How Simple is that Simple Retirement Plan, Really?

Date: March 23, 2015

Small employers with less than 100 employees may opt to install a “SIMPLE” IRA Plan or a Simplified Employee Pension Plan (SEP) as an alternative to a traditional qualified retirement plan such as a profit sharing plan or 401(k) plan.  The benefits of the arrangements are meaningful – there is no required discrimination testing, no annual reporting, and no lengthy plan document required to be adopted, but, by establishing such a plan, a small employer can provide a meaningful retirement benefit to employees and a business owner can shelter income from current taxes. 

However, along with the lack of administrative requirements comes a lack of oversight and guidance – the financial institutions that custody the funds the employer and employees contribute generally do not actively advise the employers who sponsor the plans or check to ensure that the plans are being administered correctly.  Failure to administer the programs correctly could result in loss of the tax benefits of the arrangements and the assessment of penalties by the Internal Revenue Service.  

Following are some of the frequent issues confronted by sponsors of these arrangements.

Are the plan documents current?  The Internal Revenue Service periodically updates the forms by which SIMPLEs and SEPs are established.  The Forms 5304 and 5305-SIMPLE were most recently updated in March of 2012 and the Form 5305-SEP was most recently updated in December of 2004.  Is your plan set forth on the most recent form?  Could you find your plan document if asked to produce it?  

Are you offering participation to the correct employees?  The different plans have different participation requirements.  A SEP can limit participation to employees who are at least age 21 and who have performed service for three of the last five years.  However, there are no minimum hours of service an employee must work during those three years.  For example, if an individual worked during summer breaks from school for three years, then becomes a full time employee in the fourth year, that employee would be immediately eligible to participate in the SEP.  Furthermore, the years during which service is performed do not have to be consecutive.  A SIMPLE plan generally may only exclude employees who earn less than $5,000 per year and who earned at least $5,000 during each of the last two years.  Note:  eligibility requirements can always be less stringent than the maximum age and service requirements imposed by the IRS.  But, the eligibility provisions set forth in the plan document need to be followed.

Are you contributing enough money to the plan?  SEP contributions are discretionary to the employer and a different amount (or no contribution) can be made each year.  However, all eligible employees are entitled to a contribution, including those employees who terminate employment during the year.  A uniform percentage of pay must be contributed for each participant.  The employer's contributions to the SIMPLE plan are specified in the Form 5305-SIMPLE and are set forth as a matching contribution on participants' contributions or a 2% “nonelective” contribution.  

Did you contribute too much money to the plan?  The maximum contribution to the SEP is the smaller of $53,000 (for 2015) or 25% of pay.  Only the first $265,000 (for 2015) of pay can be taken into consideration.  Contributions to SIMPLE plans can take the form of matching contributions or nonelective contributions, not both, in the percentages specified in the Form 5305-SIMPLE.

If errors have been made in the administration of your SEP or SIMPLE plans, the IRS sponsors correction programs to address the issues.  However, securing ongoing guidance and review of the plan's operations by a retirement plan professional will go a long way towards avoiding having to correct errors.