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9 SIMPLE IRA Rules You Need to Know

SIMPLE IRAs are tax-favored retirement plans that are popular with people running their own small businesses, whether by themselves or with employees.

One selling point of SIMPLE IRAs is that they are simple to open, contribute to, and maintain. However, they have their own set of rules. If you have a SIMPLE IRA or are planning to set up a SIMPLE IRA, make sure you know these requirements.

You must meet the deadlines for setting up and funding a SIMPLE IRA plan
SIMPLE IRAs have an earlier deadline than some other types of retirement plans, including traditional IRAs. A SIMPLE IRA must be generally be established by Oct. 1 of the tax year, though if you start a business after Oct. 1, you can open a SIMPLE IRA that year so long as you do it as soon as "administratively feasible," per the Internal Revenue Service.

If you've had a SIMPLE IRA in the past, you can set up a new SIMPLE IRA plan effective only on Jan. 1 of a calendar year.

You have more time, however, to actually fund a SIMPLE IRA. The deadline for funding it is your business's income tax return deadline, including extensions.

More than 100 employees? You may be out of luck
When you establish the SIMPLE IRA, you can have no more than 100 employees who received $5,000 or more in compensation during the preceding calendar year. When you're counting employees, include everyone employed at any time during the calendar year -- even employees who haven't met the plan's eligibility requirements.

Don't ditch the plan the instant you hire Employee No. 101, however: If you already have a SIMPLE IRA plan and you satisfy the 100-employee limitation in a given calendar year, you are considered to meet the limitation for the following two years, as well.

SIMPLE IRAs are strictly calendar-year vehicles
You must maintain a SIMPLE IRA on a calendar-year basis, not by a fiscal year. If your business uses a fiscal tax year and makes contributions during its fiscal year, the business deducts SIMPLE IRA contributions in the tax year within which the company's fiscal year ends. 

The amount you and your employees can contribute through salary reductions is limited
You can contribute considerably more to a SIMPLE IRA than to a regular IRA. The salary reduction contribution limit to a SIMPLE IRA is $12,000 for 2014. If you're age 50 or older at the end of the year, add a $2,500 "catch-up" contribution to your annual limits.

You may have to make employer contributions to a SIMPLE IRA
Employers make contributions to SIMPLE IRAs in one of two ways:

  • Employer matching contributions. If you have employees who earn $5,000 or more per year, you may be required to contribute to their plan. In normal years, you match employee contributions up to 3% of their compensation, although if you notify your employees within a timely manner, you may choose to contribute as little as 1% of employee compensation for no more than two years out of the most recent five-year period.

  • Nonelective contributions. Instead of matching your employees' contributions, you may choose to make contributions regardless of whether each employee contributes to the plan. You can make nonelective contributions of 2% of each employee's eligible compensation.

You must open a SIMPLE IRA at an authorized financial institution
You have a wide choice of where to establish a SIMPLE IRA. You can choose from institutions including banks, savings and loan associations, insurance companies, certain regulated investment companies, federally insured credit unions, and brokerage firms.

Your SIMPLE IRA must generally be the only plan you maintain
You'll want to keep a SIMPLE IRA as your company's only retirement plan when you intend to contribute to it. If any of your employees participates in, or receives a benefit from, another plan during the calendar year, you generally cannot contribute to a SIMPLE plan.

There are two exceptions to this rule:

  • Collective bargaining agreement for some employees. You can still contribute to a SIMPLE IRA if you have employees participating in another plan, granted that the other plan is for employees covered under a collective bargaining agreement and the SIMPLE IRA plan excludes these employees.

  • Recent business acquisition or disposition. This exception applies if your business was part of an acquisition, disposition, or similar transaction this year or during the prior two years. Only your employees who are not part of the acquisition or disposition may participate in the SIMPLE IRA.

You must contribute to a special account
Contributions must go to a SIMPLE IRA. You or your employer cannot put them into your existing IRA.

You may be penalized if you make early withdrawals
If you take money from your SIMPLE IRA before you reach age 59-1/2, you may have to pay a 10% penalty on the withdrawal. This is in addition to any income tax on the amount you withdraw.

You do not have to pay a 10% penalty for withdrawals made in the following circumstances:

  • To correct a mistake
  • To undo contributions from a plan with auto enrollment features
  • To withdraw contributions before the extended due date of the return
  • To cover qualified higher-education expenses
  • As a qualified first-time home-buyer (up to $10,000)
  • To pay health insurance premiums while unemployed
  • To pay medical expenses that exceed 10% of your adjusted gross income (7.5% if age 65 or higher)
  • If you take the withdrawals in a series of substantially equal payments based on your life expectancy and calculated using IRS rules.
  • To pay an IRS levy of the plan
  • When you make certain withdrawals as a qualified military reservist called to active duty
  • As part of a rollover to another retirement plan or other IRA, within 60 days
  • When you are totally and permanently disabled
  • After the participant or IRA owner dies

A SIMPLE IRA is a convenient way to set up a retirement plan for yourself and your employees, if you have them. Knowing the rules can help you determine whether it's the right plan for your business and avoid breaking the tax rules as you and your employees contribute to the plan.

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Sally Herigstad
Herigstad

Sally is a new Fool contributor for 2014, but a long-time personal finance writer, columnist, and certified public accountant. Sally wrote "Help! I Can't Pay My Bills" for St. Martin's Griffin.

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