These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE IRA 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.retirement2
SIMPLE IRA 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 IRA plans calculate contributions in two steps:
1. Employee out-of-salary contribution
The limit on this “elective deferral” is $12,000 in 2014, after which it can rise further with the cost of living.
Catch-up. Owner-employees age 50 or older can make an additional $2,500 deductible “catch-up” contribution (for a total of $14,500) as an employee in 2014.
2. Employer “matching” contribution
The employer match equals a maximum of 3 percent of employee’s earnings.
Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $12,000 as employee, and an additional $2,500 employee catch-up contribution, plus $1,200 (3 percent of $40,000) employer match, for a total of $15,700.
SIMPLE IRA 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 IRA plan retirement investments.
A Truly Simple Plan
A SIMPLE IRA 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 IRA Plans
Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE IRA retirement plan.
Example: If you are under 50 with $50,000 of self-employment earnings in 2014, you could contribute $12,000 as employee to your SIMPLE IRA plan plus an additional 3 percent of $50,000 as an employer contribution, for a total of $13,500. In contrast, a 401(k) plan would allow a $30,000 contribution.
With $100,000 of earnings, it would be a total of $15,000 with a SIMPLE IRA plan and $42,500 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 IRA 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 IRA 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 IRA plan must be set up as soon thereafter as administratively feasible.
If the SIMPLE IRA 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 IRA plan and the 401(k) combined (in 2014) can’t be more than $17,500 or $23,000 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 $8,500 in her SIMPLE IRA plan for 2014. The same limit applies if you have a SIMPLE IRA 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 IRA Plan
You can set up a SIMPLE IRA plan account on your own, but most people turn to financial institutions. SIMPLE IRA Plans are offered by the same financial institutions that offer any other IRAs and 401k 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 IRA plan. You need such an agreement even if you pay yourself business profits rather than salary.
Printed guidance on operating the SIMPLE IRA plan may also be provided. You will also be establishing a SIMPLE IRA plan account for yourself as participant.
Richard Lipton, CPA
The founder of Richard L. Lipton CPA & Associates LLC, located in Morris Plains, N.J., Richard has been a stockholder and manager of family-owned Sam’s Tire Co. in Paterson, N.J., for 10 years. His firm offers business consulting, tax and accounting services – including the area of forensic accounting – to large and small clients. Visit Richard L. Lipton CPA & Associates LLC online at www.liptoncpa.com.
Article courtesy of TIRE REVIEW.