Not so SIMPLE?

New retirement plans for small businesses.

Under current law, employees can save for retirement and earn significant benefits under qualified employer-sponsored retirement plans; however, to receive their tax-favored status, these plans must comply with a variety of complex administrative rules, as well as certain provisions of the Employee

Retirement Income Security Act of 1974 (ERISA). As such, retirement plan coverage among small employers lags behind that of medium-size and large employers. To remedy this situation, Congress created the Savings Incentive Match Plan for Employees, or SIMPLE retirement plan (also discussed by Stanley Person in this month's Tax Briefs, page 32).

Effective for 1997, these new plans replace salary-reduction simplified employee pensions (SARSEPs); after 1996, no new SARSEPs may be established (although existing ones may continue to receive contributions).

SIMPLE RULES

SIMPLE plans may be adopted only by employers with 100 or fewer employees earning at least $5,000 in compensation for the preceding calendar year and who do not maintain any other employer-sponsored retirement plan. (Once employers with SIMPLE plans exceed the 100-employee limit, they may continue to maintain the plans for two years.) Self-employed individuals may also establish SIMPLE plans.

A SIMPLE plan may be set up either as an individual retirement account (IRA) for each employee or as part of a qualified cash or deferred arrangement (under Internal Revenue Code section 401(k)).

Employers must provide their employees with information about their rights to make salary reductions, as well as the contribution alternative elected by the employer. To assist eligible businesses, on October 31, the Internal Revenue Service issued an optional form (form 5305-SIMPLE) for setting up SIMPLE plans through IRAs; the IRS is working on (but has not yet released) model amendments to the code for employers opting to adopt SIMPLE 401 (k) plans.

SIMPLE IRAs. Eligible employees may elect to contribute up to $6,000 (indexed for inflation in $500 increments) per year, which the employer is required to match, dollar for dollar, up to 3% of compensation; under a special rule, an employer can elect a lower percentage for all employees (but not less than 1% of each employee's compensation and for only two of any five years). As an alternative to matching employee contributions, an employer may make a 2%-of-compensation nonelective contribution for each eligible employee.

SIMPLE 401(1) plans. As with IRAs, employees will be eligible to defer up to $6,000 of income, and employers must match these deferrals up to 3% of compensation. (Note: Under a SIMPLE 40l (k) plan, an employer may not reduce the matching percentage below 3%.) If these requirements are met, the nondiscrimination rules normally applicable to 401(k) plans are automatically satisfied, and the plan is not subject to the top-heavy qualified plan rules.

ADVANTAGES

In addition to those already discussed, SIMPLE plans may provide small businesses with certain other advantages:

* Employers maintaining SIMPLE plans are not subject to ERISA's general reporting requirements. SIMPLE plans may be easier and less costly to establish and maintain.

* If properly structured, the employer (or any other plan fiduciary) may not be subject to fiduciary liability for actions taken by participants or beneficiaries.

DISADVANTAGES

At the same time, SIMPLE plans have their disadvantages:

* The maximum contribution is substantially lower than that allowed under regular qualified plans. (The effect on owner-employers is discussed further on page 32.)

* The matching of employee contributions is required. While there is some flexibility in determining the amount of the required contribution, an employer will be required to make contributions each year.

For a discussion of SIMPLE plans and other recent developments, see the Tax Clinic, edited by Michael Koppel, in the December 1996 issue of The Tax Adviser.

--Nicholas Fiore, editor The Tax Adviser

Editor's Note 

The material discussed provides general information. Before you take any action in this area, the appropriate code sections, regulations, cases and rulings should be examined.