How Does A Simple IRA Plan Work?

Not every company with employees should have a 401(k) plan. In many cases, a Simple IRA plan may be the best fit for a small business. These plans carry the following benefits

• No TPA fees

• Easy to setup & operate

• Employee attraction and retention tool

• Pre-tax contributions for the owners to lower their tax liability

Your company

To be eligible to sponsor a Simple IRA, your company must have less than 100 employees. The contribution limits to these plans are about half that of a 401(k) plan but it still may be the right fit for you company. Here are some of the most common statements that we hear from the owners of the business that would lead you to considering a Simple IRA plan over a 401(k) plan:

"I want to put a retirement plans in place for my employees that has very low fees and is easy to operate."

"We are a start-up, we don't have a lot of money to contribute to the plan as the owners, but we want to put a plan in place to attract and retain employees."

"I plan on contributing $15,000 per year to the plan, even if I sponsored a plan that allowed me to contribute more I wouldn't because I'm socking all of the profits back into the business"

"I have a SEP IRA now but I just hired my first employee. I need to setup a different type of plan since SEP IRA's are 100% employer funded"

Establishment Deadline

The deadline to establish a Simple IRA plan is October 1st. Once you have cross over that date, you would have to wait until the following calendar year to set the plan.

Eligibility

The eligibility requirements for a Simple IRA are different than a SEP IRA or 401(k) plans. Unlike these other plan "1 Year of Service" = $5,000 of compensation earned in a calendar year. If you want to only cover "full-time" employees with your retirement plan, you may need to consider a 401(k) plan which has the 1 year and 1000 hours requirement to obtain a year of service. The most restrictive "wait time" that you can put into place is 2 years. Meaning an employee must obtain 2 years of service before they are eligible to start contributing to the plan. You can also be more lenient that 2 years, such as immediate entry or a 1-year wait, but 2 years is the most restrictive it can be.

Types of Contributions

Like a 401(k) plan, Simple IRA have both employee deferral contributions and employer contributions.

Employee Deferrals

Eligible employees are allowed to make pre-tax contributions to their Simple IRA accounts. The contribution limits are less than a traditional 401(k). Below is a tale comparing the 2021 contribution limits of a Simple IRA vs a 401(k) Plan:

There are not Roth deferrals allows in Simple IRA plans.

Employer Contributions

Unlike other employer sponsored retirement plans, employer contributions are mandatory each year to a Simple IRA plan. The company must choose between two pre-set employer contribution formulas:

• 2% Non-elective

• 3$ Matching contribution

With the 2% non-elective contribution, the company must contribute 2% of each eligible employee’s compensation to the plan whether they contribute to the plan or not.

For the 3% matching contribution, it’s a dollar for dollar match up to 3% of compensation that they employee contributes to the plan. The match formula is more popular than the 2% non-elective contribution because the company only must contribute if the employee contributes.

Special 1% Rule

With the employer matching contribution there is also a special rule. In 2 out of any 5 consecutive years, the company can lower the employer match to as low as 1% of pay. We will often see start-up company's take advantage of this rule by putting a 1% employer match in place for the first 2 years of the plan to minimize costs and then they are committed to making the 3% match for years 3, 4, and 5.

100% Vesting

All employer contributions to Simple IRA plans are 100% vested. The company is not allowed to attach a "vesting schedule" to the contributions.

Important Compliance Requirements

Make sure you have a 5304 Simple Form in your files for each year you sponsor the Simple IRA plan. If you are audited by the IRS or DOL, they will ask for these forms. You need to distribute this form to all of your employee each year between Nov 1st and Dec 1st for the upcoming plan year. The documents notifies your employees that:

• A retirement plan exists

• Plan eligibility requirement

• Employer contribution formula

• Who they submit their deferral elections to within the company

If you do not have this form on file, the IRS will assume that you have immediate eligibility for your Simple IRA plan, meaning that all of your employees are due employer contributions since day one of employment. Even employee that used to work for you and have since terminated employment. It’s an ugly situation.

Make sure the company is timely when submitting the employee deferrals to the Simple IRA plan. Since you are withholding money from employees pay for the salary deferrals the IRS want you to send that money to their Simple IRA accounts “as soon as administratively feasible”. The suggested time phrase is within a week of the deduction in payroll. But you must be consistent with the timing of your remittances to your Simple IRA plan. If you typically submit contributions to your Simple IRA provider 5 days after a payroll run but one week you randomly submit it 2 days after the payroll run, 2 days just became the rule and all of the other deferral remittances are “late”. The company will be assessed penalties for all of the late deferral remittances. So be consistent.

Cannot Terminate Mid-Year

Unlike other retirement plans, you cannot terminate a Simple IRA plan mid-year. Simple IRA plan termination are most common when a company started with a Simple IRA, has grown in employee head count, and now wishes to put a 401(k) plan in place. You must wait until after December 31st to terminate the Simple IRA plan and implement the new 401(k) plan.

Special 2 Year Rule

If you replace your Simple IRA with a 401(k) plan, the balances in the Simple IRA can usually be rolled over into the new 401(k) if the employee elects to do so. However, be very careful of the special Simple IRA 2 Year Distribution Rule. If you process any type of distribution from a Simple IRA, within a two-year period of the employee depositing their first dollar to the account, and the employee is under 59½, they are hit with a 25% IRS penalty. THIS ALSO APPLIES TO DIRECT ROLLOVERS. Normally when you process a direct rollover from one retirement plan to another, no taxes or penalties are assessed. That is not the case in Simple IRA plan so be care of this rule. If you decide to switch from a Simple IRA to a 401(k), make sure you run a list of all the employees that maintain a balance in the Simple IRA plan to determine which employees are subject to the 2-year withdrawal restriction.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Does A SEP IRA Work?

 What is a SEP?

SEP stands for “Simplified Employee Pension”.  The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.

Special Establishment Deadline

SEP are one of the few retirement plans that can be established after December 31st which make them a powerful tax tool.  For example, it’s March, you are meeting with your accountant and they deliver the bad news that you have a big tax bill that is due.  You can setup the SEP IRA any time to your tax filing date PLUS extension, fund it, and capture the tax deduction.

Easy to Setup & Low Plan Fees

The other advantage of SEP IRA’s is they are easy to setup and you do not have a third-party administrator to run the plan, so the costs are a lot lower than a traditional 401(k) plans.  These plans can typically be setup with 24 hours.

Contributions limits

SEP IRA contributions are expressed as a percentage of compensation.  The maximum contribution is either 20% of the owners “net earned income” or 25% of the owners W2 wages.  It all depends on how your business is incorporated.  You have the option to contribution any amount less than the maximum contribution.

100% Employer Funded

SEP IRA plans are 100% employer funded meaning there is no employee deferral piece.  Which makes them expense plans to sponsor for a company that eligible employees because the employer contribution is uniform for all employees.  Meaning if the owner contributes 20% of their compensation to the plan for themselves they must also make a contribution equal to 20% of compensation for each eligible employee.  Typically, once employees begin becoming eligible for the plan, a company will terminate the SEP IRA and replace it with either a Simple IRA or 401(k) plans.

Employee Eligibility Requirements

An employee earns a “year of service” for each calendar year that they earn $500 in compensation.  You can see how easy it is to earn a “year of service” in these types of plans.  This is where a lot of companies make an error because they only look at their “full time employees” as eligible.  The good news for business owners is you can keep employees out of the plan for 3 years and then they become eligible in the 4th year of employment.  For example, I am a sole proprietor and I hire my first employee, if my plan document is written correctly, I can keep that employee out of the SEP IRA for 3 years and then they will not be eligible for the employer contribution until the 4th year of employment.

Read This……..Very Important…..

There is a plan document called a 5305 SEP form that is required to sponsor a SEP IRA plan.  This form can be printed off the IRS website or is sometimes provide by the investment platform for your plan.   Remember, SEP IRA plans are “self-administered” meaning that you as the business owner are responsible for keeping the plan in compliance.  Do cannot always rely on your investment advisor or accountant to help you with your SEP IRA plan. You should have a 5305 SEP for in your employer files for each year you have sponsored the plan.   This form does not get filed with the IRS or DOL but rather is just kept in your employer files in the case of an audit. You are required to give this form to all employees of the company each year.  It’s a way of notifying your employees that the plan exists and it lists the eligibility requirements.

Compliance Issues

The main compliance issues to watch out for with these plan is not having that 5305 SEP Form for each year the plan has been sponsored, not accurately identifying eligible employees, and miscalculating your “net earned income” for the max SEP IRA contribution. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Small Business Owners: How To Lower The Cost of Health Insurance

As an owner of a small business myself, I’ve had a front row seat to the painful rise of health insurance premiums for our employees over the past decade.   Like most of our clients, we evaluate our plan once a year and determine whether or not we should make a change.  Everyone knows the game.  After running on this hamster wheel for the past decade it led me on a campaign to consult with experts in the health insurance industry to find a better solution for both our firm and for our clients.

The Goal: Find a way to keep the employee health benefits at their current level while at the same time cutting the overall cost to the company.  For small business owners reducing the company’s outlay for health insurance costs is a challenge. In many situations, small businesses are the typical small fish in a big pond. As a small fish, they frequently receive less attention from the brokerage community which is more focused on obtaining and maintaining larger plans.

Through our research, we found that there are two key items that can lead to significant cost savings for small businesses.  First, understanding how the insurance market operates.  Second, understanding the plan design options that exist when restructuring the health insurance benefits for your employees.

Small Fish In A Big Pond

I guess it came as no surprise that there was a positive correlation between the size of the insurance brokerage firm and their focus on the large plan market.  Large plans are generally defined as 100+ employees.  Smaller employers we found were more likely to obtain insurance through their local chambers of commerce, via a “small business solution teams” within a larger insurance brokerage firm, or they sent their employees directly to the state insurance exchange.

Myth #1:  Since I’m a small business, if I get my health insurance plan through the Chamber of Commerce it will be cheaper.   I unfortunately discovered that this was not the case in most scenarios.  If you are an employer with between 1 – 100 employees you are a “community rated plan”. This means that the premium amount that you pay for a specific plan with a specific provider is the same regardless of whether you have 2 employees or 99 employee because they do not look at your “experience rating” (claims activity) to determine your premium.  This also means that it’s the same premium regardless of whether it’s through the Chamber, XYZ Health Insurance Brokers, or John Smith Broker.  Most of the brokers have access to the same plans sponsored by the same larger providers in a given geographic region.  This was not always the case but the Affordable Care Act really standardized the underwriting process.

The role of your insurance broker is to help you to not only shop the plan once a year but to evaluate the design of your overall health insurance solution.  Since small companies usually equal smaller premium dollars for brokers it was not uncommon for us to find that many small business owners just received an email each year from their broker with the new rates, a form to sign to renew, and a “call me with any questions”.   Small business owners are usually extremely busy and often times lack the HR staff to really look under the hood of their plan and drive the changes needed to improve the plan from a cost standpoint.  The way the insurance brokerage community gets paid is they typically receive a percentage of the annual premiums paid by your company.  From talking with individuals in the industry, it’s around 4%.  So if a company pays $100,000 per year in premiums for all of their employees, the insurance broker is getting paid $4,000 per year.  In return for this compensation the broker is supposed to be advocating for your company.  One would hope that for $4,000 per year the broker is at least scheduling a physical meeting with the owner or HR staff to review the plan each year and evaluate the plan design options.

Remember, you are paying your insurance broker to advocate for you and the company.  If you do not feel like they are meeting your needs, establishing a new relationship may be the start of your cost savings.   There also seemed to be a general theme that bigger is not always better in the insurance brokerage community. If you are a smaller company with under 50 employees, working with smaller brokerage firms may deliver a better overall result.

Plan Design Options

Since the legislation that governs the health insurance industry is in a constant state of flux we found through our research that it is very important to revisit the actual structure of the plan each year. Too many companies have had the same type of plan for 5 years, they have made some small tweaks here and there, but have never taken the time to really evaluate different design options.  In other words, you may need to demo the house and start from scratch to uncover true cost savings because the problem may be the actual foundation of the house.

High quality insurance brokers will consult with companies on the actual design of the plan to answer the key question like “what could the company be doing differently other than just comparing the current plan to a similar plan with other insurance providers?”   This is a key question that should be asked each year as part of the annual evaluation process.

HRA Accounts

The reason why plan design is so important is that health insurance is not a one size fits all.  As the owner of a small business you probably have a general idea as to how frequently and to what extent your employees are accessing their health insurance benefits.

For example, you may have a large concentration of younger employees that rarely utilize their health insurance benefits.  In cases like this, a company may choose to change the plan to a high deductible, fund a HRA account for each of the employees, and lower the annual premiums.

HRA stands for “Health Reimbursement Arrangement”.  These are IRS approved, 100% employer funded, tax advantage, accounts that reimburses employees for out of pocket medical expenses.  For example, let’s say I own a company that has a health insurance plan with no deductible and the company pays $1,000 per month toward the family premium ($12,000 per year).   I now replace the plan with a new plan that keeps the coverage the same for the employee, has a $3,000 deductible, and lowers the monthly premium that now only cost the company $800 per month ($9,600 per year).  As the employer, I can fund a HRA account for that employee with $3,000 at the beginning of the year which covers the full deductible.  If that employee only visits the doctors twice that year and incurs $500 in claims, at the end of the year there will be $2,500 in that HRA account for that employee that the employer can then take back and use for other purposes.  The flip side to this example is the employee has a medical event that uses the full $3,000 deductible and the company is now out of pocket $12,600 ($9,600 premiums + $3,000 HRA) instead of $12,000 under the old plan.  Think of it as a strategy to “self-insure” up to a given threshold with a stop loss that is covered by the insurance itself.  The cost savings with this “semi self-insured” approach could be significant but the company has to conduct a risk / return analysis based on their estimated employee claim rate to determine whether or not it’s a viable option.

This is just one example of the plan design options that are available to companies in an attempt to lower the overall cost of maintaining the plan.

Making The Switch

You are allowed to switch your health insurance provider prior to the plan’s renewal date.  However, note that if your current plan has a deductible and your replacement plan also carries a deductible, the employees will not get credit for the deductibles paid under the old plan and will start the new plan at zero.  Based on the number of months left in the year and the premium savings it may warrant a “band-aide solution” using HRA, HSA, or Flex Spending Accounts to execute the change prior to the renewal date. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.