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Tutorial: Establishing the SIMPLE Plan and SIMPLE IRA

The operational and compliance requirements that apply when establishing a SIMPLE IRA plan.
 
Establishing the SIMPLE IRA
 
A SIMPLE IRA Plan must be properly established in order for contributions to be made to the plan and for the plan to be in compliance with the applicable rules and regulations. Proper establishment includes establishing the plan by the deadline, completing the proper documentation, and providing employees with the proper notification.
 
Procedures for Establishing The SIMPLE IRA Plan
 
 
There are two key steps that must be taken when establishing the SIMPLE IRA. The first is the employer establishing the SIMPLE IRA plan and the second is the employee establishing his SIMPLE IRA under the plan.
 
Generally, financial institutions maintain a copy of the employer’s SIMPLE IRA Plan agreement ( 5304-SIMPLE, 5305-SIMPLE or prototype SIMPLE) with a copy of the participant’s SIMPLE IRA adoption agreement, so as to maintain proper records of which employer’s plan the participant’s is associated with.
 
Financial institutions usually that uses the IRS Model 5304-SIMPLE or 5305-SIMPLE Forms usually personalize these forms by adding their names and logos and may require that employers use their personalized forms or prototype forms. Exceptions usually apply in cases where an employee chooses to establish a SIMPLE IRA with a financial institution other than the one with which the employer established the SIMPLE IRA Plan. In such cases, the other financial institution will accept a copy of the SIMPLE Plan agreement that was completed by the employer, but require the participant to use their SIMPLE IRA Adoption agreement.
 
The financial institution with which the SIMPLE IRA is maintained will generally and likely require that the participant use their SIMPLE IRA adoption agreement.
 
Example:
Paul works for Employer X. Employer X established a SIMPLE IRA with Custodian Y. Employer X is required to complete Custodian Y’s SIMPLE IRA Plan agreement. This agreement can be either the Form 5304-SIMPLE, Form 5305-SIMPLE, or Custodian Y’s prototype SIMPLE IRA Plan agreement.
Paul wanted to maintain his SIMPLE IRA at Custodian P. Paul will be required to provide Custodian P with a copy of Custodian Y’s SIMPLE Plan agreement that was completed and signed by Employer X. In addition, he is required to complete Custodian P’s SIMPLE IRA Adoption agreement.
 
The employer should maintain a checklist of the items needed to establish the plan, so as to ensure that all the steps are completed.
 
Deadline for Establishing SIMPLE Plan
 
The SIMPLE IRA Plan is established when the employer completes and signs the SIMPLE Plan Agreement. This agreement can be either a:
 
  • Form 5304-SIMPLE (Not Subject to the Designated Financial Institution Rules), which is the model form that may be used by an employer to establish a SIMPLE IRA Plan that does not use a DFI,
  • Form 5305-SIMPLE (for Use With a Designated Financial Institution), which is a form that may be used by an employer establishing a SIMPLE IRA Plan with a financial institution that is a DFI , or
  • An approved prototype SIMPLE IRA Plan
 
Note: The deadline for establishing the SIMPLE IRA Plan is different from the deadline by which an employee’s SIMPLE IRA must be established.

 

First SIMPLE IRA Plan for Employer
 
If an employer (or a predecessor employer) is establishing a SIMPLE IRA Plan for the first time, the plan must be established between January 1 and October 1. After the October 1 deadline has passed, the employer must wait until the next year in order to establish a SIMPLE IRA Plan.
 
Exception to October 1 Deadline
An exception applies to a new employer that comes into existence after October 1 of the year that the SIMPLE IRA Plan is being established. For these employers, the SIMPLE IRA Plan can be established after the business is established, but must be done as soon as administratively feasible.
 
Employer That Previously had A SIMPLE IRA
 
If the employer (or a predecessor employer) previously had a SIMPLE IRA Plan, that employer may establish the SIMPLE IRA only with an effective date of January 1.
 
Choosing The SIMPLE Agreement
The type of SIMPLE IRA Plan agreement that is chosen if often determined by what is available at the financial institution with which the employer establishes the SIMPLE IRA Plan, as most financial institutions offer only one type of SIMPLE IRA Plan agreement. For instance, if the employer wants to use a financial advisor that offers SIMPLE IRA Plans through Custodian ABC, then the employer would be required to use the SIMPLE IRA Plan agreement offered by Custodian ABC. However, will first determine the type of SIMPLE IRA Plan agreement they want to use, and then look for a financial institution that uses that agreement. The key features of each are as follows:
 

First SIMPLE IRA Plan for Employer

 

If an employer (or a predecessor employer) is establishing a SIMPLE IRA Plan for the first time, the plan must be established between January 1 and October 1. After the October 1 deadline has passed, the employer must wait until the next year in order to establish a SIMPLE IRA Plan.

 

Exception to October 1 Deadline

An exception applies to a new employer that comes into existence after October 1 of the year that the SIMPLE IRA Plan is being established. For these employers, the SIMPLE IRA Plan can be established after the business is established, but must be done as soon as administratively feasible.

 

Employer That Previously had A SIMPLE IRA

 

If the employer (or a predecessor employer) previously had a SIMPLE IRA Plan, that employer may establish the SIMPLE IRA only with an effective date of January 1.

 

Choosing The SIMPLE Agreement

The type of SIMPLE IRA Plan agreement that is chosen if often determined by what is available at the financial institution with which the employer establishes the SIMPLE IRA Plan, as most financial institutions offer only one type of SIMPLE IRA Plan agreement. For instance, if the employer wants to use a financial advisor that offers SIMPLE IRA Plans through Custodian ABC, then the employer would be required to use the SIMPLE IRA Plan agreement offered by Custodian ABC. However, will first determine the type of SIMPLE IRA Plan agreement they want to use, and then look for a financial institution that uses that agreement.  The key features of each are as follows:

 

  • Prototype SIMPLE IRA Plan Document :A financial institution may design its own SIMPLE IRA Plan agreement and obtain approval of the form from the IRS. The prototype document may include the features of either the Form 5304 SIMPLE or the Form 5305-SIMPLE (see below), or a combination of both. A combination feature can allow the financial institution to serve as designated financial institution for some employers, instead of for all employers who uses their SIMPLE IRA plan document. In addition, the prototype SIMPLE IRA Plan agreement may include flexibility of employee-eligibility features that are not available under the IRS Model Forms.

 

  • Form 5304-SIMPLE (Not Subject to the Designated Financial Institution Rules):The Form 5304-SIMPLE is the IRS model form that may be used by an employer to establish a SIMPLE IRA Plan that does not use a Designated Financial Institution (DFI). When using the Form 5304-SIMPLE, the employer must allow employees to choose the financial institution with which they want to maintain their SIMPLE IRAs and receive contributions. As a result, the employer can find that he is required to write several checks when sending SIMPLE contributions to his employee’s SIMPLE IRAs. A financial institution may design its own SIMPLE IRA Plan agreement and obtain approval of the form from the IRS. The prototype document may include the features of either the Form 5304 SIMPLE or the Form 5305-SIMPLE (see below), or a combination of both. A combination feature can allow the financial institution to serve as designated financial institution for some employers, instead of for all employers who uses their SIMPLE IRA plan document. In addition, the prototype SIMPLE IRA Plan agreement may include flexibility of employee-eligibility features that are not available under the IRS Model Forms.
 
  • Form 5304-SIMPLE (Not Subject to the Designated Financial Institution Rules): The Form 5304-SIMPLE is the IRS model form that may be used by an employer to establish a SIMPLE IRA Plan that does not use a Designated Financial Institution (DFI). When using the Form 5304-SIMPLE, the employer must allow employees to choose the financial institution with which they want to maintain their SIMPLE IRAs and receive contributions. As a result, the employer can find that he is required to write several checks when sending SIMPLE contributions to his employee’s SIMPLE IRAs. 
 
  • Form 5305-SIMPLE (for Use With a Designated Financial Institution): The Form 5305-SIMPLE is the IRS model form used by an employer that establishes a SIMPLE IRA Plan with a financial institution that is a DFI. When using the Form 5305, the employer may require that all SIMPLE contributions under the SIMPLE IRA Plan be made to SIMPLE IRAs at a particular financial institution instead of making SIMPLE IRA Plan contributions to the financial institution selected by each eligible employee. This may be an attractive feature for an employer that does not want to prepare several checks for deposits at different financial institutions, and would instead prefer to write one check to one financial institution with a breakdown of how the contributions should be allocated to each participant’s SIMPLE IRA. In order for these rules to apply, the following requirements must be met:
 
  1. the employer and the financial institution must agree that the financial institution will be a designated financial institution for the SIMPLE IRA Plan;
  2. the financial institution must agree that if the participant requires a transfer,  the participant’s balance will be transferred without cost or penalty to another SIMPLE IRA (or, after the 2-year period to any IRA) at a financial institution selected by the participant; and
  3. each participant must be given written notification describing the procedures under which the participant’s balance would be transferred without cost or penalty to another SIMPLE IRA (or, after the 2-year period, to any IRA) at a financial institution selected by the participant, if the participant requests a transfer.
 
A participant who elects to have amounts transferred to a financial institution would need to maintain at least two SIMPLE IRAs. One at the DFI to which SIMPLE IRA contributions would be made, and another at the financial institution to which he wants the asset to be transferred. This could mean paying multiple account maintenance or administrative fees. The account at the other financial institution should only receive rollovers and transfers from other SIMPLE IRAs.
 
 
Example 1:
Employer B establishes a SIMPLE IRA Plan with Custodian ABC. Employer B and Custodian ABC L agree that Custodian ABC will be a DFI. Custodian ABC agrees that, if a participant so requests, it will transfer the participant’s balance without cost or penalty to another SIMPLE IRA (or, after the 2-year period to any IRA) at a financial institution selected by the participant.
A SIMPLE IRA is established for each participating employee of Employer B at Custodian ABC.
Each participant is provided with a written description of how and when the he may transfer his balance without cost or penalty to another financial institution of his choice.
Custodian ABC is a DFI, and Employer B may require that all contributions on behalf of all eligible employees be made to SIMPLE IRAs at Custodian ABC.
 
Example 2:
Employer C invites Custodian ABC to make a presentation on its investment options for
SIMPLE IRAs to Employer C’s employees. Each eligible employee receives notification that the employer must permit the employee to select which financial institution will serve as the trustee of the employee’s SIMPLE IRA.  All eligible employees of Employer C voluntarily select Custodian ABC to serve as the trustee of the SIMPLE IRAs to which Employer C will make all contributions on behalf of the employees.
Custodian ABC is not a DFI merely because all eligible employees of Employer C selected Custodian ABC to serve as the trustee of their SIMPLE IRAs and Employer C consequently makes all contributions to Financial Institution M. Therefore, Custodian ABC is not required to transfer SIMPLE IRA balances without cost or penalty.
 
Example 3:
Assume the same facts as Example 2, except that Employee X and Employee Y, who made salary reduction elections, failed to establish SIMPLE IRAs to receive SIMPLE IRA Plan contributions on their behalf before the first date on which Employer C is required to make a contribution to their SIMPLE IRAs. Employer C establishes SIMPLE IRAs at Custodian ABC for these employees and contributes the amount required to their accounts. Custodian ABC is not a DFI merely because Employer C establishes SIMPLE IRAs on behalf of Employee X and Employee Y while all other employees voluntarily select Custodian ABC to serve as the trustee of the SIMPLE IRAs to which Employer C will make contributions on their behalf.
 
 
Limiting the No-Penalty Transfers
While a DFI must allow a participating employee (participant) to transfer his balance without cost or penalty, the DFI may place limitations on time and manner in which the transfer can occur under the cost-penalty free rules, by allowing the participant to transfer the balance within a reasonable period of time each year. If the transfer occurs after the expiration of the reasonable time period, then the DFI can apply fees and penalties. The participant is considered to have been given a reasonable time within which to complete the transfer on a no-cost or penalty basis, if he is has until the end of the 60-day period for each calendar year to transfer his SIMPLE IRA contributions for the calendar year following the 60-day period. For employees who become eligible to participant in the plan during the year, the balance for that year must be allowed to be transferred cost and penalty-free.
 
If the DFI places limitations on the time within which the transfer can occur without cost or penalty, the time limitation must be explained in the written notification to the participant that explains the procedures under which the transfer can occur without penalty. If the summary description requirement is being satisfied by providing a completed copy of pages one and two of Form 5305-SIMPLE, Article VI (Procedures for Withdrawal) must contain a clear explanation of the limitation.
 
 
Example 1:
Employer A first establishes a SIMPLE IRA Plan effective January 1, 2008, and intends to make all contributions to Custodian ABC, which has agreed to serve as a DFI. For the 2008 calendar year, Employer A provides the 60-day election period [1]beginning November 2, 2007, and notifies each participant that he may request that his balance attributable to future contributions be transferred from Custodian ABC to a SIMPLE IRA at a financial institution that the participant selects. The notification states that the transfer will be made without cost or penalty if the participant contacts Custodian ABC prior to January 1, 2008. For the 2008 calendar year, the DFI rules will not be violated merely because participants are given only a 60-day period in which to request to transfer their balances without cost or penalty.
 
Example 2:
Assume the same facts as Example 1.
Participant X does not request a transfer of her balance by December 31, 2007, but requests a transfer of her current balance to another SIMPLE IRA on July 1, 2008.
Participant X’s current balance would not be required to be transferred without cost or penalty because Participant X did not request such a transfer prior to January 1, 2008.
However, during the 60-day period preceding the 2009 calendar year, Participant X may request a transfer, without cost or penalty, of her balance attributable to contributions made for the 2009 calendar year and, if she so elects, for all future calendar years (but not her balance attributable to contributions for the 2008 calendar year).
 
Example 3:
Assume the same facts as Example 1. Under the terms of the SIMPLE IRA Plan, Participant Y becomes an eligible employee on June 1, 2008, and, for Participant
Y, the 60-day period described in Q&A E-1 begins on that date. For the 2008 calendar year, Participant Y will be deemed to have been given a reasonable amount of time in which to request to transfer, without cost or penalty, his balance attributable to contributions for the balance of the 2008 calendar year if Financial Institution M allows such a request to be made prior to July 31, 2008.
 
 
Limit of Frequency of no Penalty Transfers
 
In addition to placing time limits on when the transfer can be made on a no-fee no penalty basis, the participant can be limited to having these transfers done only on a monthly basis, or less frequent.
 
Definition of Fees and Penalties
 
For the purpose of this section, cost and penalties include those relating to liquidation, transaction, redemption or termination fees, and any commission, load (whether front-end or back-end) or surrender charge, or similar fee or charge. The participant can be limited to one investment from which the transfer can be transfer cost/penalty free. In such cases, the participant would be required to keep the assets in that investment until the transfer is completed. The participants remaining balance can be invested in other assets available under the plan.
 
Example 1:
Custodian B agrees to be a DFI for the SIMPLE IRA Plan maintained by Employer D.
Employer D provides the 60-day election period described in Q&A E-1 beginning on November 2 of each year and each participant is notified that he may request a transfer of future contributions from Custodian B without cost or penalty at a financial institution selected by the participant, before the end of the 60-day period. The notification states that a participant’s contributions that are to be transferred without cost or penalty will be invested in a specified investment option and will be transferred to the financial institution selected by the participant on a monthly basis.
 
Custodian B offers various investment options to account holders of SIMPLE IRA accounts, including investment options with a sales charge. Any participant who does not elect to have his or her balance transferred to another financial institution may invest the contributions made on his or her behalf in any investment option available to account holders of SIMPLE IRA accounts at Custodian B. However, contributions that a participant has elected to have transferred are automatically invested, prior to transfer, in a specified investment option that has no sales charge. The requirement that a participant’s balance be transferred without cost or penalty will not be violated merely because contributions that have been designated to be transferred as per the participant’s election are automatically invested in one specified investment option and transferred on a monthly basis to the financial institution selected by the participant.
 
Example 2:
Assume the same facts as in Example 1.
Custodian B generally charges its IRA accounts a reasonable annual administration fee and also charges this annual administration fee with respect to SIMPLE IRA accounts, including SIMPLE IRA accounts from which balances must be transferred as per the participant’s request. The requirement that participant’s balances be transferred without cost or penalty will not be violated merely because a reasonable annual administration fee is charged to SIMPLE IRA accounts from which balances must be transferred in accordance with participants’ transfer elections.
 
 
Cost can be Passed on to Employer
Employers should be aware that the Custodian can charge the employer a fee that takes into consideration these no-cost/no-penalty transfers. If assessed, this fee must be charged directly to the employer and cannot pass through the participants’ SIMPLER IRAs. Employers should check with the financial institution and read the agreements carefully to determine whether they would be charged such amounts.
 
Deadline for Establishing the Participant’s SIMPLE IRA
 
The participants SIMPLE IRA must be established before the first day by which a contribution is required to be deposited to his SIMPLE IRA. In order to establish the SIMPLE IRA, the employee must complete the SIMPLE IRA Adoption agreement for the financial institution to which his SIMPLE IRA contributions will be made. The financial institution may also have additional documentation requirements, such as a ‘new account application form’ that must be completed by the employee. If the employee is unable or unwilling to complete the SIMPLE IRA adoption agreement, the employer may complete the agreement on his behalf.
 
Example 1:
John works for Company B and Company B adopted a SIMPLE IRA Plan on February 1, 2008. John did not elect to make salary deferral contributions to his SIMPLE IRA. Company B had elected to make a 2% nonelective contribution to eligible employees, and is required to deposit the 2% nonelective contribution by its tax filing deadline including extensions. Company B will be depositing the contributions on March 31, 2009. Since no SIMPLE IRA contributions will be deposited to John’s SIMPLE IRA before March 31 2009, his SIMPLE IRA need not be established until March 30, 2009
 
Example 2:
The facts are the same as in Example 1, except that Company C elected to make a 3% matching contribution. Since John will not receive a matching contribution (there is no salary deferral to match), a SIMPLE IRA should not be establish for John. Establishing a SIMPLE IRA for John may only mean paying account administrative fees for a zero balance account.
 
Example 3:
Mary also works for Company B. However, she chose to make salary deferral contributions to the SIMPLE IRA Plan beginning March 1, 2008. As SIMPLE IRA salary deferral contributions are required to be made to the financial institution ( with which the employee’s SIMPLE IRA is maintained) no later than the close of the 30-day period following the last day of the month to which the salary deferral applies, Mary’s SIMPLE IRA must be established by April 29, 2008. If the contributions are sent to the financial institution before the 30-day period, her SIMPLE IRA must be established at least one day before her SIMPLE salary deferral amount is delivered to the financial institution.
 
Employees establish their SIMPLE IRAs by completing the financial institution’s Model Form 5305-S, SIMPLE Individual Retirement Trust Account, or Form 5305-SA, SIMPLE Individual Retirement Custodial Account. The financial institution may also have their own prototype SIMPLE IRA agreement, which the participant would use instead of the IRS Model Forms. Form 5305-S are used with Trust accounts and Form 5305-SA are used with custodian accounts.
 
Financial institutions that use the IRS Model forms typically customize the forms by adding their names and logo, and adding their disclosure statements.
                                   
 
 
If The Employee Refuses to Establish a SIMPLE IRA

If an employee refuses to establish a SIMPLE IRA and the employer is require to make a SIMPLE IRA contribution for that employee, the employer may choose a financial institution on behalf of the employee and complete the documentation that is necessary to establish the SIMPLE IRA. Financial institutions may be hesitant to establish a SIMPLE IRA without the receiving the necessary authorization and documentation from the employee. However, they may be willing to make an exception to their policies and procedures if the employer provides a written explanation of the circumstances, and information/ documentation that would provide proof of identification of the employee.
 
 
Calendar Year-Only Plan
SIMPLE IRA Plans must be maintained on a calendar year basis. As such, determining employer eligibility to establish the plan, and taking deductions for contributions to the plan are determined on a calendar year basis.
 
Steps for Establishing the SIMPLE IRA Plan
An employer who wants to establish a SIMPLE IRA for his business may follow these simple steps:
 
Ø Check to make sure the business is eligible to adopt a SIMPLE IRA
Ø Determine the type of SIMPLE IRA Plan agreement he wants to use. One key determining factor is whether writing several checks each month, instead of one check each month would be an issue
Ø Contact a financial professional or financial institution to discuss their SIMPLE IRA product, and determine if they offer the SIMPLE IRA that he prefers. In some cases, this may be the first step if the employer prefers to stay with a particular financial institution or financial advisor
Ø Complete the Form 5304-SIMPLE, Form 5305-SIMPLE or the prototype SIMPLE, whichever one will be used to establish the SIMPLE IRA Plan
Ø Provide the required notification to employees
 
If an employee chooses to establish his SIMPLE IRA at another financial institution, the employer may need to provide that employee with a copy of the SIMPLE IRA Plan agreement, as it may be required by that other financial institution to establish the employee’s SIMPLE IRA.
 
Employers Tax Credit
An employer may be able to claim a tax credit of 50% of expenses incurred for administrative expenses and for educating participants about the SIMPLE IRA Plan, if the plan is a new SIMPLE IRA, and the employer did not maintain another plan that covered the same employees that would be covered under the SIMPLE at anytime during the three years preceding the for which the credit can be claimed.  
 
The dollar amount  for this credit is limited to $500, and can be claimed for three years[2]. In order to be eligible for this credit, the employer must have had had no more than 100 employees who received at least $5,000 of compensation from the employer for the preceding year.
An eligible employer who satisfies the requirement for one year and who fails to be an eligible employer for any subsequent year is given a grace period for the two years following the last year the employer was an eligible employer, except in cases where the failure to satisfy the requirement is due to a any acquisition, disposition, or similar transaction involving the eligible employer.
 


[1]described in Q&A E-1
[2] IRC § 45E