8.17 Who Is Eligible for a SIMPLE IRA?

A SIMPLE IRA is a salary-reduction retirement plan that qualifying small employers may offer their employees. For 2012, the maximum salary-reduction contribution was $11,500, or $14,000 for participants age 50 or older (by the end of 2012) if the plan allowed the additional contributions. See the e-Supplement at jklasser.com for the 2013 limits. Employers are required to make matching contributions or a flat contribution (8.18).

Qualifying employers.

A SIMPLE IRA may be maintained only by an employer that (1) in the previous calendar year had no more than 100 employees who earned compensation of $5,000 or more and (2) does not maintain any other retirement plan (unless the other plan is for collective bargaining employees). A self-employed individual who meets these tests may set up a SIMPLE IRA, as discussed in Chapter 41. A simple IRA must be maintained on a calendar-year basis.

In determining whether the 100-employee test is met for the prior year, all employees under the common control of the employer must be counted. For example, Joe Smith owned two businesses in 2012, a computer rental company with 80 employees and a computer repair company with 60 employees. If they all earned at least $5,000, they all count towards the 100 limit, so if Joe decides in 2013 to set up a retirement plan for his businesses, a different type of plan must be used. He may not establish a SIMPLE IRA for either business under the 100-employee limit.

If a SIMPLE IRA is established but the employer in a later year grows beyond the 100-employee limit, the employer generally has a two-year “grace period” during which contributions may continue to be made.

Planning Reminder

401(k) SIMPLE Plans

An employer with a 401(k) plan that reports on the calendar year may avoid the regular 401(k) nondiscrimination tests by following the contribution rules for SIMPLE IRAs (7.17).

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Eligible employees.

In general, an employee must be allowed to contribute to a SIMPLE IRA for a year in which he or she is reasonably expected to earn $5,000 or more, provided at least $5,000 of compensation was received in any two prior years, whether or not consecutive. If the employer owns more than one business (under common control rules) and sets up a SIMPLE IRA for one of them, employees of the other business must also be allowed to participate if they meet the $5,000 compensation tests. Employees who are covered by a collective bargaining agreement may be excluded if retirement benefits were the subject of good-faith negotiations.

The employer may lower or eliminate the $5,000 compensation requirement in order to broaden participation in the plan. No other conditions on eligibility, such as age or hours of work, are permitted.

Deadline for setting up a SIMPLE IRA.

An employer generally may establish a SIMPLE IRA effective on any date between January 1 and October 1 of a year. If the employer (or a predecessor employer) previously maintained a SIMPLE IRA, a new SIMPLE IRA may be effective only on January 1 of a year. A new employer that comes into existence after October 1 of a year may establish a SIMPLE IRA for that year if the plan is established as soon as administratively feasible after the start of the business.

The employer may use a model SIMPLE IRA approved by the IRS to set up a SIMPLE IRA. Form 5304-SIMPLE allows employees to select a financial institution to which the contributions will be made. With Form 5305-SIMPLE, the employer selects the financial institution to which contributions are initially deposited, but employees have the right to subsequently transfer their account balances without cost or penalty to another SIMPLE-IRA at a financial institution of their own choosing. Use of the IRS model forms is optional; other documents satisfying the statutory requirements for a SIMPLE IRA may be used.

SIMPLE IRA contributions and distributions.

Contributions and distributions to SIMPLE IRAs are subject to limitations (8.18).