. With a traditional 401(k), employer contributions can be subject to a vesting schedule, and this may help to reduce high employee turnover. But contributions to a SIMPLE 401(k) retirement plan are immediately 100% vested, which means that an employee who meets the requirements to receive distributions from the plan may withdraw his/her entire account balance at any time.
  
• Also, contribution limits for a SIMPLE 401(k) retirement plan are much lower than the limits for the traditional 401(k) retirement plan. For instance, the salary deferral limits of both plans are as follows:

Year	SIMPLE Deferral Limit	Traditional 401(k) Deferral Limit
2002	$7,000	$11,000
2003	$8,000	$12,000
2004	$9,000	$13,000
2005	$10,000	$14,000
2006	$10,000	$15,000
2007	$10,500	$15,500

Furthermore, employer contributions to an employee's SIMPLE 401(k) retirement plan account are limited to 3% of the employee's compensation, while for the traditional 401(k) retirement plan; the employer may contribute up to 25% of the employee's compensation. Also, the compensation limit applies to both plans, which means the employer cannot consider compensation in excess of $220,000 for 2006 ($225,000 for 2007) (indexed) for plan purposes. Therefore, an employee's total contribution to a SIMPLE 401(k) retirement plan for 2007 can be as much as $17,250 (salary deferral of $10,500 + 3% contribution of maximum salary of $225,000) + catch-up contributions, while contributions to a traditional 401(k) retirement plan can be as much as $45,000 + catch-up contributions.

• An employer who establishes a SIMPLE 401(k) retirement plan cannot maintain any other plan for employees who are eligible to participate in the SIMPLE 401(k) retirement plan. By contrast, provided certain requirements are met, an employer who establishes a traditional 401(k) retirement plan may choose to establish a SEP, profit-sharing or other defined-contribution plan, maintain both plans concurrently and allow eligible employees to participate in both plans.

SIMPLE 401(k) Retirement Plan Eligibility Requirements for Employer and Employee

• The SIMPLE 401(k) retirement plan is available to those same employers who are eligible to adopt a traditional 401(k) retirement plan: this includes sole proprietors, partnerships and corporations. However, while there is no restriction on the number of employees for the traditional 401(k) retirement plan, only employers who adhere to the 100-employee limit can adopt a SIMPLE 401(k) retirement plan. Under the 100-employee limitation rule, a SIMPLE may be established by an employer that had no more than 100 employees who received at least $5,000 in compensation for the preceding year.
  
• Employees who are at least 21 years old and have completed at least one year of service must be allowed to participate in the SIMPLE 401(k) retirement plan.

Annual Notice Requirements
Employer must provide a deferral notice to each eligible employee for the year the plan is established and for each year the employer continues to maintain the plan. Generally, the notification must be provided at least 60 days before the employee would be eligible to participate in the plan. This notification must include a statement of the employee's right to make salary-deferral contributions to the plan and to terminate his or her participation in the plan.

Also, an employer is required to provide employees with an explanation of the plan’s features and benefits prior to the effective date of the plan.

Deadline to Establish SIMPLE 401(k) Retirement Plan
A SIMPLE 401(k) retirement plan must be established between Jan. 1 and Oct. 1. An exception applies to businesses that come into existence after Oct. 1. For these businesses, the plan can be established as soon as administratively feasible.

Conclusion
We have reviewed some of the highlights of the SIMPLE 401(k) retirement plan. As you can see, the SIMPLE 401(k) retirement plan boasts some attractive features, but it also has some disadvantages when compared with other retirement plans. If you think SIMPLE 401(k) retirement plan might be suitable for your business, be sure to consider the pros and cons.

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SIMPLE Retirement Plan: IRA Version

The SIMPLE Individual Retirement Account plan is an IRA-based plan that gives small employers a simplified method to make contributions toward their employees' retirement and their own retirement. Under this retirement plan, employees may choose to make salary reduction contributions and the employer makes matching or non-elective contributions. All contributions are made directly to an Individual Retirement Account or Individual Retirement Annuity set up for each employee. This type of retirement plans (SIMPLE IRA) is maintained on a calendar-year basis. See IRS Publication 560, IRS Publication 590 and IRS Notice 98-4 for detailed information on this type of retirement plans.

The IRA-type SIMPLE retirement plan provides you and your employees with a simplified way to contribute toward retirement. It reduces taxes and, at the same time, attracts and retains quality employees. And compared to other types of retirement plans, SIMPLE IRA plans offer lower start-up and annual costs … they are just simpler to operate.

Other Advantages of a SIMPLE Retirement Plan IRA version:

· SIMPLE IRA plans are easy to set up and run – your financial institution handles most of the details.

· Employees can contribute, on a tax-deferred basis, through convenient payroll deductions.

· You can choose either to match the employee contributions of those who decide to participate or to contribute a fixed percentage of all eligible employees’ pay.

· You may be eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting a SIMPLE IRA plan. (IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs).

· Administrative costs are low.

· You are not required to file annual financial reports.

Actually, this retirement plan is much less burdensome for an employer than other types of retirement plans. For example, the employer has no requirement to make annual filings to the IRS. Employers with other types of retirement plans must file Form 5500 each year.

The employer must provide a description of the retirement plan to employees but it is a much simpler format than the Summary Plan Description required of other types of qualified retirement plans. The SIMPLE summary description includes the name and address of the employer, eligibility requirements for employees, a description of the benefits provided, the time and method of collecting contributions, and the procedures and effects of withdrawals from the plan including rollovers. A one or two-page summary should be sufficient to meet this requirement as compared to the detailed summary plan descriptions that are often needed for other qualified retirement plans.

The other information that must be provided to an employee is the election form at least 60 days in advance of the year and an annual statement of accounts within 30 days after the end of the year.

The employer is also responsible for applying the proper tax treatment on employee and employer contributions. Employee contributions are not subject to income tax withholding but are subject to social security (FICA) taxes.

The employer must observe the $150,000 (indexed) limit on the compensation that can be considered in the plan as required for other qualified retirement plans.

The IRA-time SIMPLE retirement plans also give the employer some flexibility in making the contribution. For example, the 100% match on the first 3% of employee contributions can be reduced to a 100% match on the first 2% or 1% of pay the employee contributes. This limit, however, cannot be used any more frequently than two years out of five. For example, an employer might match employee contributions of up to 3% for the first year, reduce the match to only 1% for the next two years, and revert to matching up to 3% for the following two years.

The employer also has the option of making a uniform 2% of pay contribution for all employees eligible for the retirement plan whether or not they contribute, in lieu of the matching contribution. Depending on how many employees elect to participate and the percentage of pay they choose to contribute, the 2% uniform contribution may be more or less expensive than the matching contribution. The matching contribution, however, provides more incentive for employees to save their own money towards retirement on a tax-efficient basis.

SIMPLE Retirement Plan: An Easier Way for Employers to Provide Retirement Benefits

The Small Business Job Protection Act of 1996 makes available a new type of retirement plan for employers with no more than 100 employees. This type of plan is referred to as the SIMPLE plan (for Savings Incentive Match Plans for Employees of Small Employers). The purpose of the SIMPLE plan is to allow employers an easier way to establish and maintain a retirement plan for their employees.

To implement this, an employer must meet two basic requirements to have a SIMPLE plan. First, the employer must have no more than 100 employees (counting only employees with at least $5,000 of annual compensation). If an employer has adopted a SIMPLE plan and then grows to more than 100 employees, it's given a 2-year grace period to operate the SIMPLE plan and then must convert to another type of qualified retirement plan. The second is that the employer should have no other qualified retirement plan. For example, an employer with a defined benefit pension plan cannot establish a SIMPLE plan. However, as we shall see an employer that currently sponsors a 401(k) plan and has no other plan can easily modify their 401(k) plan to meet the rules for SIMPLE plans.

There are two routes for setting up a SIMPLE plan:

1. An employer can either use IRA's for holding the retirement accounts of each participant or

2. can set up a trust or insurance contract and operate the plan as a kind of 401(k) plan.

Some of the rules for SIMPLE plans are the same for the IRA and 401(k) variations but other rules are significantly different. Understanding these differences is a key to deciding which arrangement will work better for a specific employer.

Basic Features

SIMPLE plans have a specified employer contribution and immediate vesting. The employer contribution required to a SIMPLE plan is a 100% match of the first 3% of pay an eligible employee elects to contribute to their retirement account.

Employees are allowed to contribute to the plan on a pretax basis as much as $6,000 per year.