Business Glossary

form of salary reduction plan that qualifying small employers may offer to their employees.Simple stands for Savings Incentive Match Plans for Employees. Employers with no more than 100 employees earning $5,000 or more in a year who do not offer any other retirement plan can offer Simple IRAs. Self-employed workers also are eligible to establish these accounts.

Workers offered a Simple IRA may contribute up to $10,000 per year into the account. Employees age 50 or older can contribute up to $12,500. Employee contributions are excluded from taxable pay on Form W-2 and are not subject to income tax withholding, although Social Security taxes are paid on those earnings. While the employer may pick the financial institution in which to deposit the simple IRA funds, employees have the right to transfer the funds to another financial institution of their choice without cost or penalty.

Employers must make either a matching contribution or a fixed "non-elective" contribution to their employees' accounts each year. If the employer chooses matching contributions, the employer must match the amount the employee contributes up to 3% of compensation. Or the employer may make a non-elective contribution of 2% of wages for each eligible employee.

Distributions from simple IRAs follow the same rules as regular IRAs, with one exception. If premature distributions are taken before the employee reaches age 59½ and during the first two years after the employee starts participating in the plan, the penalty is 25%, not the usual 10%. After the first two years, the regular 10% penalty applies to pre-age 59½ withdrawals. Withdrawals taken after age 59½ are fully taxable at regular income tax rates, and mandatory withdrawals must begin at age 70½, according to IRS life expectancy tables.

Assets inside simple IRAs can be invested like any other IRAs, in stocks, bonds, mutual funds, bank deposits, annuities, or precious metals.

The simple IRA replaced the Salary Reduction Simplified Employee Pension plan (known as SARSEP) in 1997. SARSEPs may be continued only by employers who established them before 1997.

retirement plan specifically designed for self-employed people and small business owners. The owner and any eligible employees establish their own separate SEP-IRAs; employer contributions are then made into each eligible employee's SEP-IRA. The plan is available to sole proprietors, partners in a partnership, or owners of businesses (either unincorporated or incorporated, including S Corporations) and to self-employed persons who earn income by providing a service, either full time or part time, even those already covered by a retirement plan at their full-time job. Those eligible may contribute up to 25% of compensation (as much as $44,000 for 2006), and any investment earnings are tax-deferred until withdrawn.

employee investment plan; also called salary reduction plan. It allows employees to defer part of their gross salary and to invest the amount in stocks, bonds, or money market funds. The amount is indexed for inflation, using the Consumer Price Index (CPI). Employee contributions and all earnings arising from them go tax-free until withdrawn at the request of the employee or until the employee retires or leaves the company. Usually the employer provides a choice of investment vehicles into which the funds may be placed while earning tax-deferred returns. Furthermore, many employers offer matching contributions. The limitation of annual deferrals to 401(k) plans applies only to an employee's elective deferrals-not the employer's matching funds. These contributions, plus the current reduction in income taxes, make 401(k) salary reduction plans an excellent longterm investment.