Roth and Simple IRAs

With the 1997 Taxpayer Relief Act, Congress created the ‘Roth IRA.’ This offers significant opportunities for some. One form is a rollover from a traditional IRA. The amount is taxable in the year of rollover. In which case it is often best to rollover the entire amount and then pay the tax from other funds.

The other Roth IRA format is to make a contribution of up to $6,000 per year (2019 limit) - on a non-deductible basis. Also, a $1,000 catch-up contribution may be made for those aged 50+.

The major advantage of the Roth IRA is that the income will be tax-free when withdrawn, after the later of 5 years or 59 1/2. For some, the later tax savings are justification for the higher tax payment now.

The 1996 Tax Law established a new simplified retirement plan for small businesses called the Savings Incentive Match Plan for Employees (SIMPLE) retirement plan. The SIMPLE plan may be either an IRA for each employee or a 401(k) salary deferral plan, and may be adopted by employers having no other plan and employing 100 or fewer employees earning at least $5,000 in during the previous year.

With a SIMPLE plan in IRA form, participating employees may elect to contribute up to $13,000 per year to an IRA (for 2019 to be increased in future years). Also, a $3,000 catch-up contribution may be made for those aged 50+. The employer generally must match employee elective contributions dollar-for-dollar up to 3% of the employee’s compensation, although a lower match (not less than 1%) can be elected (in no more than two of any five years). Alternatively, the employer may elect, in lieu of making matching contributions, to make a 2% of compensation non-elective contribution on behalf of each eligible employee with $5,000 in annual compensation.

Contributions to a SIMPLE account are generally deductible by the employer and are excludable from the employee’s income. Distributions are taxed to the employee under the IRA rules, except that an increased additional tax on early withdrawals (25%) applies to distributions within two years of the employee’s first participating in the SIMPLE plan. Tax free rollovers may be made from one SIMPLE account to another. The plan must allow all eligible employees to participate.

Self-employed individuals may also participate in a SIMPLE plan. Like other 401(k) plans, the SIMPLE 401(k) plan allows employees to elect to defer a portion of their pay to the plan on a pre-tax basis. Employees’ salary deferrals and any investment earnings on the deferrals are not taxed until distributed. A SIMPLE 401(k) plan is automatically considered to satisfy the tax law’s special nondiscrimination rules applicable to 401(k) plans if it is the only qualified plan sponsored by the employer, and: (1) employees’ elective deferrals are limited to no more than $13,000 (2019), (2) the employer matches employees’ elective deferrals up to 3% of compensation (or, alternatively, makes a 2%-of-compensation non-elective contribution on behalf of all eligible employees with at least $5,000 in compensation), and (3) no other contributions are made to the arrangement. Under this safe harbor, all the contributions have to be 100% vested and the employer cannot reduce the matching percentage below 3% of compensation

Withdrawals prior to age 59 1/2 may be subject to penalties and taxes on some plans.

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