Hidden in the flurry of activity on Capitol Hill two weeks ago was passage of the Small Business Job Protection Act. The measure creates a new retirement plan for small businesses called a savings incentive match plan, or Simple. The President supports the legislation and is expected to sign it into law soon.
Congress designed the incentive plan to appeal to small businesses that want to offer a 401(k) plan to their employees but find the product's appeal limited because of the technical and reporting requirements involved. The new plan addresses many of the concerns small businesses have with 401(k) plans and provides an alternate salary deferral plan.
The explosive growth and popularity of 401(k) plans may transfer to Simple, making it potentially lucrative for banks.
The new product works like a 401(k) plan. Under Simple, employees may defer into the plan a percentage of their pretax compensation, up to $6,000; 401(k) plans allow deferrals up to $9,500.
An employer places all contributions directly into the individual retirement accounts of its employees - a significant difference from 401(k) plans, in which contributions are made into a trust. This may present an opportunity for banks, as they already serve as custodians or trustees of IRAs.
Although at this point it is too early to be certain, it appears that the documentation and administration of IRAs receiving Simple contributions will require only slight modifications from today's IRA. In other words, it may not be too difficult for banks to offer Simple to their small-business customers even if the banks do not currently offer 401(k) plans.
As with any tax-driven retirement plan, additional rules exist. Simple is available only to businesses with 100 or fewer employees. Once an employer establishes a Simple, it must allow participation by all employees to whom it paid at least $5,000 in compensation from the employer during each of the previous two years and who are reasonably expected to receive $5,000 during the current year. Simple further requires a plan document and disclosure statements. No vesting schedules are allowed under a Simple: contributions must be 100% vested immediately.
The Achilles' heel of Simple may be its required employer match.
The employer must match an employee's contributions on a dollar for dollar basis up to 3% of the employee's annual compensation. An employer may elect a lower match than 3% for certain years, but never less than 1%. The employer may not elect a match lower than 3% more than twice in a five year period.
No matching contribution is required if the employer instead makes a 2% contribution to all employees eligible to participate in the Simple. This alternative, however, may cost the employer more than the match.
Many small businesses are not in a position to provide a match or make any other employer contributions. This requirement, more than any other, may limit the plan's popularity.
Employees, for their part, generally must follow IRA distribution rules when contributing to a Simple. A severe penalty exists for early withdrawal of contributions made to a Simple. During the first two years an employee participates in a Simple, the penalty for premature distributions is 25% instead of the normal 10% for IRAs.
As you may already have concluded, Simple does not quite live up to its name. Nonetheless, it is easier to establish and administer than a 401(k) plan. Simple manages to avoid many of the requirements associated with 401(k) plans, such as the filing of Internal Revenue Service determination letters and IRS Form 5500s, top-heavy and nondiscrimination testing, and the setting up of a trust for the assets.
Simple also improves upon the plan it is to replace, the salary reduction simplified employee pension plan. The latter never gained widespread popularity.
It is limited to employers with 25 or fewer employees and subject to nondiscrimination testing and top-heavy testing - both of which are burdensome for small employers. Additionally, no match is allowed. Simple avoids these problems.
In an interesting twist, the Small Business Job Protection Act extends the idea of Simple to traditional 401(k) plans. A 401(k) plan adopting many of the provisions of Simple will avoid some of the required 401(k) testing.
Simple is to become available Jan. 1. This allows bankers a couple of months to consider the market and develop strategies for the new plan. Because Simple is somewhere between a 401(k) plan and a Simplified Employee Pension plan, determining where in the bank it should be assigned is difficult. It may belong in the deposit area along with IRAs and SEPs, or it may belong more in the employee benefits area along with 401(k) plans. In any case, Simple represents a new product opportunity that bankers must review in the very near future.
Mr. Johnson serves as legal counsel for the retirement plan services division of Bankers Systems Inc., St. Cloud, Minn.
