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A pair of new IRA strategies.

The passage of the Small Business Job Protection Act of 1996 created, a significant new Individual Retirement Account (IRA). The Savings Incentive Match Plan (SIMPLE) IRA retirement plan is designed to help employees working for smaller businesses save for retirement on a tax-favored basis, while allowing employers current-year tax deductions.

A SIMPLE plan is a new type of salary reduction retirement strategy for small businesses. Due to its basic design features, it is not subject to the complex eligibility and testing requirements associated with traditional 401(k) plans or Salary Reduction-Simplified Employee Pension Plans. Administrative and other plan costs, therefore, are minimized.

Another advantage of SIMPLE IRA plans, from an employer's standpoint, is that they are not subject to annual reporting and testing requirements. Also, the employer will not be subject to fiduciary liability resulting from an employee exercising control over the assets in the SIMPLE IRA account.

Businesses are eligible to adopt a SIMPLE plan if they employ 100 or fewer employees who each received at least $5,000 in compensation for the preceding year and do not maintain another employer-sponsored retirement plan. This includes corporations, partnerships, sole proprietors, tax-exempt organizations, and state or local governments or agencies. It allows employees to make pre-tax elective contributions to a SIMPLE individual retirement account. Employee contributions may be any percentage of their compensation (up to 100%), but can not exceed $6,000 per year (as indexed for inflation).

Employers must contribute to employee accounts using one of two contribution formulas: Under the matching contribution formula, they are required to match employee contributions dollar for dollar up to three percent of each participating worker's compensation. (A special rule allows employers to elect a lower percentage matching contribution rate, but not less than one percent of each employee's compensation. Employers can not elect to use a lower percentage for more than two out of any five consecutive years.)

Instead of making matching contributions, for any year, employers may select a nonelective contribution formula of two percent of compensation on behalf of each eligible employee who actually receives at least $5,000 in compensation during the year, whether or not the employee made pre-tax elective contributions during the year. For this purpose, compensation taken into account may not exceed $150,000 (as indexed for inflation). The employer must give written notice specifying the employee's contribution formula for a year to every eligible employee at least 60 days before the start of the year. Eligible employees then have 60 days to decide what their contributions, if any, will be for the coming year.

SIMPLE IRA contributions may only be made to a SIMPLE IRA account. Except for rollovers from other SIMPLE IRAs, no other contributions may be made (a SIMPLE can't be combined with any other type of IRA).

Generally, any employee who received at least $5,000 in compensation during any two prior years and is reasonably expected to receive at least $5,000 in compensation during the current year is eligible. All SIMPLE contributions (employee and employer matching) must be fully vested.

All contributions are tax-deductible for the employers. In addition, they are excluded from an employee's income for Federal income tax purposes in the year contributed, and the assets of a SIMPLE account grow on a tax-deferred basis. The employee's pre-tax contributions are included in income for Social Security (both retirement and Medicare benefits) and unemployment taxes, if applicable. Thus, participation in a SIMPLE IRA plan will not reduce an employee's Social Security benefits.

Generally, distributions are taxed under the rules applicable to IRAs. However, a 25% early distribution penalty applies to those taken prior to the two-year anniversary of initial participation unless the employee is 59 l/2 or older or another exception applies. After the two-year period, the penalty tax rate is 10%. Tax-free rollovers may be made from one SIMPLE account to another.

If the employee no longer is making contributions under the SIMPLE plan and two years have passed since he or she first participated in that plan, a SIMPLE IRA may be rolled over to an IRA on a tax-free basis and the employee's SIMPLE account is treated as an ordinary IRA. A SIMPLE IRA account also may be transferred to a SIMPLE IRA account at another financial institution.

For those employees wishing to put away additional funds for retirement, a self-directed IRA offers many benefits. Included are a wide choice of investments within a single account to meet retirement planning needs today and in the future.

A self-directed IRA works much like any other type of IRA, allowing employed individuals to set aside money for retirement through tax-deferred savings (whether or not the person is covered under an employer's retirement plan). A self-directed IRA permits participants to designate, through a single account, exactly what portion of IRA funds they would like invested in various types of investments--common stocks, corporate bonds, zero coupon bonds, mutual funds, and certificates of deposit, among other alternatives--and to select among these investments without tax penalty as long as they are held within the account.
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Title Annotation:Savings Incentive Match Plan Individual Retirement Accounts and self-directed Individual Retirement Accounts
Author:Lizzio, Joseph P.
Publication:USA Today (Magazine)
Article Type:Column
Date:Nov 1, 1997
Previous Article:In defense of affirmative action.
Next Article:Moral and ethical issues for the new millennium.

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