SIMPLE IRA Plans: They Aren’t Always So Simple
By Mike Rahn, CISP
SIMPLE plans were created by Congress in the 1996 Small Business Job Protection Act. In doing so they created a retirement plan option for small employers that provided meaningful retirement saving opportunities, while being substantially simpler to administer than 401(k) and other retirement plans of the time. This option is available only to employers with no more than 100 employees who earned $5,000 or more in the preceding year.
Based on the interest to date shown by small businesses, the Savings Incentive Match Plan for Employees of Small Employers—the full name for the SIMPLE acronym—has been a definite success. The SIMPLE IRA plan is considered by many small employers to be a great first retirement plan, characterized by little need for professional retirement plan administrators and minimal disclosure and reporting. Other features, such as the ability to make Roth SIMPLE contributions, also help make the SIMPLE IRA attractive to employers.
Ironically, given their official name, SIMPLE IRA plans have a number of elements that are anything but simple. Congress has altered the governing rules from time to time over the last three decades. As a result, some would say that SIMPLE IRA plans—while still a fine small employer plan option—are getting less and less simple.
The Exclusive Plan Rule
Both the 1996 statute that created these plans and the early guidance found in IRS Notice 97-6 make clear that SIMPLE IRA contributions cannot be made for any calendar year if the employer maintains another retirement plan under which contributions are made, or benefits accrue.
Perhaps this was intended to discourage employers from “backpedaling” from a more robust plan to a SIMPLE IRA. Realistically, employers that have decided to terminate another plan may do so regardless, even if having to wait until the subsequent calendar year to operate a SIMPLE IRA plan. As a result, fewer benefits may accrue to employees in that transition year.
The Two-Year Rule
SIMPLE IRA plans have several restrictions that apply to the two-year period that starts with the first contribution made to a participant’s SIMPLE IRA. Unlike a 401(k) plan, where contributions are held in a common trust and available only at certain limited times and events, assets in a SIMPLE IRA—like all IRAs—are available on demand.
To discourage premature distribution of SIMPLE IRA assets, the pre-59½ early distribution penalty tax is elevated from the standard 10 percent to 25 percent during the first two years.
In addition, SIMPLE IRA assets generally cannot be moved to non-SIMPLE IRAs or other retirement plans during the initial two-year period. The SECURE 2.0 Act of 2022 provided an exception in the case of a SIMPLE IRA plan’s termination during the initial two-year period. In such cases, the SIMPLE IRA assets can be rolled over to a 401(k) or 403(b) plan.
While SIMPLE IRAs can accept rollovers of non-SIMPLE assets, such as from a 401(k) plan, this can only be done after the initial two-year period.
Restrictions on SIMPLE IRA Plan Termination
The primary SIMPLE IRA guidance since 1996 has been in the form of IRS Notices and taxpayer publications, not regulations. The retirement industry has had to rely on this and less formal IRS guidance—including commentary at the IRS web site—on numerous issues. One such issue has been mid-year termination of a SIMPLE IRA plan. The IRS has long taken the position that such plans cannot be terminated mid-year. This has differed from qualified retirement plans, which have always had the ability to implement mid-year terminations.
The SECURE 2.0 Act of 2022 provided an exception for employers that choose to transition from a SIMPLE IRA plan to a safe harbor 401(k) plan mid-year, on the condition that each plan is operated in accordance with its own governing rules—including contribution limitations—for their respective periods of the transition year. In addition, the safe harbor plan’s effective date must be the day after the SIMPLE IRA plan’s termination date.
Where Must the Contributions Go?
SIMPLE IRA contributions are not held in a common trust, like 401(k) plans, and are always available on demand. But that does not mean that each participant has full control over his own contributions, at least initially. The sponsoring employer has the option to have all salary deferral contributions made initially to a single custodial organization, into the investments offered there. Such an organization is called a designated financial institution, or DFI.
However, a participant who wishes to have his SIMPLE IRA assets held and invested elsewhere can request to have them transferred to another custodial organization. At least one investment option at the initial institution must offer the option of transfers without charge or penalty. The IRS considers it “reasonable” if the participant is allowed to request such transfers on a monthly basis.
An employer could elect to maintain a “non-DFI” SIMPLE IRA plan, in which each participating employee chooses the custodian who will receive his salary deferrals and maintain his SIMPLE IRA. However, due to the payroll and general administrative simplicity of having one destination for contributions, most employers choose the DFI model.
Contribution Limits are a Moving Target
IRA and other retirement plan contribution limits typically change from year to year due to cost-of-living adjustments. But basic contribution options have historically been stable. SIMPLE IRA plans, too, have had a predictable employee contribution structure. Employer contributions have historically included only the straightforward options of matching contributions up to three percent of compensation, or a two percent nonelective employer contribution.
Things are not so simple now. The SECURE Act of 2022 created several modifications to SIMPLE IRA contribution options. Effective in 2024, an optional employer nonelective or profit sharing-type contribution can be made, in addition to the mandatory employer matching contribution or two percent nonelective contribution. This, like the basic two percent nonelective contribution, would be contributed by the employer on behalf of all eligible employees, even those who are not deferring their own compensation into the plan. The maximum discretionary nonelective contribution is 10 percent of an employee’s compensation, or $5,000, whichever is less.
But that’s not all. In addition, SECURE 2.0 authorized an increase in the SIMPLE IRA annual salary deferral limit to 10 percent above the annual cost-of-living-adjusted level, both base salary deferrals and catch-up deferral contributions for those age 50 or older.
This 10 percent increase is automatic for SIMPLE IRA plans with 1-26 employees. It is optional for plans with 26-100 employees. If these larger plans make this election, the required basic employer match of three percent is increased to four percent, and the standard nonelective contribution of two percent is raised to three percent. These amounts equate to the required employer contributions in a safe harbor 401(k) plan. This may be intended as an inducement for such employers to transition to a more robust retirement plan.
There’s still more enhanced contribution dimensions. SECURE 2.0 created a second tier of catch-up contributions for those ages 60-63. Some call it the “super catch-up.” For comparison, those who are age 50 or older are eligible for SIMPLE catch-up salary deferrals of up to $3,850 per year; this, over and above the base salary deferral limit of $17,600 for 2025. But for those age 60-63, the 2025 catch-up deferral limit is $5,250.
Keeping Employees Informed
Employer SIMPLE IRA plan administrative responsibilities are minimal compared to a 401(k) or profit sharing plan. Perhaps most important is ensuring that employee salary deferrals withheld from pay are deposited timely. It goes without saying that the investment array offered to employees must be appropriate.
There are no reports equivalent to a qualified plan’s annual Form 5500 that must be filed with the Department of Labor or the IRS. But there are required annual employee notifications. At least 60 days before the start of the coming plan year, an “annual notice“ must be provided to eligible employees. It must contain the following.
The employee's opportunity to make or change a previous salary deferral election
The employees' ability to select a financial institution that will serve as custodian or trustee of the employees' SIMPLE IRA, if the plan does not use a DFI
The employer’s intention to make either matching contributions or nonelective contributions on behalf of employees in the coming year
A plan summary description
Written notice that the employee can transfer his SIMPLE IRA balance without cost or penalty if the plan is using a DFI
The summary description noted above in bullet number 4 must include the following.
Employer’s name and address
The SIMPLE IRA plan’s eligibility requirements
Benefits of participation in the plan
When employee elections must be made
Procedures and effects of withdrawing SIMPLE IRA contributions
Summary
SIMPLE IRA plans are a good first step for small employers who meet its 100-or-fewer-employee limitation, and who feel they’re not ready to go full-on with a 401(k) or other more robust retirement plan. But “simple” is in the eye of the beholder, and these plans prove that no tax-qualified retirement arrangement is without its complications.
