Unlike other qualified plans, SIMPLE plans are not available to all employers. First, only employers who do not have any other qualified retirement plans may set up a SIMPLE plan.* Secondly, only employers who have 100 or fewer employees may establish a SIMPLE plan. When counting employees, the employer must include all employees employed at any time during the year, regardless of whether those employees were eligible to participate in the plan.** Businesses that operate under common control are treated as a single employer. Thus, the employees of two businesses under the control of a sole proprietor would be combined for purposes of determining whether either business could establish a SIMPLE plan. Likewise all employees of a parent company and subsidiary must be counted to determine if a SIMPLE plan can be established.
Existing employers wishing to establish a first-time SIMPLE plan may do so on any date between January 1 and October 1. New employers that come into existence after October 1 may set up a SIMPLE plan for that year provided it is established as soon as is administratively feasible. Employers that previously maintained a SIMPLE plan, may establish a SIMPLE plan effective only on January 1 of a year.
Employers who maintained a SIMPLE plan for at least one year, but are ineligible in subsequent years, may continue to maintain the plan for an additional “two-year grace period” following the last year of employer eligibility. If the employer remains ineligible after the two-year grace period, the SIMPLE plan may no longer be maintained.
Stellar Corporation is a rapidly growing business. It established a SIMPLE plan in 2005 when it had 95 employees. In early 2007 it hired its 101st employee, and it is no longer eligible for a SIMPLE plan. However, it may maintain its plan for the next two years under the grace period. If at the end of the grace period its payroll drops to less than 100 employees, it may continue to operate the plan. If not, no SIMPLE plan contributions may be made in future years.
A special rule applies to mergers and acquisitions. If an employer becomes ineligible for a SIMPLE plan due to a merger, acquisition or similar restructuring, the SIMPLE may be maintained for the rest of the year and the year following the restructuring.
ABC Corporation operates a SIMPLE IRA plan for its 35 employees. XYZ, Inc. maintains a defined benefit plan for 47 employees. ABC merges with XYZ in August 2007. Since the combined enterprise has another type of qualified plan, it is no longer eligible for a SIMPLE plan (even though it has fewer than 100 employees). The tax code allows ABC to continue operation of the SIMPLE IRA for 2007 and 2008. However, during this time, XYZ's employees may not participate in the SIMPLE IRA and participants in ABC's SIMPLE plan are not eligible for the pension plan.
SIMPLE IRAs and 401(k) plans
Employers may adopt a SIMPLE plan as part of a 401k arrangement or establish the SIMPLE plan using employee IRAs. They are similar in concept, but differ in some aspects of their operation. The following discussion focuses on SIMPLE IRA plans — but will note differences between SIMPLE IRAs and SIMPLE 401ks: highlighted with [ § ].
Of the two, the SIMPLE IRA is easier to establish. The IRS has a model SIMPLE IRA document that employers may use to set up the program. To set up a SIMPLE IRA plan, the employer simply completes Form 5305-SIMPLE, a two-page document. (click here to view Form 5305-SIMPLE
in PDF format) In addition, the employer must notify eligible employees of their coverage by the plan and ensure that an IRA account has been established by each eligible employee. Contributions to the plan are then deposited in the employees’ IRAs. The employer will claim a tax deduction for contributions under a SIMPLE plan. All IRAs established under a SIMPLE arrangement must be traditional IRAs, not Roth IRAs. All eventual distributions from the account will be fully taxable to the employee, and are subject to the same restrictions as traditional IRAs. [§
SIMPLE 401ks allow a Roth account to accept employee after-tax deferrals, however, employer 401k contributions must be placed in a regular, “non-Roth” account.]
To establish a SIMPLE 401k plan, the employer must conform to the requirements of a regular 401k plan — which is more complicated than setting up a SIMPLE IRA. The employer may establish a new SIMPLE 401k plan or “convert” an existing 401k plan into a SIMPLE 401k by agreeing to operate under the SIMPLE rules. The advantage of a SIMPLE 401k plan is that the complex nondiscrimination tests for “regular” 401ks are satisfied if the plan meets the SIMPLE contribution and vesting requirements. SIMPLE 401k plans, however, the must satisfy all of the other, somewhat complicated rules governing 401ks — SIMPLE IRAs do not. [§ SIMPLE 401k plans may permit loans to plan participants and withdrawals for financial hardship, SIMPLE IRAs may not.]
All SIMPLE plans — 401k or IRA — must be maintained on a calendar year basis. If an employer “converts” an existing 401k plan that is maintained on a fiscal year basis into a SIMPLE 401k, the plan must be converted to a calendar year in order to adopt the SIMPLE arrangement.
The tax code requires an employer’s SIMPLE plan to be available to every eligible employee who:
received at least $5,000 in compensation from the employer during any two preceding years, and
is reasonably expected to receive at least $5,000 in compensation during the year.
Eligible employees need only have earned $5,000 in compensation in any two preceding years and not in the immediately preceding two years. Nor must the two years be consecutive. In addition, an employer may establish a SIMPLE plan even if none of its employees wish to participate, although the employer must notify employees of their right to participate in the plan. Self-employed individuals are eligible to participate in a SIMPLE plan, as are employees who may participate in a retirement plan of a different employer for the same year.
Employers may choose to make the participation requirements of their SIMPLE IRA less restrictive. In fact, employers may waive the compensation rule altogether and simply cover all employees. The employer's decision is indicated by filling the appropriate amounts in the spaces indicated on Form 5305-SIMPLE. [§ SIMPLE 401k plans may limit participation to those age 21 and older, SIMPLE IRAs may not.]
In some situations, employers may exclude nonresident aliens and employees who are covered under a collective bargaining agreement from participation the SIMPLE plan. (Although these employees are counted for purposes of qualifying under the 100 employee rule.) The employer’s decision regarding these employees is indicated by simply checking the appropriate boxes on Form 5305-SIMPLE for SIMPLE IRAs.