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SIMPLE PLANS are the new mountains in the retirement planning landscape. In order to understand their features, I want to discuss how they fit in with the other plans we have available. See Diagram below. In the following, I will review five major types of plans with respect to the following parameters:
1. Number of workers usually found in firms with such plans,
2. Maximum and usual level of worker contribution made,
3. Rigidity of the plan versus flexibility and complexity. (With
flexibility you get complexity automatically, believe me.)
401(K) PLANS. These are now the retirement plans for many workers at major corporations. They do require more administration than older types of retirement plans --because of the flexibility they offer-- and thus are usually only suitable for firms with more than 50 employees. If your firm does have one, I always recommend that an employee contribute; and if you can afford to, contribute the maximum. Tax deferred compounding of investment earnings is a powerful tax advantage and you should take it if your budget allows. The maximum and usual level of employee contribution, which is made through payroll deductions, is several thousand dollars annually. The exact amount varies from plan to plan.
SEP-IRA. The SEP-IRA is almost the perfect employee
benefit plan if you, the owner, are the only employee. On the
plus side:
1. You can make a contribution of up to 15% of your earnings (13.04%
if you are self-employed) up to an annual maximum of $22,500.
2. Contributions are not required every year. Down year -- no
need for contributions.
3. You can start one at any time before the extended due date
for your return.
4. No filing is required by or with the IRS other than the worker
completing a form when the worker's plan is set up.
However, on the minus side, if you have employees:
1. The employer makes all contributions,
2. Employees are immediately vested in any money you contribute
for them, and
3. You must make contributions for any and each employee who has
worked for you three of the preceding five years, and who will
earn at least $400 in the current year. That means that practically
all semi-permanent part-timers would need to be included.
In summary, this is a good plan for someone who is self-employed
or can live with the very strict participation rules of this plan.
KEOGH PROFIT-SHARING AND MONEY-PURCHASE PLANS. Generally,
Keogh Profit-Sharing Plans and Keogh Money-Purchase Pension Plans
are the plans for the employer who can stand more paper-work for
the greater ability to control who receives contributions. On
the plus side:
1. You can make the same high percentage level of contributions
with a Keogh Profit-Sharing Plan as with a SEP-IRA. You can make
even more if you have a combination Profit-Sharing and Money Purchase
Plan.
2. You can define who will be a participant to a degree not possible
with other small plans -- for instance, you can require 1,000
hours of employment a year for two years prior to participation.
3. You can allocate contributions more toward the higher compensated
through either age-weighted plans or other allowable adjustments.
On the minus side, is the complexity:
1. Annual forms must be prepared for the I.R.S., as well as summary
reports for employees.
2. Where any real complexity has been put into the plan to make
it more advantageous for the highly compensated, the employer
will need to have a professional administrator to calculate annual
contributions and annual additions to participant's accounts.
SIMPLE PLANS. There are actually two new types of SIMPLE
PLANS, SIMPLE-IRA's and SIMPLE-401(K) Plans.
SIMPLE-IRA's are funded through a combination of employee salary deferrals (i.e., amounts withheld from workers paychecks, like a 401 (K) plan), and employer contributions (see more below). An employee can contribute up to $6,000 a year. The required employer contribution is either a dollar for dollar matching of the employee contribution up to 3% of the employee's compensation, or the employer can make a 2% contribution, whether or not the employee contributes. Also, the employer contribution rate can be reduced to as little as 1% in any two of five consecutive years.
Although a SIMPLE-IRA for a year (e.g. 1997), can be set up at any time up until the extended due date of that year's returns (Oct. 15, 1998), the worker payroll deferrals for a year need to be done by year-end. Thus only employer funding can be done after the end of the year.
The filing requirements are similar to that for SEP-IRAs. The
employee participation requirements are more reasonable than with
a SEP-IRA. With SIMPLE-IRAs, you need to cover any employee that
is expected to receive $5,000 in compensation in a year, and who
received at least this much income from you in the any two preceding
years.
SIMPLE-401(K) plans are restricted to employers who have
100 or fewer employees, and who have no other employee benefit
plan.
The one advantage of a SIMPLE-401(k) is that is does not have
to satisfy the special non-discrimination tests ordinarily applicable
to 401(K)'s. Thus they could be useful to some employers with
50-100 employees, due to decreased complexity and paperwork.
SIMPLE-401(K) plans could also be useful to firms where the interaction of the special non-discrimination rules for 401(K) plans and the rules limiting contributions for highly compensated workers in top-heavy plans resulted in many highly compensated workers unable to make annual contributions.
IN SUMMARY, the landscape has not changed in a major
way. If a SEP-IRA or a Keogh was right for you before, it probably
still is. If it was not, then taking a longer look at a SIMPLE-IRA
or SIMPLE-401(K) plan could be worthwhile for you.
Copyright Eleanor S. Hansen 1997.
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