In our last blog post, we explained what a SIMPLE 401(k) plan is, how much an employer can contribute, why to adopt a SIMPLE 401(k), etc. In this post, we’ll cover some additional details that will help you decide if a SIMPLE 401(k) plan is right for your business.
Investment Earnings & Losses
Most SIMPLE 401(k) plans are self-directed. This means that the employee chooses his or his investments from the list of available options. Investment earnings accrue on a tax deferred basis, meaning that the employee does not pay taxes on the earnings until they withdraw the funds from the SIMPLE 401(k).
Contribution Types and Amounts
SIMPLE plans allow two types of contributions: employee and employer.
Employees may make elective contributions up to 100% of their compensation, limited to the year’s cap. The 2012 cap is $11,500; the 2013 cap is $12,000. In addition, employees who are 50 or older may make catch-up contributions up to $1,000 annually (2012 & 2013 limit).
Employers contribute to SIMPLE 401(k) plans using one of two formulas.
1. Matching Contribution Formula: Employers must generally match employee contributions on a dollar-for-dollar basis, up to 3% of the employee’s compensation for the calendar year. Only employees who make elective contributions are eligible for a matching contribution.
2. Non-Elective Contribution Formula: Instead of making matching contributions, the employer contributes 2% of compensation for each eligible employee who earns at least $5,000 of compensation in the calendar year. For this formula, compensation for each eligible participant is capped at $200,000. A non-elective contribution must be made to all employees, whether or not they make their own contributions.
Participants in SIMPLE 401(k) plans are 100% vested at all times. In other words, their contributions cannot be forfeited upon separation from service.
When Are The Retirement Funds Withdrawn?
Distributions from an employee’s SIMPLE 401(k) account are made upon one of these events: termination, retirement, death or disability. In the case of retirement, distribution must begin the later of:
– April 1 of the year following attainment of age 70 1/2
– The year in which the employee retirees
If an employee quits or is fired, he or she may receive the account balance of contributions, plus or minus, investment earnings. To avoid adverse tax consequences, it is advisable to roll the SIMPLE 401(k) plan payout to an IRA.
Investment earnings and contributions are taxed as ordinary income when they are received. If funds are withdrawn prior to age 59 1/2, they are subject to a 10% penalty in addition to this income tax.
Benefits to a Small Business Owner
A SIMPLE 401(k) plan is a typically advantageous for an employer with a small number of employees and a business owner who is not highly compensated. The SIMPLE 401(k) plan allows a business owner to make larger employee deferrals than a 401(k) plan. Why? Because a traditional 401(k) plan is subject to certain nondiscrimination testing requirements, per the IRS.
A SIMPLE 401(k) plan is not for every business, but it is a good retirement planning tool for some. To identify your best options for retirement planning for your business, contact me at 206-386-5455. We can discuss the different types of plans and identify the one that best fits your goals and situation.
To your wealth,
Joe Maas, CFA, AVA, CFP®, ChFC, CLU®, MSFS, CCIM
President of Synergetic Finance