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Retirement Perspectives

While SIMPLE IRAs have come a long way, the rules governing these popular retirement savings plans for small businesses are at times anything but simple.

As summer vacations come to an end, small business owners may want to provide a way for their workers to save for retirement. If they act soon, they may be able to meet the October 1st deadline to set up a Savings Incentive Match Plan for Employees (SIMPLE) IRA.

Created in 1996 as a replacement for SAR-SEPs, SIMPLE IRAs continue to be a popular option for small business owners who want to help their workers and themselves save for retirement.  Among the attractions of SIMPLE plans is they’re cost-effective, easy to administer, low maintenance, and generally simple. Notably, Congress attached a host of tricky rules that apply only to SIMPLE plans. Failure to follow the maze of rules can result in significant time and penalties.

Here is a compendium of quirky rules that could trip up tax professionals, advisors, as well as sponsors of SIMPLE plans. In addition, I will explain a “newer” rule that may have escaped your attention.

Lord Abbett offers SIMPLE IRA plans and a guide to set them up: SIMPLE IRA Plan Sponsor Guide.
Call 888-522-2388 for more information.

1) 100-employee rule—Any type of business, including tax-exempt organizations and governmental entities can establish a SIMPLE plan. However, they must have had no more than 100 employees with $5,000 or more in compensation during the preceding calendar year.

What happens if an otherwise eligible employer surpasses the 100 employee threshold?  The IRS provides transition rules that apply for those businesses that exceed the 100-employee limit. IRS rules have a two-year grace period for employers who had 100 or fewer employees, but then grew to exceed the 100-employee limit. An employer that maintains a SIMPLE plan is treated as satisfying the 100-employee limitation for the two calendar years immediately following the calendar year for which it last satisfied the 100-employee limitation, except in the case of a merger or acquisition.

2) Exclusive plan rule—A SIMPLE IRA must be the only qualified retirement plan (e.g., 401(k), SEP, 403(b), etc.) that an employer maintains during a calendar year. If no contributions are made and no benefits accrue to an existing qualified plan (e.g. 401(k)) of the employer during this time period, the employer will satisfy the requirement referred to as the “exclusive plan rule.”

3) Plan establishment (timing)—SIMPLE IRA plans can be maintained only on a calendar-year basis.

4) Plan establishment (timing) Part II—Government rules mandate that a new SIMPLE IRA plan must be established between January 1 and October 1 of the year in which the plan is being established.  Therefore, a newly established SIMPLE IRA plan meant to be effective in 2019 must be established by October 1. A plan established after October 1 would be effective January 1, 2020 at the earliest.

Tip: The deadline is waived for a new business that was established after October 1 of the same year provided the plan was formed as soon as administratively possible after the new business was created. For example, if a new business is established effective November 1, 2019, the owners could still establish a SIMPLE plan effective for 2019, assuming they do it as soon as the business is sufficiently established.

5) Contributions (Employee and Employer)—In 2019, both employees and owners can contribute on a pretax basis up to $13,000 of income, plus a $3,000 catch-up contribution for those individuals age 50-plus.

Employers are required to make a fully vested annual contribution on a dollar-for-dollar basis of up to a 3% match or a 2% non-elective contribution. Notably, the matching contribution can be reduced to as little as 1% in two out of every five years. The employer’s contribution can be made as late as the employer’s tax-filing deadline, including extension.

No other SIMPLE IRA contributions by either the employee or employer are permitted. However, SIMPLE participation does not affect IRA (traditional or Roth) eligibility. Employees, assuming they are otherwise eligible, can contribute up to the maximum annual limit to their traditional or Roth IRAs, in addition to SIMPLE participation.

6) Distributions/Rollovers (to/from SIMPLE Plans)—Distributions timing rules (including rollovers, Roth conversions, etc.) are complex under any employer sponsor retirement plan but additional care must be taken with respect to SIMPLE accounts.

Typically, investors who take IRA distributions before age 59½ are subject to a 10% early-distribution penalty, plus income taxes on the amount withdrawn. In general, the same tax rules apply to all IRAs, including SEP and SIMPLE IRAs. However, there is a significant caveat for distributions from a SIMPLE IRA: penalties on an early distribution from a SIMPLE plan can be as high as 25% if the withdrawal occurs within the first two years of participation.

SIMPLE IRAs, unlike any other IRA, are subject to a two-year holding period that restricts distributions, conversions, or rolling over assets into any account other than another SIMPLE IRA for two years from the date of initial participation (defined as the day on which employers deposit contributions to workers’ SIMPLE IRAs). After two years, the early-distribution penalty is 10%.

Under this unique rule, if the participant is younger than 59½ and withdraws assets before the two-year holding period, the rate of the penalty tax would be increased, from 10% to 25%. However, if an early withdrawal qualifies as exempt from penalty (under IRS section 72(t)), the two-year holding limit does not apply and the exemption would prevail.

 

The Protecting Americans from Tax Hikes (PATH) Act of 2015 allowed for SIMPLE IRAs to receive rollovers from qualified plans, such as 401(k), 403(b), government 457(b), and IRAs. Rollovers will be permitted only after a participant has satisfied their two-year holding period.

 

During the initial two-year holding period, participants cannot roll over their SIMPLE IRA assets (even with a direct, “trustee-to-trustee” transfer) to another retirement plan (e.g. 401(k)) or convert assets to a Roth IRA without being assessed a 25% penalty. It is, however, permissible to transfer assets to another SIMPLE IRA provider within the first two years. Therefore, individuals can transfer their SIMPLE accounts directly to a new SIMPLE IRA provider at any time, without incurring taxes or penalties.

Once the two-year holding period has been satisfied, SIMPLE IRAs are very portable and can be rolled over to any retirement plan that otherwise accepts rollovers. (See our Rollover guide here.)

7) 60-day rollover—As with all other IRAs, SIMPLEs are subject to the once per year 60-day withdrawal and rollover. Notably, a rollover cannot be repaid to a SIMPLE IRA unless funds were withdrawn from a SIMPLE IRA; but SIMPLE assets, if the SIMPLE were at least two years old, could be returned to any IRA.

8) Required minimum distributions (RMDs)—Workers older than 70½ are eligible to participate in a SIMPLE IRA, although they also are subject to RMDs.

9) Qualified Charitable Distributions—QCDs allow owners and beneficiaries who are age 70½ and older to directly transfer $100,000 to a charity tax free. However, the participant can do a QCD from their traditional IRA, Roth IRA or inactive SIMPLE IRA.

10) Annual notice—SIMPLE IRA plan sponsors must distribute an employee notice annually to all eligible plan participants. November 1, 2019, is the notification deadline for employers who continue to offer a SIMPLE IRA plan for the next year. The notice (among other plan details) notifies the participants of the plan’s employer-contribution formula that will be used for next year (i.e., a 3% match or a 2% non-elective contribution).

Tip: Once the employer contribution formula is made, it can’t be modified. Further, an employer can neither terminate a SIMPLE IRA plan during the year nor change or cease making the employer contributions during the year.

11) Plan Termination—As the life of a business evolves, objectives change too; therefore a time may come when the SIMPLE plan may need to terminate. How does a business owner terminate a SIMPLE plan? First, an employer must finish the plan year and fulfill all promised contributions.

An employer should follow these steps to properly terminate a SIMPLE IRA:

  1. Notify all plan participants within a reasonable time of the intent to terminate the plan. In general, it is considered reasonable to notify employees before November 2 that the plan will be terminated on January 1 of the following year.
  2. Notify the SIMPLE IRA custodian of the intent to terminate the plan.
  3. Document and retain records that participants and the custodian were notified of the intent to terminate the plan.

It’s understandable for a small business owner to run afoul of the numerous rules governing the SIMPLE IRA plan. Lord Abbett offers these plans and a guide to set them up: SIMPLE IRA Plan Sponsor Guide or call 888-522-2388.

In addition, the IRS provides a number of resources to assist owners. We urge small business owners to discuss any potential plan issues with a financial professional, tax professional, or retirement specialist.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

A required minimum distribution (RMD) is the minimum amount an account owner must withdraw from a retirement account each year. An owner generally has to start taking withdrawals from a retirement plan account at age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

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The Lord Abbett SIMPLE IRA Plan Sponsor Guide
Call 888-522-2388 for more information.

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