SIMPLE IRAs Explained

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is an retirement plan that can be offered through an employer to encourage employees to save for retirement. As it is a deferred compensation plan, the money is intended to be withdrawn when the employee reaches retirement age or the age of 59.5 as mandated by the Internal Revenue Code.

In a SIMPLE IRA, the employer is required to match a percentage of the contributions made to the IRA by the employee. This is done through either "elective-deferral" contributions or "non-elective" contributions.

Elective-deferral contributions: These are contributions where an employer matches the contributions based on the amount contributed by an employee from that employee's salary.

Non-elective contributions: These are contributions made by the employer to an employee's IRA but are not based on the contributions made by the employee.

The Internal Revenue Code has established provisions for the creation of SIMPLE IRAs on the behalf of employers. In order to offer a SIMPLE IRA to employees, the employer must have less than 100 persons in its employ each year in order to be eligible for this type of IRA. Those employees must also have earned a minimum of $5,000 in any two years prior to the creation of the SIMPLE IRA.

If an employer should exceed the 100 person limit, that employer may continue to offer SIMPLE IRAs for up to two years after the limit has been exceeded. However, after that two year period expires and if the employer continues to exceed the 100 person limit, the employer loses eligibility to offer the SIMPLE IRA retirement option.

Additional provisions that determine if an employer may offer a SIMPLE IRA are deadlines and other options offered. A SIMPLE IRA must be established between January 1st and October 1st of the year in which contributions are to be made. However, if an business is established after October 1st, the employer is still eligible to provide the SIMPLE IRA plan as soon as it is feasible. An employer will also be considered ineligible to provide SIMPLE IRAs if that employer offers any of the following options:

401(k) plans;

403(b) plans;

Qualified annuity plans;

Employee funded pensions;

SEP IRAs;

or, A benefits plan provided by state or federal agencies.

An employer must make contributions to the SIMPLE IRA each year that the IRA is funded. The employer has until April 15th to make those contributions as that is the date that tax returns must be filed. If the employer makes an elective-deferral contribution, the employer can match an employee's contributions dollar-for-dollar up to 3 percent of the wages earned by the employee that year.

If the employer makes a non-elective contribution, the employer can make a contributon up to 2 percent of that employee's compensation earned that year. If the employer makes a dollar-for-dollar contribution but the contribution made by the employee is less than 3 percent of their annual wages that year, then the employee can only match the amount contributed by that employee.

Any withdrawals made from SIMPLE IRAs prior to the employee reaching the age of 59.5 is subject to a penalty of 10 percent of the withdrawn amount. Also, if the funds in a SIMPLE IRA have been withdrawn or transferred within the two years following the creation of the IRA, the employee is subject to a 25 percent penalty (not the 10 percent penalty) on the amount moved; this is because SIMPLE IRAs are not to be moved during the two years after its creation as mandated by the "Two Year Rule".

These penalties, known as excise taxes, are made in addition to any income taxes that would apply to the funds withdrawn.