Of all the retirement plans available to small business owners, the SIMPLE plan is the easiest to set up and the least expensive to manage.
These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE plans work well for small business owners who don’t want to spend a lot of time and pay high administration fees associated with more complex retirement plans.
SIMPLE plans really shine for self-employed business owners. Here’s why…
Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings.
SIMPLE plans calculate contributions in two steps:
1. Employee out-of-salary contribution
The limit on this “elective deferral” is $11,500 in 2012, after which it can rise further with the cost of living.
Catch-up. Owner-employees age 50 or over can make an additional $2,500 deductible “catch-up” contribution (for a total of $14,000) as an employee in 2012.
2. Employer “matching” contribution
The employer match equals a maximum of 3% of employee’s earnings.
Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $11,500 as employee, and an additional $2,500 employee catch-up contribution, plus $1,200 (3% of $40,000) employer match, for a total of $15,200.
SIMPLE plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.
If living expenses are covered by your day job (or your spouse’s job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE retirement investments.
A Truly Simple Plan
A SIMPLE plan is easier to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules – in investment options, spousal rights, creditors’ rights – don’t have a lot new to learn.
Requirements for reporting to the IRS and other agencies are negligible. Your plan’s custodian, typically an investment institution, has the reporting duties. And the process for figuring the deductible contribution is a bit easier than with other plans.
What’s Not So Good About SIMPLE Plans
Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE retirement plan.
Example: If you are under 50 with $50,000 of self-employment earnings in 2012, you could contribute $11,500 as employee to your SIMPLE plus an additional 3% of $50,000 as an employer contribution, for a total of $13,000. In contrast, a 401(k) plan would allow a $29,500 contribution.
With $100,000 of earnings, it would be a total of $14,500 with a SIMPLE and $42,000 with a 401(k).
Because investments are through an IRA, you’re not in direct control. You must work through a financial or other institution acting as trustee or custodian, and you will generally have fewer investment options than if you were your own trustee, as you would be in a 401(k).
It won’t work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE plan effective for a year, it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE must be set up as soon thereafter as administratively feasible.
If the SIMPLE plan is set up for a sideline business and you’re already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE plan and the 401(k) combined (in 2012) can’t be more than $17,000 or $22,500 if catch-up contributions are made to the 401(k) by someone age 50 or over.
So someone under age 50 who puts $9,000 in her 401(k) can’t put more than $8,000 in her SIMPLE 2012. The same limit applies if you have a SIMPLE plan while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).
How to Get Started with a SIMPLE Plan
You can set up a SIMPLE account on your own, but most people turn to financial institutions. SIMPLE Plans are offered by the same financial institutions that offer IRAs and 401k master plans.
You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement you will choose an “effective date” – the beginning date for payments out of salary or business earnings. That date can’t be later than October 1 of the year you adopt the plan, except for a business formed after October 1.
Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.
Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.
401k, SEPs, and SIMPLES Compared
|Plan type: Can be defined benefit or defined contribution (profit sharing or money purchase)||Defined contribution only||Defined contribution only|
|Number you can own: Owner may have two or more plans of different types, including an SEP, currently or in the past||Owner may have SEP and 401k||Generally, SIMPLE is the only current plan|
|Due dates: Plan must be in existence by the end of the year for which contributions are made||Plan can be set up later – if by the due date (with extensions) of the return for the year contributions are made||Plan generally must be in existence by October 1 of the year for which contributions are made|
|Dollar contribution ceiling (for 2012): $50,000 for defined contribution plan; no specific ceiling for defined benefit plan||$50,000||$23,000|
|Percentage limit on contributions: 50% of earnings for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan.||Lesser of $50,000 of 25% of eligible employee’s compensation ($250,000 in 2012). Elective deferrals in SEPs formed before 1997 not subject to this limit.||100% of earnings, up to $11,500 (for 2012) for contributions as employee; 3% of earnings, up to $11,500, for contributions as employer|
|Deduction ceiling: For defined contribution, lesser of $50,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings.||Lesser of $50,000 or 25% of eligible employee’s compensation. Elective deferrals in SEPs formed before 1997 not subject to this limit.||Same as percentage ceiling on SIMPLE contribution|
|Catch-up contribution age 50 or over: Up to $5,500 in 2012 for 401(k)s||Same for SEPs formed before 1997||Half the limit for 401k and SEPs (up to $2,500 in 2012)|
|Prior years’ service can count in computing contribution||No||No|
|Investments: Wide investment opportunities. Owner may directly control investments.||Somewhat narrower range of investments. Less direct control of investments.||Same as SEP|
|Withdrawals: Some limits on withdrawal before retirement age||No withdrawal limits||No withdrawal limits|
|Permitted withdrawals before age 59 1/2 may still face 10% penalty||Same as 401k rule||Same as 401k rule except penalty is 25% in SIMPLE’s first two years|
|Spouse’s rights: Federal law grants spouse certain rights in owner’s plan||No federal spousal rights||No federal spousal rights|
|Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE.||Same as 401k rule||Rollover after 2 years to another SIMPLE and to plans allowed under 401k rule|
|Some reporting duties are imposed, depending on plan type and amount of plan assets||Few reporting duties||Negligible reporting duties|
Please contact us if you are a business owner interested in exploring retirement plan options, including SIMPLE plans.