A pair of new IRA strategies.

• Author: Lizzio, Joseph P.

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...