SIMPLEs

If you are self-employed or a shareholder in a corporation, the business can set up a savings incentive match plan for employees (SIMPLE) that allows you (and your employees) to make elective deferrals (salary reduction contributions) to the plan. Such amounts are excluded from your income. As an employer, you must contribute a set amount for each plan participant; you deduct your employer contribution as a business expense.

Whether you are the owner of the business or merely a rank-and-file employee, you can make elective deferral contributions to the plan. Like 401(k) plans discussed earlier, the portion of your compensation that you treat as your elective deferral is not included in your income for the year.

There are only 2 key conditions for setting up a SIMPLE:

1. You must be a “small employer.” You must have had 100 or fewer employees who received $5,000 or more in compensation from you in the preceding year. If you set up the plan but in a later year exceed the 100-employee limit, you have 2 more years to continue the SIMPLE; after 2 years you no longer qualify for a SIMPLE because you are not a small employer. You can also set up a plan if you are self-employed (even though you don’t have any employees).
2. You do not maintain any other qualified plan. If, for example, you already have a profit-sharing plan, you can’t also have a SIMPLE.

Whether you are the owner of the business or just an ordinary employee who is eligible to participate, you can agree to contribute a portion of your annual compensation to the SIMPLE. Your contribution, or elective deferral amount, is limited in 2011 to $11,500, or $14,000 if you are age 50 or older by the end of 2011. However, your contribution cannot exceed 100% of your compensation.

Example: In 2011, you are under age 50; you can contribute $11,500 whether your wages are $11,500, $30,000, or even $100,000. You can contribute up to 100% of your compensation, but no more than $11,500.

Required employer contribution. Like other retirement plans, you must meet certain nondiscrimination requirements; your plan cannot favor you as the owner and other highly paid employees. However, SIMPLEs don’t have any complicated nondiscrimination formulas. Instead, if you make the required employer contribution on behalf of each employee who is eligible to participate, your plan is viewed as nondiscriminatory.

You must adopt 1 of these 2 contribution formulas and make contributions accordingly:

1. Employer matching contribution on a dollar-for-dollar basis
2. Nonelective contributions of 2% of compensation

In an employer matching contribution arrangement, you match employee contributions on a dollar-for-dollar basis up to 3% of employee compensation. If an employee does not make an elective deferral, you do not have to contribute anything on behalf of the employee.

Example: Your employee makes an elective deferral contribution to the SIMPLE of $5,000. Her annual compensation is $40,000. You must contribute $1,200 on behalf of this employee (matching her contribution of $5,000 up to 3% of $40,000).

Example: You make an elective deferral of $11,500, the maximum permitted in 2011. Your compensation is $390,000. Your matching contribution in this case is $11,500 (matching your contribution of $11,500, which is smaller than 3% of $390,000, or $11,700).

If the formula requires nonelective contributions of 2% of compensation, these contributions must be made without regard to any employee elective deferrals. Thus, even if the employee makes no elective deferral, you must still contribute 2% on the employee’s behalf if the employee is eligible to participate in the SIMPLE. No more than $245,000 of compensation can be taken into account in figuring nonelective contributions.

Example: Your employee makes an elective deferral contribution to the SIMPLE of $5,000. Her annual compensation is $40,000. You must contribute $800 (2% of $40,000).

Example: You make an elective deferral of $11,500, the maximum permitted in 2011. Your compensation is $280,000. Your nonelective contribution in this case is $4,900 (2% of $245,000).

SIMPLEs may enable you to make the largest contribution possible (compared with self-employed retirement plans and SEPs) if your self-employment income is modest. SIMPLEs may also be the most cost-effective plan to use if you have employees. Discuss your retirement plan options with a benefits expert. If you have made contributions to a SIMPLE-IRA, you can convert it to a Roth IRA. But you must wait at least 2 years following the contribution to make the conversion or be subject to a 25% early distribution penalty if you are under age 59û .The basic limit ($11,500) and the limit for those age 50 and older will be adjusted annually for inflation.

Distributions from SIMPLE-IRAs before age 59û are subject to a higher early distribution penalty than the penalty imposed on traditional IRAs. Instead of the usual 10% early distribution penalty, you may be subject to a penalty of 25% for distributions within 2 years of SIMPLE-IRA participation if you are under age 59û.