Because many small businesses can’t afford to participate in a 401k plan, the Internal Revenue Service developed the Savings Incentive Match Plan for Employees individual retirement account, or SIMPLE IRA. The plan allows small employers to contribute to their workers’ retirement. To participate, an employer must have 100 or fewer employees who earn $5,000 or more each year, and must evenly administer the plan to all employees. As with other retirement plans, contribution and distribution rules apply to SIMPLE IRAs.
Employees can make elective contributions to their SIMPLE IRA in the form of a pretax payroll deduction. Because these are made as pretax deductions, they’re not included in an employee’s yearly earnings. Employees shouldn’t itemize these contributions as a deduction, as they’re reported through earnings statements. While workers don’t pay income taxes on contributions to SIMPLE IRAs, those earnings are still subject to Social Security, Medicare and unemployment taxes.
As a function of SIMPLE IRA administration, employers must either match employees’ contributions or provide a nonelective payroll-based contribution to all employees. Matching contributions qualify as deductions when the employer files business taxes. SIMPLE plans must be administered on a calendar-year basis, not on a fiscal-year basis, so employers may need to make contributions on a different schedule than other taxes. Additionally, an employer may claim $500 per participant for administrative and setup fees for the first three years the plan operates.
Types of Employer Contributions
Employers can contribute to retirement accounts by a 3 percent matching contribution applied to employees who make contributions, or by a 2 percent nonelective contribution. Employers who match contributions must contribute to employees’ accounts on a dollar-for-dollar basis. Employers may cap the amount of matching contributions made at 3 percent of employees' total income. Employees can continue to contribute additional amounts, but employers aren’t required to match contributions. Other employers contribute a flat 2 percent of employee earnings to all qualifying employees’ accounts, regardless of whether employees make contributions.
Employees can only contribute $11,500 a year to a SIMPLE IRA. If an employee participates in other employer-sponsored retirement plan during the year, such as a 401k, she may not contribute more than $16,500 in total to all plans. Employers calculate contribution amounts based on a $200,000 salary limit for each employee. This effectively caps the total mandatory contribution to a SIMPLE IRA at $6,000 for matching contributions, or $4,000 for nonelective contributions.
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