SIMPLE IRA Plan. Davis & Graves CPA LLP Jerry Davis, CPA/PFS 700 N Main Gresham, OR jerryd@davisgraves.com

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1 Davis & Graves CPA LLP Jerry Davis, CPA/PFS 700 N Main Gresham, OR jerryd@davisgraves.com SIMPLE IRA Plan Page 1 of 11, see disclaimer on final page

2 SIMPLE IRA Plan What is it? If you're self-employed or own a small business, you may be able to establish a savings incentive match plan for employees (SIMPLE) IRA plan. A SIMPLE IRA plan is a salary reduction retirement plan for certain small businesses that is established in the form of employee-owned traditional individual retirement accounts (but with a higher contribution level). To qualify, you can't maintain another employer-sponsored retirement plan and must have no more than 100 employees who were employed in the past year and who earned at least $5,000. The SIMPLE IRA plan is funded with voluntary employee contributions and mandatory matching or nonelective contributions by the employer. Establishing such a retirement plan can provide you with a tax-advantaged way to save funds for your retirement; it may also help you attract and retain qualified employees. Tip: The SIMPLE IRA effectively replaces the SAR-SEP, which can only be used by employers who established a SAR-SEP before Tip: Even though government employers generally can't sponsor 401(k) plans they (along with tax-exempt employers) can sponsor SIMPLE IRA plans, as long as they meet the 100-employee test described above. How much can an employee defer? Eligible employees may defer up to $12,000 of their wages to the plan in 2013 ($11,500 in In addition, employees age 50 and older can make an additional "catch-up" contribution of $2,500 in 2012 and These limits are indexed for inflation. The employee contributions are excludable from the employees' income, although they are subject to payroll taxes under the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and Railroad Retirement Act (RRA). Definition of eligible employees Employees (including self-employed individuals) are eligible if they have earned at least $5,000 from the employer during any two preceding years (whether or not consecutive) and are expected to earn at least $5,000 in the current year. Eligibility does not depend upon an employee's age or how many hours the employee worked for the employer. However, employees don't have to be included if they are under a collectively bargained agreement where retirement benefits were the subject of good-faith bargaining. Nonresident aliens who receive no earned income from the employer from sources within the United States can be excluded as well. Tip: An employer may, at its discretion, lower the $5,000 threshold to include more employees. Must the employer contribute to the plan? As an employer, you must make either a matching contribution or a nonelective contribution every year that you maintain the plan using one of two contribution formulas. (No other employer contributions to the SIMPLE IRA plan are permitted.) A matching contribution must equal the amount (if any) that each employee chooses to contribute up to a maximum of 3 percent of the employee's annual compensation. Because the maximum employee deferral for 2013 is $12,000 ($14,500 if age 50 or older), your maximum employer matching contribution effectively is the lesser of $12,000 ($14,500 if age 50 or older) or 3 percent of the employee's compensation. You may reduce the 3 percent match to as little as 1 percent in any two of five consecutive years. (There are special employee notification requirements if you reduce the 3 percent contribution level.) There is no limit on the amount of employee compensation taken into account when applying this matching contribution formula. If you choose to make a nonelective contribution, you must make a contribution of 2 percent of annual compensation for each eligible employee, even for those employees who choose not to contribute to the plan. For this purpose, no more than $255,000 (in 2013, $250,000 in 2012) of an employee's annual compensation is taken into account. So Page 2 of 11, see disclaimer on final page

3 the maximum nonelective contribution for any employee in 2013 is $5,100 (2 percent times $255,000). Example(s): Assume Joe's Meat Market employs three employees: Mary, Kelly, and Sally. Each employee earns a different salary and contributes a different amount to the SIMPLE IRA plan. The following table demonstrates how much Joe's Meat Market would be required to pay under the matching and nonelective options. Employee Compensation Deferral Percentage Amount Deferred Match up to 3% of Pay Mary $65,000 10% $6,500 $1,950 $1,300 Kelly $10,000 0% $0 $0 $200 Sally $30,000 3% $900 $900 $600 Joe's Meat Market Total Contribution Tip: For more detailed information about SIMPLE IRAs, see IRS Publication 560. Quick comparison with SIMPLE 401(k) and traditional 401(k) $2,850 $2,100 Nonelective 2% of Pay Despite the similarities the SIMPLE IRA shares with the SIMPLE 401(k), there are significant differences between these two retirement vehicles. In particular, the SIMPLE 401(k) is more difficult to administer than the SIMPLE IRA and offers less flexibility. The following table shows some of the differences between traditional 401(k) plans, SIMPLE 401(k) plans, and SIMPLE IRAs. Table Comparison of traditional 401(k)s, SIMPLE 401(k)s, and SIMPLE IRAs: Traditional 401(k) SIMPLE 401(k) SIMPLE IRA Number of employees Any number of employees 100 or fewer employees earning at least $5,000 Maximum deferral $17,500 in 2013 ($17,000 in 2012) Required employer contribution Vesting schedule ADP/ACP discrimination testing? Roth contributions permitted? None, unless plan is top-heavy, or is a safe harbor plan, or includes qualified automatic contribution arrangement (QACA) For employer contributions only Yes (unless safe-harbor plan, or includes qualified automatic contribution arrangement (QACA)) $12,000 in 2013 ($11,500 in 2012) Dollar-for-dollar match up to 3% of pay, or 2% of pay for all eligible participants; pay for both limited to $255,000 in 2013 ($250,000 in 2012) No, all contributions 100% vested No Yes Yes No 100 or fewer employees earning at least $5,000 $12,000 in 2013 ($11,500 in 2012) Dollar-for-dollar match up to 3% of pay, or 2% of pay (up to $255,000 in 2013, $250,000 in 2012) for all eligible participants (3% of pay match may be reduced to as little as 1% in any two of five years) No, all contributions 100% vested No Page 3 of 11, see disclaimer on final page

4 Early withdrawal penalty 10% 10% 25% first two years of participation, then 10% Withdrawal of employee pre-tax contributions Restricted Restricted Unrestricted excludable employees under age 21 less than one year of service certain collectively bargained employees, nonresident aliens, and other classes of employees under age 21 less than one year of service certain collectively bargained employees, nonresident aliens, and other classes of employees employees who have not earned at least $5,000 in any 2 prior years, or who are not expected to earn at least $5,000 in the current year certain collectively bargained employees and nonresident aliens Federal reporting by employer May the employer have other plans? May the plan include an automatic contribution arrangement? Same as other qualified plans Same as other qualified plans Yes No No None Yes Yes Yes Are loans allowed? Yes Yes No Who can establish a SIMPLE IRA? If you have 100 or fewer employees and don't maintain another employer-sponsored retirement plan, you can establish a SIMPLE IRA whether you're self-employed or have a qualified small business. Self-employed If you are self-employed, with or without employees, you can set up a SIMPLE IRA for yourself and make contributions to the plan. You are considered to be self-employed if you are in business for yourself or you are a sole proprietor or partner. Self-employment income can include part-time work. If you receive a Form 1099-MISC for work you performed as an independent contractor, you probably have self-employment income. Qualified small business You may also set up a SIMPLE IRA if you have 100 or fewer employees who were employed at any time in the past year and who earned at least $5,000. The number of employees is figured on an aggregate calendar-year basis, rather than on an average daily basis. For instance, say you employed 97 employees earning over $5,000 in January. Two months later, 7 employees left and were replaced by 7 other employees receiving over $5,000. You would not qualify as a small employer. That's because you would have employed a total of 104 employees during the year who earned $5,000 or more. Tip: See Questions & Answers for more information about the 100-employee limit. Technical Note: The term "employer" includes corporations, partnerships, sole proprietorships, and other trades or businesses under common control (whether incorporated or not). For instance, if you operate both a computer rental agency and a computer repair business as sole proprietorships, the employees from both businesses would be counted together to determine if you have more than 100 employees. Page 4 of 11, see disclaimer on final page

5 Can't maintain another employer-sponsored retirement plan You may not set up a SIMPLE IRA if you maintain, during any part of the calendar year, any other employer-sponsored retirement plan (such as a 401(k) plan or a simplified employee pension plan) for which contributions are made or benefits are accrued for the calendar year. Tip: If you maintain a qualified plan for collective bargaining employees, you are permitted to maintain a SIMPLE IRA plan for other employees. What are some advantages of a SIMPLE IRA? The SIMPLE IRA plan is exempt from the nondiscrimination rules that usually govern qualified plans The SIMPLE IRA plan is not required to follow certain Internal Revenue Code rules that prohibit discrimination in favor of higher-paid workers. As a result, the following are true: A minimum number of employees is not required to participate in the plan The plan does not have to maintain a specific ratio of contributions by non-highly-compensated employees to contributions by highly compensated employees Top-heavy plan requirements do not apply Therefore, even if no employees want to contribute, you may establish a plan, contribute on your own behalf, and provide an employer matching contribution. You aren't required to file reports with the government Only the financial institution holding the IRAs is required to file reports with the government. You are required only to report employees' contributions on their W-2 forms. In addition, you must check the pension plan box on the employee's W-2. You have limited fiduciary responsibility Once your employees exercise control over the assets in their accounts, you are relieved of any fiduciary responsibility. An employee is considered to have exercised control when: The employee has made an affirmative election on how to invest the contributions (i.e., the employee has selected the financial institution for his or her SIMPLE IRA) The employee has rolled over the account to another SIMPLE IRA (for more details on when and how this can be done, see Questions & Answers), or The employee's SIMPLE IRA has been established for one year The contribution limit for a SIMPLE IRA is more than the amount allowed for a traditional IRA In 2013, an employee may make an elective contribution (expressed as a percentage of compensation unless you permit employees to express the contribution as a dollar amount) of up to $12,000 ($11,500 in 2012). For instance, an employee who earned only $12,000 in 2013 may contribute 100 percent of his or her income ($12,000) to the plan. This amount is significantly higher than the contribution limit for a traditional IRA. Employees age 50 or older may also make additional catch-up contributions of $2,500 in 2012 and Caution: An employee who has several jobs with different employers and participates in several plans can't make total elective deferrals in excess of $17,500 in 2013 ($17,000 in 2012) (plus allowable catch-up contributions). Elective deferrals to 401(k) plans, 403(b) plans, SIMPLEs, and SAR-SEPs are included in this overall limit, but deferrals to Section 457(b) plans are not. Page 5 of 11, see disclaimer on final page

6 Employer contributions can be flexible You can change your employer contribution annually. That is, each year, you can decide whether you want to provide a matching contribution or a nonelective contribution. The plan requires minimal paperwork The IRS has developed Forms 5304-SIMPLE and 5305-SIMPLE, which are model forms for setting up plans. These forms can also satisfy employer notification requirements (i.e., they can provide necessary information about the plan to your employees). Pretax dollars are contributed and grow tax deferred Whether you're making contributions for only yourself, or for yourself and your employees, your business can deduct contributions made to a SIMPLE IRA. The dollars invested are pretax dollars and accrue tax deferred. That means that your employees can exclude the contributions from their gross income. Rollovers are permitted Income-tax-free rollovers or direct trustee-to-trustee transfers can be made from one SIMPLE IRA to another SIMPLE IRA. Caution: A rollover from a SIMPLE IRA to a traditional IRA, another qualified plan, or a 403(b) plan or Section 457 plan can be made tax free only after you've participated in the SIMPLE IRA for at least two years. SIMPLE IRA plans may offer more protection from creditors than regular IRAs in the event of bankruptcy Funds held in a SIMPLE IRA plan are generally fully shielded from an employee's creditors under federal law in the event of the employee's bankruptcy. This is in contrast to traditional and Roth IRA funds, which are generally protected only up to $1,245,475 (as of April 1, 2013) under federal law (plus any amounts attributable to a rollover from an employer qualified plan or 403(b) plan). (Traditional and Roth IRAs may also have additional creditor protection under state law.) What are some drawbacks of establishing a SIMPLE IRA? You're required to make a contribution every year Even if your business is doing poorly in a given year, you must make a contribution (either matching or nonelective) to the plan. In contrast, some other retirement plans (e.g., a profit-sharing plan) can give you year-to-year discretion regarding whether you want to contribute and how much. Your employees are vested immediately Your employees do not have to be employed for a certain number of years before they have full ownership of employer contributions. In other words, employees are immediately 100 percent vested in employer contributions. Conversely, with a 401(k), you can require employees to remain employed for a certain period of time before they are fully vested in employer contributions. Tip: The SIMPLE IRA might not be a good choice if your goal is to induce employees to remain with your company. Furthermore, immediate vesting can be extremely costly if you have high turnover. You're not allowed to maintain any other employer-sponsored retirement plans In general, you can't maintain a SIMPLE plan if you maintain any other plan for which contributions are made or benefits are accrued for your employees during any part of the calendar year. Consequently, the SIMPLE IRA will not be the appropriate plan if you want to maintain two or more benefit plans, especially when you have groups of employees with different plan needs. Page 6 of 11, see disclaimer on final page

7 The annual employee deferral is limited Highly compensated employees and business owners who are hoping to save considerable money for retirement may find the annual deferral amount limiting. For instance, if you are a business owner earning $200,000 per year, your employee deferral is still limited to $12,000 in 2013 ($11,500 in 2012), or $14,500 if age 50 or older ($14,000 in 2012). Under certain other employer-sponsored retirement plans, in contrast, you might be able to contribute considerably more. Early withdrawals may result in significant penalties Distributions from a SIMPLE IRA are generally subject to the regular IRA rules. So, if you make a withdrawal before age 59½, you'll be subject to the 10 percent premature penalty tax (unless you meet one of the exceptions). Caution: If you make a withdrawal from a SIMPLE IRA before participating in the plan for two years, you may be hit with a 25 percent (rather than 10 percent) penalty tax for pre-age 59½ withdrawals. SIMPLE IRA plans may offer less protection from creditors than regular IRAs outside of bankruptcy Many states have enacted legislation specifically protecting IRA assets from creditors. These laws clearly apply to IRAs that an employee establishes outside of a SIMPLE IRA plan. However, there is some question whether these laws apply to SIMPLE IRAs. The reason for the ambiguity is that SIMPLE IRA plans are generally considered "pension plans" for purposes of the Employee Retirement Income Security Act of 1974 (ERISA). While SIMPLE IRA plans are exempt from most of ERISA's provisions, they are covered by ERISA's preemption rules. These rules preempt (that is, render inapplicable) all state laws that "relate to" ERISA plan benefits. It is possible, then, that state laws that provide SIMPLE IRA plans with protection from creditors are preempted by ERISA. If this is the case, then SIMPLE IRAs would be fully protected from creditors under federal law in the event of bankruptcy, but would have no protection from creditors under state law outside of bankruptcy. If creditor protection is important to you, be sure to consult a qualified professional before establishing a SIMPLE IRA plan. Note: if your SIMPLE IRA plan covers only you (or you and your spouse), then your plan is not subject to ERISA, and your SIMPLE IRA should be entitled to any creditor protection your state's laws provide. Tip: Qualified employer plans subject to ERISA generally provide full protection from an employee's creditors, regardless of whether the employee has filed for bankruptcy. How do you establish a SIMPLE IRA? Establish a SIMPLE IRA at the appropriate time of the year If you're an existing employer who did not previously maintain a SIMPLE IRA plan, you may establish a plan effective on any date between January 1 and October 1. If you previously maintained a SIMPLE plan, you may establish a new plan effective only on January 1. You don't need to establish a new plan every year--only when you want to change your plan (for example, when you decide to change your designated financial institution or change employee participant requirements). If you are a new employer and you came into existence after October 1, you may establish a plan as long as you do it as soon as "administratively possible" after the start of the business. Set up a plan document and give eligible employees notice of the plan before the beginning of the annual enrollment period Although you can establish a SIMPLE IRA by using any document that satisfies the statutory requirements, you'll probably find it easier to use one of the model forms created by the IRS. If you want to allow employees to choose the financial institution that will receive their contributions to their SIMPLE IRAs, you can use IRS Form 5304-SIMPLE. If you're setting up all of the IRAs in the same place, you can use IRS Form 5305-SIMPLE. Both forms contain a model plan, employee notification information, and a salary reduction agreement. The notice also must include a summary plan description prepared by the SIMPLE IRA trustee. Page 7 of 11, see disclaimer on final page

8 Provide employees at least 60 days to elect whether or not to contribute to the plan Every eligible employee must have the right to elect to make a salary reduction contribution for a year or modify a previous election during the 60-day period before the start of each calendar year (i.e., November 2 to December 31 of the preceding year). For the first year an employee becomes eligible to make contributions, the election can be made during the 60-day period that includes either the date the employee becomes eligible or the day before the date. Employees establish their individual SIMPLE IRAs prior to the date contributions must be made under the plan Each employee completes either Form 5305-S (Individual Retirement Trust Account) or Form 5305-SA (SIMPLE Individual Retirement Custodial Account). Tip: If you have an employee who refuses or is unable to establish a SIMPLE IRA account, you may do so on the employee's behalf at a financial institution of your choosing. What are the federal income tax considerations? Employers can deduct their contributions to a SIMPLE IRA As an employer, you can deduct from business income your matching or nonelective contributions to employees. Deduct your contributions in the tax year for the calendar year in which they are made. If you do not use a calendar year, contributions are deductible for the tax year that includes the end of the calendar year for which contributions are made. Tip: You can deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including extensions) of your federal income tax return for that year. Contributions are excluded from income and accounts accrue tax deferred Both your matching or nonelective contributions and the employees' salary reduction contributions are excludable by the employee for federal income tax purposes, and earnings on the contributions grow tax deferred. The employees' contributions, but not your matching or nonelective contributions, are subject to FICA, FUTA, and RRA payroll taxes. Income tax is generally due as distributions are made Distributions from a SIMPLE IRA are subject to the IRA rules and generally are includable in income for the year received. You (or your employees) may be assessed a penalty for early withdrawal If you or your employees make a withdrawal from a SIMPLE IRA before age 59½, there is a federal 10 percent premature distribution tax and possibly a state penalty, too, unless an exception applies. If you or your employees make a withdrawal before participating in the plan for two years, the federal pre-age 59½ penalty tax is 25 percent, not 10 percent. Your business may qualify for the small employer pension plan start-up tax credit If you establish a new SIMPLE IRA plan, you may be eligible to receive a business tax credit of up to $500 (50 percent of the first $1,000 of qualified start-up costs to create or maintain the plan) in three tax years. The credit may be claimed for qualified costs incurred in each of the three years starting with the tax year when the plan became effective. You or your employees may qualify for the tax credit for IRAs and retirement plans Some low- and middle-income taxpayers may claim a federal income tax credit (" Saver's Credit ") for elective deferrals made to SIMPLE IRAs and certain other employer-sponsored retirement plans. Page 8 of 11, see disclaimer on final page

9 Questions & Answers What happens if you exceed the 100-employee limit after setting up a SIMPLE plan? You have a two-year grace period after you exceed the limit. That is, you may continue to maintain the SIMPLE plan for the two calendar years following the calendar year in which you last satisfied the 100-employee limit. Example(s): Smith and Sons, an architectural firm with 58 employees, set up a SIMPLE plan for its employees in The firm grew at a very rapid rate, and in 2010, the number of employees totaled 110. As a result, the next two years (2011 and 2012) were considered a grace period in which the firm could continue the SIMPLE plan. During those years, the firm employed 108 employees in 2011 and 95 employees in In 2013, Smith and Sons will be allowed to continue to maintain a SIMPLE plan, because in the prior year (2012), the firm employed fewer than 100 employees. Caution: If the failure to satisfy the 100-employee limitation is due to an acquisition, special rules may apply. Can you impose different eligibility requirements for participation? You can impose less restrictive eligibility requirements by eliminating or reducing the $5,000 salary requirement. So, for instance, you could allow employees who made $3,000 in the previous year to participate in the plan. Of course, if you reduce the eligibility requirements for participation, you must do so for all employees. You may not impose more restrictive eligibility requirements. You are generally allowed to exclude certain employees from participation, such as employees covered by a collective bargaining agreement (if retirement benefits were bargained over) and nonresident aliens who receive no earned income from the employer from sources within the United States. What happens if an employee participates in the retirement plan of another employer? While the SIMPLE IRA must be your company's only employer-sponsored retirement plan, it need not be the only plan in which your employees participate. Employees who also participate in plans of other employers are subject to overall limits on salary reduction contributions to the plans. The employee (and not you) is responsible for monitoring compliance with those limitations. Example(s): John (age 25) has a full-time job working as an architect for his father's firm, Smith and Sons. He participates in a 401(k) plan with the firm. John also has a sideline business, Groovy Tunes, which he operates as a sole proprietorship. Groovy Tunes establishes a SIMPLE IRA. In 2013, John will defer $8,000 of his income from Smith and Sons to the 401(k) plan. John can contribute only $9,500 to his SIMPLE IRA in 2013 because his aggregate annual salary reduction contributions cannot exceed the maximum amount of elective deferrals permitted under a 401(k) plan ($17,500 in 2013). What counts as compensation for SIMPLE plan contributions? Compensation includes wages, tips, and other compensation that is subject to income tax withholding, plus any contributions that the employee makes to the SIMPLE plan. For self-employed persons, compensation means net earnings from self-employment before subtracting any contributions to the SIMPLE IRA on behalf of the self-employed individual. The compensation on which the 2 percent nonelective contributions are made may not exceed the annual limit on compensation as specified in the Internal Revenue Code ($255,000 for 2013, $250,000 for 2012). This annual limit does not apply to matching contributions. What if your employees don't want their accounts in the institution that you have selected? Employees must be allowed to transfer their accounts to other financial institutions without cost or penalty. You, however, can limit the transfers so that they may only be made during the annual enrollment period. In addition, during the first two years of participation, employees can move their funds to another SIMPLE IRA in a direct, tax-free, trustee-to-trustee transfer. After the end of this two-year period, employees can move their funds in a Page 9 of 11, see disclaimer on final page

10 tax-free, trustee-to-trustee transfer to a traditional IRA. Does an employee have the right to terminate a salary reduction agreement outside of the plan's normal election period? Yes. The employee must be allowed to terminate a salary reduction agreement at any time during the year. Your plan, however, may provide that any employee who terminates the salary reduction at any time outside of the annual election period is not eligible to resume participation until the beginning of the next calendar year. Are employees allowed to take out loans or hardship withdrawals from their SIMPLE IRAs? The SIMPLE IRA may not provide for participant loans. Employees can withdraw funds at any time subject to penalties. For applicable penalties, see the section above on tax considerations. When must you deposit employees' salary reduction contributions? You must deposit the salary reduction contributions no later than 30 days after the close of the month in which they are withheld from the employees' paychecks. The Department of Labor has informed the IRS that, for enforcement purposes, salary reduction contributions must be deposited as of the earliest date on which the contributions reasonably can be segregated from the employer's general assets, but in no event later than this 30-day deadline. Tip: Regulations proposed by the Department of Labor provide a safe-harbor rule for SIMPLE-IRA plans that have less than 100 participants at the beginning of a plan year. Under this special rule, if employee salary reduction contributions are deposited to the plan on or before the seventh business day following the day those amount would have otherwise been paid to the employee in cash, then those contributions will be deemed to have been deposited "as of the earliest date on which the contributions reasonably can be segregated from the employer's general assets." The DOL has indicated that taxpayers can rely on these regulations even though they have not yet been finalized. When must you make your matching and nonelective contributions? You must make the contributions no later than the due date for filing your income tax return, including extensions. You have established a SIMPLE IRA, and your employee is deferring a portion of his or her income to the plan. Can the employee also make a deductible contribution to his or her own individual traditional IRA? The employee also may contribute to his or her own individual IRA account, but whether that contribution is deductible depends on the rules governing IRAs. Those rules take into account the employee's gross income, filing status, and participation in employer-sponsored retirement plans, including SIMPLE IRA plans. Are distributions required at age 70½? Yes, required minimum distributions apply each year beginning with the year the employee turns age 70½. Page 10 of 11, see disclaimer on final page

11 IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. Davis & Graves CPA LLP Jerry Davis, CPA/PFS 700 N Main Gresham, OR jerryd@davisgraves.com Page 11 of 11 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013