IRAs: Six SIMPLE Rules for Small-Employer Plans

SIMPLE IRAs are a popular retirement-plan option that features low cost, flexibility, and minimal administrative requirements. Here’s what plan sponsors and participants need to know.

For many small-business owners, the waning summer season is a reminder that the leisurely days soon will be replaced with the more eventful schedule of fall, including preparing for the deadline of October 1 to establish a SIMPLE IRA plan for 2018.

The SIMPLE IRA was created in 1996 as part of the Small Business Job Protection Act (SBJPA), replacing the SAR SEP IRA, and now it has become a popular retirement-savings plan for small businesses and sole proprietors alike, due to its low cost, flexibility, minimal administrative requirements, and, yes, simplicity.  In addition, SIMPLEs generally are not subject to the numerous requirements of the Employee Retirement Income Security Act (ERISA) that qualified plans must follow. This makes the SIMPLE IRA well worth considering when discussing the numerous workplace retirement-plan savings options with your clients. Like all tax-advantaged accounts, SIMPLE IRAs have a myriad of rules that must be closely adhered to, or the holder may face unintended consequences. Below, I discuss the rules that have often escaped advisors, accountants, and attorneys in the past, as well as one newer rule that may not be on their radar.

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

There is a grace period for employers who subsequently fail to satisfy the 100-employee limit. An employer that maintains a SIMPLE plan for at least one year and, subsequently, ceases to satisfy the 100-employee limit in a later year, will be treated as though the employer had met the requirement for the two calendar years immediately following the calendar year for which the limit was last met.

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. In other words, plan sponsors generally cannot establish a SIMPLE plan if they maintain a 401(k) or other qualified plan in the same year in which contributions are made. However, there is an exception: if another qualified plan is maintained for union employees covered by collective bargaining agreements, the plan sponsor may maintain a SIMPLE IRA for the other non-union employees.

If no contributions are made and no benefits accrue to an existing qualified plan of the employer during this time period, the employer will satisfy the requirement.

3) Plan establishment—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 started.  For example, a new SIMPLE must be established by October 1, 2018, to be effective for the 2018 plan year. Those plans established after October 1 would not be effective until January 1, 2019, at the earliest. Notably, an exception applies for a newly established business. If you’re a new employer that started your business after October 1, you can establish a SIMPLE IRA plan for the plan year by the end of the same calendar year as soon as administratively feasible after your business came into existence.

Tip: SIMPLE IRA plans can be maintained only on a calendar-year basis.

4) Annual notice—SIMPLE IRA plan sponsors must distribute an employee notice annually to all eligible plan participants. November 1, 2018, is the notification deadline for employers that will continue to offer a SIMPLE IRA plan in the 2019 plan year. The notice provides employees a wealth of plan information, including the opportunity to participate in the plan by making salary deferrals, or to change the amount previously being deferred. In addition, the notice informs the participant of the employer contribution formula (e.g., 3% match or 2% non-elective contribution).  Once the employer has chosen the contribution formula, it cannot be modified till the following plan year. Further, an employer is not permitted to terminate a plan during the plan year.

5) Rollovers— Rollovers are now easier under recent legislation that gives SIMPLE IRAs full portability.

In late 2015, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) was signed into law. The legislation contained a SIMPLE IRA rollover sweetener: SIMPLE IRA participants can now roll over employer plan assets (e.g., funds from IRAs, 401(k)s, 403(b)s,  457(b)s, etc.) into their SIMPLE IRA account.

Typically, unless an exception applies, 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 a SEP IRA. Unlike any other IRA, SIMPLE IRAs have a unique rule in regard to distributions: the penalty on certain distribution from a SIMPLE IRA can be as high as 25%, if the withdrawal occurs within the first two years of plan participation. Therefore, participants 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, that is, the date that  contributions are deposited into a  worker’s SIMPLE IRA. 

Now, since Congress passed the PATH Act, the two-year rule takes on even more importance. Rollovers will be permitted only after the participant has satisfied a  two-year holding period. Prior to enactment, only SIMPLE assets could be rolled into a SIMPLE IRA. This legislation places SIMPLEs on equal footing with their retirement plan brethren, in that they allow full portability.

During the initial two-year period, participants cannot roll over their SIMPLE IRA assets (even with a direct, “trustee-to-trustee” transfer) to another workplace retirement plan or convert the SIMPLE IRA 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. In general, participants may move their accounts to another SIMPLE IRA provider at any time without being penalized.

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

Now that we’ve addressed the key rules to follow, let’s address some important questions on SIMPLE IRAs that employers and plan participants may have:

Q: Can an employer sponsor another retirement plan in the same year as a SIMPLE?

A: No. As we noted earlier, SIMPLE IRAs are subject to an “exclusive plan rule.” A SIMPLE plan must be the only qualified plan maintained by the employer.

Tip: This rule does not affect IRA eligibility. Eligible employees can contribute up to the maximum annual limit to their traditional or Roth IRAs, in addition to SIMPLE participation.

Q: When can employees make withdrawals from their SIMPLE IRAs?

A: At any time, but they should proceed with caution. Any withdrawals before age 59½ are subject to a 25% penalty during the first two years of participation in a SIMPLE IRA. For example, converting SIMPLE assets to a Roth IRA or rolling assets to a 401(k) plan within the first two years will subject an employee to the 25% penalty.

Tip: The two-year rule does not apply to SIMPLE-to-SIMPLE transfers. In other words, employees can transfer their SIMPLE accounts directly to a new SIMPLE IRA provider at any time, without incurring taxes or penalties.

Q: Are SIMPLE plans required to file IRS Form 5500?

A: No. Form 5500 is intended to satisfy annual reporting requirements for ERISA-covered qualified plans, such as 401(k)s. SIMPLE plans generally are not subject to ERISA (Employee Retirement Income Security Act), so these filings are not required.

Q: Is the employer required to make an annual contribution on behalf of employees?

A: Yes. An employer has two options available satisfying this requirement: 1) fully vested, dollar-for-dollar matching contributions up to 3% of employees’ compensation, or 2) fully vested, non-elective contributions of 2% of each employee’s compensation.

Tip: An employer has the ability to reduce the matching contribution to less than 3%, but not less than 1%, in two out of any five years.

Q: Can an employer make additional contributions?

A: No. SIMPLE contributions are limited to 1) a rollover from another eligible employer plan, 2) employee pretax salary deferrals, and 3) an employer match, or non-elective contribution. No additional contributions are permitted.

Q Can I contribute to both a SIMPLE IRA and an IRA (traditional or Roth)?

A: Yes. Assuming you’re eligible, you can contribute up to $5,500 ($6,500 if you’re age 50+) in your traditional or Roth IRA in addition to funding your SIMPLE IRA.

Q: What correction methods are available if a mistake was made operating a SIMPLE plan?

A: The IRS has a number of resources available to assist you in correcting plan errors (as explained here). We urge you to discuss any plan issues with a financial professional and/or a tax professional.

Q: How do employers set up a Lord Abbett SIMPLE IRA?

A. The plan setup process is straightforward: Employers can simply follow the steps outlined in our SIMPLE IRA Plan Sponsor Guide or call 888-522-2388.