What Is a 408(p) SIMPLE Plan and How Does It Work?

A 408(p) SIMPLE Plan is a retirement savings option designed to help small businesses offer employees an efficient way to save for the future. It is appealing due to its straightforward administration, avoiding the complexity of larger retirement plans.

This article explores the key aspects of a SIMPLE Plan, including setup, employer and employee responsibilities, contributions, and tax implications.

Plan Setup Steps

Setting up a 408(p) SIMPLE Plan begins with selecting a financial institution to serve as the plan’s trustee. This institution manages the plan’s assets and ensures compliance with IRS guidelines. Employers typically choose between banks, insurance companies, or other financial service providers, depending on their service offerings and investment options.

After selecting a trustee, the employer drafts a written plan document detailing the plan’s terms, such as eligibility criteria and contribution formulas. Employers can use IRS Form 5304-SIMPLE or Form 5305-SIMPLE, depending on whether employees can select their own financial institutions. These forms must be completed and signed to officially establish the plan.

Employers must notify eligible employees about the plan, including its features, employee rights, and contribution limits. For 2024, the employee deferral limit is $15,500, with a $3,500 catch-up contribution for those aged 50 and over. This notification must be provided annually, typically before the 60-day election period begins.

Employer Requirements

Employers must ensure their business qualifies as a small employer, defined as having 100 or fewer employees who earned $5,000 or more in the previous year. This qualification is reviewed annually.

Employers are also responsible for providing timely notifications about the plan, including annual updates at least 60 days before the election period. Additionally, employee deferrals must be deposited into the plan promptly—no later than 30 days after the end of the month in which they were withheld. Employer contributions, whether matching or non-elective, must be deposited by the due date of the employer’s tax return, including extensions.

Employee Participation Criteria

Employees must meet eligibility criteria to participate. Typically, employees must have earned at least $5,000 in compensation during any two preceding years and be expected to earn $5,000 in the current year. Employers may choose less restrictive criteria but cannot impose stricter conditions.

Eligible employees determine how much of their salary to defer into the SIMPLE Plan, up to the annual limit of $15,500 for 2024, with an additional $3,500 allowed for those aged 50 and over. SIMPLE Plans offer immediate vesting, meaning employees fully own their contributions and any employer contributions immediately.

Contributions

Contributions to a 408(p) SIMPLE Plan involve both employees and employers. There are three types of contributions: elective deferrals, employer matching contributions, and non-elective contributions.

Elective Deferrals

Elective deferrals are employee contributions made by deferring a portion of their salary, up to the IRS annual limit. For 2024, the deferral limit is $15,500, with a $3,500 catch-up contribution for employees aged 50 and over. These deferrals are pre-tax, reducing taxable income for the year. Employers must ensure these contributions are deducted and deposited promptly, following Department of Labor guidelines.

Employer Match

Employers match employee contributions dollar-for-dollar up to 3% of the employee’s compensation. This match is immediately vested, adding directly to the employee’s retirement savings. Employers may reduce the match to as low as 1% in two out of five years, with advance notice to employees.

Non-Elective Contributions

Instead of matching, employers can opt to make non-elective contributions of 2% of each eligible employee’s compensation, regardless of whether the employee makes deferrals. The contribution is based on the annual compensation limit, which is $330,000 for 2024. This approach ensures all eligible employees benefit from the plan.

Distributions and Rollovers

Distributions from a SIMPLE Plan are subject to ordinary income tax. Withdrawals before age 59½ may incur a 10% early withdrawal penalty, which increases to 25% if made within the first two years of participation. Exceptions to these penalties include qualified medical expenses, disability, or first-time home purchases.

After two years of participation, SIMPLE Plan funds can be rolled over into another qualified retirement plan, such as a traditional IRA or 401(k), without penalties or taxes. Rollovers made within the first two years can only transfer to another SIMPLE IRA to avoid penalties.

Tax Considerations

The 408(p) SIMPLE Plan offers significant tax benefits. For employees, contributions are pre-tax, reducing taxable income, though distributions are taxed as ordinary income. Proper planning is essential to prepare for tax obligations during retirement.

Employers benefit from tax-deductible contributions as a business expense under IRC Section 404. Additionally, the SECURE Act provides a tax credit of up to $5,000 per year for the first three years of establishing a SIMPLE Plan, further incentivizing small businesses to offer retirement benefits.