The tax code permits two types of contributions to a SIMPLE IRA account: elective deferrals contributed by the employee and matching contributions or nonelective contributions made by the employer.
Under the SIMPLE plan, an employee can elect to contribute up to $6,000 per year (adjusted for inflation, $13,000 in 2019). The contribution formula in a SIMPLE plan is expressed as a percentage of compensation, not as a flat dollar amount, so not every employee may be able to contribute the maximum. Participants aged 50 or older may contribute an additional $3,000 per year as a "catch-up" provision (adjusted annually for inflation).
Any employee contribution to a SIMPLE plan counts toward the employee's maximum annual elective deferrals that applies cumulatively to all SIMPLEs, SARSEPs, "regular" 401ks or tax-sheltered annuities the employee may participate in. This maximum annual limit is $19,000 in 2019 (adjusted annually for inflation).
SIMPLE plans require employers to contribute to their employee's accounts. Employers must satisfy one of two contribution formulas: matching contributions or nonelective contributions.
As an alternative, employers may choose to match contributions for a given year at a rate less than 3% - but no lower than 1% - of each employee's compensation. In these cases, the employer must notify employees of the lower percentage within a reasonable time before the 60-day election "window" during which employees decide whether to participate in the SIMPLE IRA plan (see below). In addition, the employer may not choose a lower percentage if that would cause the matching percentage to drop below 3% of employee compensation in more than two of the past five years. [§ This alternative is not available to employers with SIMPLE 401k plans].
A matching contribution formula requires a contribution each year. Employers cannot simply choose to not contribute in some years due to financial difficulties or other reasons. If the employee chooses to defer income, the employer must match it (to some extent).
For example, Samantha's unincorporated catering business, Goodies on the Go, employs Hannah, Chris and Jack as employees - each is paid $50,000. Samantha's net business income is $300,000 in 2019.
Under the nonelective formula, an employer simply contributes 2% of the compensation for each eligible employee that year. When calculating nonelective contributions to a SIMPLE IRA, employee compensation is limited to the first $150,000 of income - adjusted for inflation ($280,000 in 2019). Please note: the matching contribution formulae above refer to participating employees, i.e., those who choose to defer income into their SIMPLE IRA account. The nonelective formula applies to all eligible employees, whether they choose to contribute or not. The employer must contribute 2% of all eligible employee's compensation to the SIMPLE plan. The employer must notify each eligible employee of the nonelective contributions before the 60 day election period during which an employee decides whether to participate in the SIMPLE plan.
Please note that Goodies on the Go must contribute for Jack even though he did not elect to defer, and Chris receives more than under the matching contribution formula.
The annual contribution limit and the requirement of an annual contribution may make SIMPLE plans less attractive to small employers. For example, the owner of a small business whose income is much higher than that of her employees and who is interested in compiling retirement assets for herself as quickly as possible, may prefer to adopt a more traditional qualified plan (such as a Keogh plan) that allows higher annual contributions. In addition, small businesses that have fluctuating profits should be aware that they must continue to make contributions to the SIMPLE IRA even if the business is not performing well in that year. Even in lean years, an employer will be required to match at least one-percent of its employees' compensation. A SEP plan, which does not mandate annual contributions, would be a more flexible option.
Employers may deduct any contributions they make to the SIMPLE account for the year in which they are made. This includes a deduction for the employee's compensation that was "deferred into the account", i.e., the employee's elective contributions. Employers may take a deduction for matching contributions to a SIMPLE plan for the tax year, provided the contributions are made by the date that the employer's tax return is due (including extensions).
All SIMPLE plans operate on a calendar year basis. If the employer operates on a fiscal tax year, the employer claims the deduction when the tax year ends.
All contributions (elective employee deferrals and employer matching or non-elective contributions) to the SIMPLE account are excluded from an employee's income for federal income tax purposes. Employee contributions to a SIMPLE IRA are subject to Social Security/Medicare (FICA) and federal unemployment taxes (FUTA). Employer contributions to a SIMPLE IRA, however, are not subject to federal payroll taxes.
Eligible employees participate in a SIMPLE plan by making elective deferrals. This is similar to a salary reduction program - the employee chooses to contribute a portion of his or her before-tax earnings into the SIMPLE plan. The IRS requires a minimum 60-day window in which employees may elect to contribute to a SIMPLE plan. Typically the "window" is the 60-day period before January 1st. SIMPLE plans may expand this window - some plans offer up to 90 days in which to decide, others may offer a 30-day window each quarter. Employees must decide if they will contribute to the plan during that "window" of opportunity - or if they wish to modify the amount they previously elected.
Employers must notify their employees of their eligibility to contribute to the SIMPLE plan. In SIMPLE IRAs, the notice form is part of Form 5305-SIMPLE. The notice indicates what type of employer contributions will be made for the upcoming year (matching vs. non-elective). All notices must be provided within a reasonable period of time before the start of the period in which employees choose to contribute. Employees respond to the notice indicating if they wish to contribute elective deferrals, and if so, how much.
Employees may terminate their participation in the SIMPLE plan by discontinuing their contributions - at any time during the calendar year. However, the employer can restrict an employee from resuming participation until the beginning of the following year.
The monies contributed by employees to a SIMPLE must be segregated from the employer's assets as quickly as possible. IRS regulations require employers to deposit employee contributions into the employee's SIMPLE IRA within 30 days of the end of the month. In the event that an eligible employee is unwilling or unable to establish a SIMPLE IRA prior to the expiration of the 30 day period during which a contribution must be made, the employer may establish a SIMPLE IRA on the employee's behalf with a financial institution selected by the employee.
Employers must make their matching or nonelective contributions to a SIMPLE plan by the date that its tax return for the tax year is due, including extensions.
All contributions to an employee's SIMPLE account must be nonforfeitable, that is, every contribution is immediately, 100% vested. Similarly, amounts held in a SIMPLE IRA may be withdrawn without restriction (other than general IRA rules) at any time.