Guides

Planning For Retirement

The “SIMPLE” Plan: A Retirement Plan for the Really Small Business

Several different types of retirement plan – 401(k), defined benefit, and profit-sharing – can be made to suit a prosperous small business or professional practice. But if yours is a really small business such as a home-based, start-up, or sideline business, maybe you should consider adopting a SIMPLE IRA plan.

Table of Contents

  • How Much You Can Put in and Deduct
  • Withdrawal: Easy, but Taxable
  • A SIMPLE IRA Plan
  • What’s Not So Good about SIMPLE IRA Plans
  • How to Get Started in a SIMPLE IRA Plan
  • Keoghs, SEPs and SIMPLE IRA Plans Compared

A SIMPLE IRA plan is a type of retirement plan specifically designed for small business and is an acronym for “Savings Incentive Match Plans for Employees.” SIMPLE IRA plans are intended to encourage small business employers to offer retirement coverage to their employees but work just as well for self-employed persons without employees.

SIMPLE IRA plans contemplate contributions in two steps: first by the employee out of salary, and then by the employer, as a “matching” contribution (which can be less than the employee contribution). Where SIMPLE IRA Plans are used by self-employed persons without employees – as IRS expressly allows – the self-employed person is contributing both as employee and employer, with both contributions made from self-employment earnings.

One form of SIMPLE IRA plan allows employer contributions without employee contributions. The ceiling on contributions, in this case, makes this SIMPLE IRA Plan option unattractive for self-employed individuals without employees.

To establish a SIMPLE IRA Plan you:

  • Must have 100 or fewer employees.
  • Cannot have any other retirement plans.
  • Employees must earn $5,000 a year.

And, here is a quick list of pros and cons:

  • Plan is not subject to the discrimination rules that everyday 401(k) plans are.
  • Employees are fully vested in all contributions.
  • Straightforward benefit formula allows for easy administration.
  • Optional participant loans and hardship withdrawals add flexibility for employees.
  • No other retirement plans can be maintained.
  • Withdrawal and loan flexibility adds administrative burden for the employer.

How Much You Can Put in and Deduct

Those with relatively modest earnings will find that a SIMPLE IRA Plan lets them contribute (invest) and deduct more than other plans. With a SIMPLE IRA Plan, you can put in and deduct some or all of your self-employed business earnings. The limit on this “elective deferral” is $13,500 in 2020 ($13,000 in 2019).

If your earnings exceed that limit, you could make a modest further deductible contribution–specifically, your matching contribution as an employer. Your employer contribution would be three percent of your self-employment earnings, up to a maximum of the elective deferral limit for the year. So employee and employer contributions for 2020 can’t total more than $27,000 ($13,500 maximum employee elective deferral, plus a maximum $13,500 for the employer contribution.)

Catch up contributions. Owner-employees age 50 or over can make a further deductible “catch up” contribution as employee of $3,000 in 2020 (same as 2019).

An owner-employee age 50 or over in 2020 with self-employment earnings of $40,000 could contribute and deduct $13,500 as employee plus an additional $3,000 employee catch up contribution, plus a $1,200 (3 percent of $40,000) employer match, for a total of $17,700.

Low-income owner-employees in SIMPLE IRA Plans may also be allowed a tax credit up to $2,000 in 2020 for single filers ($4,000 married filing jointly). This is known as the “Saver’s Credit” and income must not be more than $65,000 for married filing jointly, $32,500 for singles and $48,750 for heads of household.

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), then you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE IRA plan retirement investments.

An individual 401(k) plan, however, could allow you to contribute more, often much more, than SIMPLE IRA Plan. For example, if you are less than 50 years old with $50,000 of self-employment earnings in 2020, you could contribute $13,500 to your SIMPLE IRA PLAN plus an additional 3 percent of $50,000 as an employer contribution, for a total of $15,000. A 401(k) plan would allow a $32,000 contribution.

With $100,000 of earnings, the total for a SIMPLE IRA Plan would be $16,500 and $44,500 for a 401(k).

Back to top

Withdrawal: Easy, but Taxable

There’s no legal barrier to withdrawing amounts from your SIMPLE IRA Plan, whenever you please. There can be a tax cost, though: Besides regular income tax, the 10 percent penalty tax on early withdrawal (generally, withdrawal before age 59 1/2) rises to 25 percent on withdrawals in the first two years the SIMPLE IRA Plan is in existence.

Back to top

A SIMPLE IRA Plan

A SIMPLE IRA Plan really is a “simple” plan to set up and operate than most other plans. Contributions go into an IRA that you set up. Those already familiar with IRA rules investment options, spousal rights, and creditors’ rights don’t have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible, at least for you, the self-employed person. Your SIMPLE IRA Plan’s trustee or custodian, typically an investment institution, has reporting duties and the process for figuring the deductible contribution is a bit simpler than with other plans.

Back to top

What’s Not So Good about SIMPLE IRA Plans

Other types of retirement plans are often better than the SIMPLE IRA Plan once self-employment earnings become significant. Other not-so-good features include the following:

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 will in practice have fewer investment options than if you were your own trustee, as you could be in a Keogh. For many self-employed individuals, however, this won’t be an issue. In this respect, a SIMPLE IRA Plan is like the SEP-IRA.

Other plans for self-employed persons allow a deduction for one year (say 2020) if the contribution is made the following year (2021) before the prior year’s (2020) return is due (April 2021 or later with extensions). This rule applies to SIMPLE IRA Plans, for the matching (3 percent of earnings) contribution you make as an employer. But there’s no IRS pronouncement on when the employee’s portion of the SIMPLE IRA Plan is due where the only employee is the self-employed person. Those who want to delay contribution would argue that they have as long as it takes to compute self-employment earnings for 2020 (though not beyond the 2020 return due date, with extensions).

The sooner your money goes in the plan, the longer it’s working for you tax-free. So delaying your contribution isn’t the wisest financial move.

You can’t set up the SIMPLE IRA Plan after the year ends and still get a deduction for that year, as is allowed with SEPs. Generally, to make a SIMPLE IRA Plan effective for the year it must be set up by October 1 of that same year. A later date is allowed where the business is started after October 1. In this instance, the SIMPLE IRA Plan must be set up as soon thereafter as administratively feasible.

Then there’s a problem if the SIMPLE IRA Plan is intended for a sideline business and you’re already in a 401(k) plan in another business or as an employee. In this scenario, the total amount you can put into the SIMPLE IRA Plan and the 401(k) plan combined can’t be more than $19,500 in 2020 or 56,00 if catch-up contributions are made to the 401(k) by one age 50 or over.

Here’s an example: If someone who is less than age 50 puts $10,000 in her 401(k), they can’t put more than $9,500 in her SIMPLE IRA Plan in 2020. 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).

Back to top

How to Get Started in a SIMPLE IRA Plan

You can set up a SIMPLE IRA Plan on your own by using IRS Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)–Not for Use With a Designated Financial Institution, or Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)–for Use With a Designated Financial Institution, but most people turn to financial institutions to take care of the paperwork for them. SIMPLE IRA Plans are offered by the same financial institutions that offer IRAs and 401(k) plans.

You can expect the institution to give you a plan document (approved by IRS or with approval pending) and an adoption agreement. In the adoption agreement, you will choose an “effective date,” which is the beginning date for payments out of salary or business earnings. Remember, that date can’t be later than October 1 of the year you adopt the plan, except when a business is 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 a participant.

Back to top

Keoghs, SEPs and SIMPLE IRA Plans Compared For 2020

Keogh SEP SIMPLE IRA PLAN
Plan type: Can be defined benefit or defined contribution (profit-sharing or money purchase) Defined contribution only Defined contribution only
Owner may have two or more plans of different types, including a SEP, currently or in the past Owner may have SEP and Keoghs Generally, SIMPLE IRA PLAN is the only current plan
Plan must be in existence by the end of the year for which contributions are made Plan can be set up later–if by the due date (with extensions) of the return for the year contributions are made Plan generally must be in existence by October 1st of the year for which contributions are made
Dollar contribution ceiling (for 2020): $57,000 for defined contribution plan; no specific ceiling for defined benefit plan $57,000 $27,000
Percentage limit on contributions: 50% of earnings, for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan. 50% of earnings (100% of earnings after contribution). Elective deferrals in SEPs formed before 1997 not subject to this limit. 100% of earnings, up to $13,500 for 2020 for contributions as employee; 3% of earnings, up to $13,500 for contributions as employer
Deduction ceiling: For defined contribution, lesser of $57,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings. Lesser of $57,000 or 20% of earnings (25% of earnings after contribution). Elective deferrals in SEPs formed before 1997 not subject to this limit. Maximum contribution $13,500 (in 2020)
Catch up contribution 50 or over: Up to $6,500 in 2020 for 401(k)s Same for SEPs formed before 1997 Half the limit for Keoghs, SEPs (up to $3,000 in 2020)
Prior years’ service can count in computing contribution No No
Investments: Wide investment opportunities. Owner may directly control investments. Somewhat narrower range of investments. Less direct control of investments. Same as SEP
Withdrawals: Some limits on withdrawal before retirement age No withdrawal limits No withdrawal limits
Permitted withdrawals before age 59 1/2 may still face 10% penalty Same as Keogh rule Same as Keogh rule except penalty is 25% in SIMPLE IRA PLAN Plan’s first two years
Spouse’s rights: Federal law grants spouse certain rights in owner’s plan No federal spousal rights No federal spousal rights
Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE IRA PLAN. Same as Keogh rule Rollover after 2 years to another SIMPLE IRA PLAN and to plans allowed under Keogh rule
Some reporting duties are imposed, depending on plan type and amount of plan assets Few reporting duties Negligible reporting duties

Back to top

Ask a Question

Find comfort in knowing an Expert in accounting is only an email or phone-call away.

We Are Here to Help

We will happily offer you a free consultation to determine how we can best serve you.

Blog

Attestation Services: Compilations, Reviews, and Audits CPAs offer attestation services as unbiased options

frequently asked questions

  • What Is A Virtual CFO & How Can It Transform My Business?
    • a. A Virtual CFO can be a much-needed sounding board, coach, and guide. Outsourced Virtual CFO is generally not just one person, but an experienced team of professionals providing a full-stack Accounting and Finance Department at a fraction of the cost that it would otherwise cost a business to hire even just one full-time CFO internally. The right virtual CFO service team, such as the one at Perpetual CPA, can deliver timely, detailed, comprehensive financial reporting, interpret the financial data, prioritize recommendations, give expert guidance on how to execute those recommendations, and ultimately give a better path to business success.
  • How can a Virtual Accounting Department help small businesses scale and grow?
    • a. A growing number of small businesses are opting to outsource services such as IT, human resources, or accounting. The benefit of a Virtual Accounting Department is that the company can reduce or increase services to accommodate current business needs. Because the service provider has multiple clients they can absorb fluctuations in workflow more easily than the average small/medium business can on its own.

      b. A Virtual Accounting Department can integrate with a company’s own accounting department to create a blended solution or provide a full-stack accounting department, including Accounting Staff, Manager, Controller, and Virtual CFO. By using a Virtual Accounting Department Small business owners don’t have to worry about hiring, training, figuring out compensation, and payroll compliance for the internal accounting team. Also as the business grows and new and more complex accounting and tax issues come up, the outsourced Virtual Accounting Department can provide all the needed expertise to facilitate continued business success.
  • What are the benefits of hiring a CPA firm?
    • a. Certified Public Accountants (CPAs) do a lot more than just crunch numbers and prepare taxes. They provide valuable expertise and strategies to help businesses and individuals achieve their business and financial goals. A CPA firm can help small businesses with management financial reporting, tax compliance, strategic business advice, and much more. Firms like Perpetual CPA, that specialize in helping small and medium-sized businesses achieve growth, can also provide Virtual CFO services, that help the business owners have the foresight into the short-term future cashflows and be able to more successfully navigate their business performance.
  • What are the best strategies for small business growth?
    • a. A business growth strategy is, simply, a plan of how a business gets from where it is today to where it wants to be in the future.

      b. Some of the questions to consider when coming up with a growth strategy are:
      i. Where will the business get new customers from?
      ii. How will the business expand into new markets?
      iii. What new products could the business offer?

      c. In reality, what happens with many small businesses, is that they generally achieve a specific level of business activity or sales and then the business growth trend flattens. In those cases, working with a firm like Perpetual CPA, which provides Virtual CFO services, can help small businesses avoid stagnation. Virtual CFO services, aside from providing timely accounting and tax reporting, can also provide valuable insight into the current performance of the business, as well as, foresight into the future cash flows for the business. Perpetual CPA Virtual CFO team helps small businesses interpret their financial information and come up with business strategies to help improve business performance and achieve growth.
  • What are the best strategies for small business risk management?
    • a. A risk management plan helps a business develop a detailed strategy to deal with certain risks that are particularly important for the businesses’ success.

      b. For many small and medium-sized businesses, the easiest way to develop and implement a business risk management plan is to work with a reputable CPA firm, such as Perpetual CPA. Large corporations invest a lot of resources and time into managing risk, which is a material factor that allows those large corporations to continue to generate billions of dollars in revenue every year. Small businesses, however, almost never manage any business risks, which is the major reason that over half of all the small businesses do not survive for more than 5 years. Generally, small business owners are not experienced corporate business professionals and lack the needed business knowledge, yet they often have to wear many hats while trying to get their businesses off the ground. In those situations, a CPA firm such as Perpetual CPA, can help small businesses better manage tax compliance risks, cash flow, internal controls, business administration, financial reporting, and much more.
  • What is Strategic Advisory and Virtual CFO? / How do Strategic Advisory and Virtual CFO services work?
    • a. When small businesses start spinning wheels, it is a good time to consider hiring a reputable CPA firm, such as Perpetual CPA, which can provide both Strategic Advice and Virtual CFO services.

      b. As a strategic advisor, the CPA firm will work with business management to improve the effectiveness and profitability of the business. They will look holistically at the business and find ways to operate the business more efficiently, increase customers through additional or improved marketing or improve customer touchpoints and service.

      c. As a Virtual CFO, the CPA firm is like a part-time version of a traditional CFO or Chief Financial Officer plus a full Accounting support team. They perform the tasks that in a larger organization would be performed by the CFO, Controller, and Accounting Staff such as preparing and overseeing the budget process, identifying and analyzing current and future trends, and developing strategies for the business growth.
  • How can timely financial visibility and management reporting help with better business decisions and growth?
    • a. A simple way to a successful business is to prioritize the timely financial visibility and management reporting as it means:
      i. Timely financial information and analysis are essential for making informed decisions, evaluating your company’s results, improving financial performance, and ensuring you are on the path to meet your strategic goals.
      ii. Management reporting is a source of business intelligence that helps business leaders make more accurate, data-driven decisions. But, these reports are most useful if they are available timely and the management receives proper interpretation of the business financial information.

free initial 30-minute consultation

    © Perpetual CPA 2020   •   Site Map   •   Privacy Policy   •   Disclaimer   •   Powered By   Designed by Dot Com Media Moguls