Publication 590: Individual Retirement Arrangements (IRAs); Chapter 3 - Savings Incentive Match Plans for Employees (SIMPLE)

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Table of Contents

What's New for 2004

Increase in limit on salary reduction contributions under a SIMPLE. For 2004, salary reduction contributions that your employer can make on your behalf under a SIMPLE plan increased to $9,000 (up from $8,000 in 2003). For more information, see How Much Can Be Contributed on Your Behalf? in this chapter.

Additional salary reduction contributions to SIMPLE IRAs for persons 50 and older. Additional salary reduction contributions of $1,500 for 2004 could be made to your SIMPLE IRA if:

You were age 50 by the end of 2004, and
No other salary reduction contributions could be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

See How Much Can Be Contributed on Your Behalf? in this chapter.

What's New for 2005

Increase in limit on salary reduction contributions under a SIMPLE. For 2005, salary reduction contributions that your employer can make on your behalf under a SIMPLE plan are increased to $10,000 (up from $9,000 in 2004). For more information about salary reduction contributions, see How Much Can Be Contributed on Your Behalf, later.

Additional salary reduction contributions to SIMPLE IRAs for persons 50 and older. For 2005, additional salary reduction contributions can be made to your SIMPLE IRA if:

You will be 50 or older in 2005, and
No other salary reduction contributions can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

For 2005, the additional amount will be the lesser of the following two amounts.

$2,000 (up from $1,500 for 2004), or
Your compensation for the year reduced by your other elective deferrals for the year.

For more information, see How Much Can Be Contributed on Your Behalf, later.

Introduction

This chapter is for employees who need information about savings incentive match plans for employees (SIMPLE plans). It explains what a SIMPLE plan is, contributions to a SIMPLE plan, and distributions from a SIMPLE plan.

Under a SIMPLE plan, SIMPLE retirement accounts for participating employees can be set up either as:

Part of a 401(k) plan, or
A plan using IRAs (SIMPLE IRA).

This chapter only discusses the SIMPLE plan rules that relate to SIMPLE IRAs. See Publication 560 for information on any special rules for SIMPLE plans that do not use IRAs.

If your employer maintains a SIMPLE plan, you must be notified, in writing, that you can choose the financial institution that will serve as trustee for your SIMPLE IRA and that you can roll over or transfer your SIMPLE IRA to another financial institution. See Rollovers and Transfers Exception, later under When Can You Withdraw or Use Assets.

What Is a SIMPLE Plan?

A SIMPLE plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. See Publication 560 for information on the requirements employers must satisfy to set up a SIMPLE plan.

A SIMPLE plan is a written agreement (salary reduction agreement) between you and your employer that allows you, if you are an eligible employee (including a self-employed individual), to choose to:

Reduce your compensation (salary) by a certain percentage each pay period, and
Have your employer contribute the salary reductions to a SIMPLE IRA on your behalf. These contributions are called salary reduction contributions.

All contributions under a SIMPLE IRA plan must be made to SIMPLE IRAs, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account or an individual retirement annuity, described in chapter 1. Contributions are made on behalf of eligible employees. (See Eligible Employees, later.) Contributions are also subject to various limits. (See How Much Can Be Contributed on Your Behalf, later.)

In addition to salary reduction contributions, your employer must make either matching contributions or nonelective contributions. See How Are Contributions Made, later.

You may be able to claim a credit for contributions to your SIMPLE. For more information, see chapter 4.

Eligible Employees

You must be allowed to participate in your employer's SIMPLE plan if you:

Received at least $5,000 in compensation from your employer during any 2 years prior to the current year, and
Are reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made.

Self-employed individual. For SIMPLE plan purposes, the term employee includes a self-employed individual who received earned income.

Excludable employees. Your employer can exclude the following employees from participating in the SIMPLE plan.

Employees whose retirement benefits are covered by a collective bargaining agreement (union contract).
Employees who are nonresident aliens and received no earned income from sources within the United States.
Employees who would not have been eligible employees if an acquisition, disposition, or similar transaction had not occurred during the year.

Compensation. For purposes of the SIMPLE plan rules, your compensation for a year generally includes the following amounts.

Wages, tips, and other pay from your employer that is subject to income tax withholding.
Deferred amounts elected under any 401(k) plans, 403(b) plans, government (section 457) plans, SEP plans, and SIMPLE plans.

Self-employed individual compensation. For purposes of the SIMPLE plan rules, if you are self-employed, your compensation for a year is your net earnings from self-employment (Schedule SE (Form 1040), Section A, line 4, or Section B, line 6) before subtracting any contributions made to a SIMPLE IRA on your behalf.

For these purposes, net earnings from self-employment include services performed while claiming exemption from self-employment tax as a member of a group conscientiously opposed to social security benefits.

How Are Contributions Made?

Contributions under a salary reduction agreement are called salary reduction contributions. They are made on your behalf by your employer. Your employer must also make either matching contributions or nonelective contributions.

Salary reduction contributions. During the 60-day period before the beginning of any year, and during the 60-day period before you are eligible, you can choose salary reduction contributions expressed either as a percentage of compensation, or as a specific dollar amount (if your employer offers this choice). You can choose to cancel the election at any time during the year.

Salary reduction contributions are also referred to as “elective deferrals.”

Your employer cannot place restrictions on the contributions amount (such as by limiting the contributions percentage), except to comply with the salary reduction contributions limit, discussed under How Much Can Be Contributed on Your Behalf, later.

Matching contributions. Unless your employer chooses to make nonelective contributions, your employer must make contributions equal to the salary reduction contributions you choose (elect), but only up to certain limits. See How Much Can Be Contributed on Your Behalf, later. These contributions are in addition to the salary reduction contributions and must be made to the SIMPLE IRAs of all eligible employees (defined earlier) who chose salary reductions. These contributions are referred to as matching contributions.

Matching contributions on behalf of a self-employed individual are not treated as salary reduction contributions.

Nonelective contributions. Instead of making matching contributions, your employer may be able to choose to make nonelective contributions on behalf of all eligible employees. These nonelective contributions must be made on behalf of each eligible employee who has at least $5,000 of compensation from your employer, whether or not the employee chose salary reductions.

One of the requirements your employer must satisfy is notifying the employees that the election was made. For other requirements that your employer must satisfy, see Publication 560.

How Much Can Be Contributed on Your Behalf?

The limits on contributions to a SIMPLE IRA vary with the type of contribution that is made.

Salary reduction contributions limit. Salary reduction contributions (employee-chosen contributions or elective deferrals) that your employer can make on your behalf under a SIMPLE plan are limited to $9,000 for 2004 ($10,000 for 2005).

If you are a participant in any other employer plans during 2004 and you have elective salary reductions or deferred compensation under those plans, the salary reduction contributions under the SIMPLE plan also are included in the annual limit of $13,000 for 2004 ($14,000 for 2005) on exclusions of salary reductions and other elective deferrals.

You, not your employer, are responsible for monitoring compliance with these limits.

Additional elective deferrals can be contributed to your SIMPLE if:

You reached age 50 by the end of 2004, and
No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

The most that can be contributed in additional elective deferrals to your SIMPLE is the lesser of the following two amounts.

$1,500 for 2004 ($2,000 for 2005), or
Your compensation for the year reduced by your other elective deferrals for the year.

The additional deferrals are not subject to any other contribution limit and are not taken into account in applying other contribution limits. The additional deferrals are not subject to the nondiscrimination rules as long as all eligible participants are allowed to make them.

Matching employer contributions limit. Generally, your employer must make matching contributions to your SIMPLE IRA in an amount equal to your salary reduction contributions. These matching contributions cannot be more than 3% of your compensation for the calendar year. See Matching contributions less than 3%, later.

Example 1.

In 2004, Joshua was a participant in his employer's SIMPLE plan. His compensation, before SIMPLE plan contributions, was $41,600, ($800 per week). Instead of taking it all in cash, Joshua elected to have 12.5% of his weekly pay ($100) contributed to his SIMPLE IRA. For the full year, Joshua's salary reduction contributions were $5,200, which is less than the $9,000 limit on these contributions.

Under the plan, Joshua's employer was required to make matching contributions to Joshua's SIMPLE IRA. Because his employer's matching contributions must equal Joshua's salary reductions, but cannot be more than 3% of his compensation (before salary reductions) for the year, his employer's matching contribution was limited to $1,248 (3% of $41,600).

Example 2.

Assume the same facts as in Example 1, except that Joshua's compensation for the year was $302,000 and he chose to have 2.98% of his weekly pay contributed to his SIMPLE IRA.

In this example, Joshua's salary reduction contributions for the year (2.98% × $302,000) were equal to the 2004 limit for salary reduction contributions ($9,000). Because 3% of Joshua's compensation ($9,060) is more than the amount his employer was required to match ($9,000), his employer's matching contributions were limited to $9,000.

In this example, total contributions made on Joshua's behalf for the year were $18,000, the maximum contributions permitted under a SIMPLE IRA for 2004.

Matching contributions less than 3%. Your employer can reduce the 3% limit on matching contributions for a calendar year, but only if:

The limit is not reduced below 1%,
The limit is not reduced for more than 2 years out of the 5-year period that ends with (and includes) the year for which the election is effective, and
Employees are notified of the reduced limit within a reasonable period of time before the 60-day election period during which they can enter into salary reduction agreements.

For purposes of applying the rule in item (2) in determining whether the limit was reduced below 3% for the year, any year before the first year in which your employer (or a former employer) maintains a SIMPLE IRA plan will be treated as a year for which the limit was 3%. If your employer chooses to make nonelective contributions for a year, that year also will be treated as a year for which the limit was 3%.

Nonelective employer contributions limit. If your employer chooses to make nonelective contributions, instead of matching contributions, to each eligible employee's SIMPLE IRA, contributions must be 2% of your compensation for the entire year. For 2004, only $205,000 of your compensation can be taken into account to figure the contribution limit.

Your employer can substitute the 2% nonelective contribution for the matching contribution for a year, if both of the following requirements are met.

Eligible employees are notified that a 2% nonelective contribution will be made instead of a matching contribution.
This notice is provided within a reasonable period during which employees can enter into salary reduction agreements.

Example 3.

Assume the same facts as in Example 2, except that Joshua's employer chose to make nonelective contributions instead of matching contributions. Because his employer's nonelective contributions are limited to 2% of up to $205,000 of Joshua's compensation, his employer's contribution to Joshua's SIMPLE IRA was limited to $4,100. In this example, total contributions made on Joshua's behalf for the year were $13,100 (Joshua's salary reductions of $9,000 plus his employer's contribution of $4,100).

Traditional IRA mistakenly moved to SIMPLE IRA. If you mistakenly roll over or transfer an amount from a traditional IRA to a SIMPLE IRA, you can later recharacterize the amount as a contribution to another traditional IRA. For more information, see Recharacterizations in chapter 1.

Recharacterizing employer contributions. You cannot recharacterize employer contributions (including elective deferrals) under a SEP or SIMPLE plan as contributions to another IRA. SEPs are discussed in Publication 560. SIMPLE plans are discussed in this chapter.

Converting from a SIMPLE IRA. Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained in chapter 1 under Converting From Any Traditional IRA Into a Roth IRA.

However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date you first participated in any SIMPLE IRA plan maintained by your employer.

When Can You Withdraw or Use Assets?

Generally, the same distribution (withdrawal) rules that apply to traditional IRAs apply to SIMPLE IRAs. These rules are discussed in chapter 1.

Your employer cannot restrict you from taking distributions from a SIMPLE IRA.

Are Distributions Taxable?

Generally, distributions from a SIMPLE IRA are fully taxable as ordinary income. If the distribution is an early distribution (discussed in chapter 1), it may be subject to the additional tax on early distributions. See Additional Tax on Early Distributions, later.

Rollovers and Transfers Exception

Generally, rollovers and trustee-to-trustee transfers are not taxable distributions.

Two-year rule. To qualify as a tax-free rollover (or a tax-free trustee-to-trustee transfer), a rollover distribution (or a transfer) made from a SIMPLE IRA during the 2-year period beginning on the date on which you first participated in your employer's SIMPLE plan must be contributed (or transferred) to another SIMPLE IRA. The 2-year period begins on the first day on which contributions made by your employer are deposited in your SIMPLE IRA.

After the 2-year period, amounts in a SIMPLE IRA can be rolled over or transferred tax free to an IRA other than a SIMPLE IRA, or to a qualified plan, a tax-sheltered annuity plan (section 403(b) plan), or deferred compensation plan of a state or local government (section 457 plan).

Additional Tax on Early Distributions

The additional tax on early distributions (discussed in chapter 1) applies to SIMPLE IRAs. If a distribution is an early distribution and occurs during the 2-year period following the date on which you first participated in your employer's SIMPLE plan, the additional tax on early distributions is increased from 10% to 25%.

If a rollover distribution (or transfer) from a SIMPLE IRA does not satisfy the 2-year rule, and is otherwise an early distribution, the additional tax imposed because of the early distribution is increased from 10% to 25% of the amount distributed.

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