Self-employed taxpayers or employees who in addition to their traditional job have "side businesses" or outside income should consider the SIMPLE IRA (Savings Incentive Match Plan for Employees) retirement plan.  Though not as popular as its cousins the 401(k), the traditional IRA, or even the SEP (Simplified Employee Pension), the SIMPLE IRA retirement, hereafter SIMPLE, has compelling advantages for many taxpayers.

The SIMPLE IRA is a low-maintenance retirement plan that offers many features of the more common 401(k) without the complexity, administrative burden and increased administration costs.   The SIMPLE allows self-employed business owners or "side business owners" to defer up to a maximum of $6,500 a year (plus certain matching contribution amounts) from their net business earnings.  In other words, if the taxpayer makes a $6,500 SIMPLE contribution, he can deduct $6,500 from his adjusted gross income. The investment choices within the SIMPLE, which are almost endless, grow tax deferred.  At withdrawal, the distributions are taxable.

Small business owners with employees have a multitude of retirement plan options available, but should still consider the benefits of a SIMPLE.  This article will focus on taxpayers with self-employment income who do not have employees.  If you are considering implementing a SIMPLE IRA for this year, the deadline is October 1, 2001.

THE IDEAL SIMPLE CANDIDATE

The ideal candidate for a SIMPLE is a self-employed individual who makes less than $35,000 and has the financial resources available to maximize retirement plan contributions.  With a SIMPLE, the maximum contribution would be $7,470 ($6,500 elective deferral portion plus a matching contribution of $970) which is greater than the maximum amount allowed with a SEP or a combination Keogh plan.  The following is an illustration:

Assume an individual earns $10,000 in consulting income during the year.  After accumulating his business expense deductions of $3,000, the individual has net taxable business income of $7,000.  If the individual has established a SIMPLE IRA, he or she can make a tax deferred contribution of $6,500.  Because the SIMPLE is a matching contribution plan, our individual chooses to make a matching contribution of 3% (the highest matching percentage available) to maximize his or her contribution.  The matching contribution for our individual is $194.  The matching contribution is computed by taking the net business income multiplied by .9235 multiplied by 3% ($7,000 x .9235 x 3%).  The total tax-deductible SIMPLE contribution on $7,000 of net business income would be $6,694 ($6,500 plus $194).

Effective January 1, 2002, the newly introduced one-person 401(k) plan is in a league of its own.  It offers the biggest potential benefits for one-person businesses with no employees.  It also has the same limitations discussed below.

SIMPLE LIMITATION

The current maximum contribution to a 401(k) or 403(b), which includes SRA contributions, in tax year 2001 is $10,500. For individuals who are already making contributions to a 401(k) or 403(b) retirement plan through their work, the maximum allowable contribution to the SIMPLE will be reduced by any elective tax deferred contributions made to the other plans.  That is to say, if our individual had contributed $7,500 to his 401(k) or 403(b) plan at work, he would be only able to contribute $3,000 to the SIMPLE instead of $6,500 ($7,500 + $3,000 = $10,500).  The benefits of the SIMPLE are gradually reduced to zero once an individual has made the maximum contributions to their 401(k) or 403(b) plans at work.  In these instances, the individual should consider other alternatives to the SIMPLE.

GETTING STARTED

Participants must choose a SIMPLE IRA plan provider.  Many mutual fund companies such as Fidelity, TIAA-CREF, Vanguard, T. Rowe Price and most other major companies along with banks and insurance companies offer the plan.  Administrative plan fees can range from $25-$40 a year per participant.  The highest administrative fee we have seen is at $350 a year.  To establish a SIMPLE IRA, the participant must sign an adoption agreement, which outlines the plan provisions.

Effective for tax years beginning in 2002, The Economic Growth and Tax Relief Reconciliation Act of 2001 provides additional "catch-up"  provisions for taxpayers who are 50 years and older.  The maximum amount of SIMPLE contributions under these new provisions is:

2002        $  7,500
2003        $  9,000
2004        $10,500
2005        $12,500
2006        $12,500
2007        $12,500
2008        $12,500

OTHER HIGHLIGHTS YOU SHOULD CONSIDER

SIMPLES aren't for everyone, but they are my favorite retirement plan for many taxpayers.  It is worthwhile to considered their benefits and evaluate their appropriateness for your situation.  For additional information about SIMPLE plans, I recommend the web site, www.troweprice.com.