SIMPLE IRA Eligibility Rules: Who You Must Cover

In addition to having an Eligibility Test on the Employer Side of a SIMPLE IRA, there is also an Eligibility Test for Employees. Your business qualifies to Sponsor a SIMPLE IRA if it meets both of the following conditions: your business employed 100 or fewer employees in the prior year whose earnings were $5,000 or more, and your business has NO other retirement plans. On the Employee Side of the Eligibility Tests, you MUST include in your SIMPLE IRA Plan coverage any employee(s), who you reasonably believe will earn $5,000 during the current tax year and who earned at least $5,000 during ANY TWO PRIOR CALENDAR YEARS. Those two figures determine most cases involving whether a business or an Employee is eligible for a SIMPLE IRA. This guide continues with procedures regarding an Employee that may fall into a gray area based upon these figures.

What are the SIMPLE IRA eligibility rules?

Both tests are based solely on compensation monies and have no minimum age, no minimum hours, and no time requirement to wait (months): it simply depends upon whether the employee's pay history meets the $5,000 threshold set by the IRS employee standards.^[1] The same threshold determines which workers will be eligible for benefits under each plan as well as which employees apply toward your business' 100-employee limit under each plan. Begin here if you are still determining what type of plan to adopt, what a SIMPLE IRA is.

Who counts as an eligible employee?

An employee test has two parts which must be satisfied. First, a look back: the employee earned $5,000 or more in any two calendar years preceding this year (and these do not have to be consecutive). Second, a look forward: you reasonably expect the employee will earn at least $5,000 this year.^[1] That reasonable expectation is what decides an initial new hire, who has no two-year history yet but can still be pulled in if your plan document is generous. Work out actual cases before relying on your gut:

The $100 gap will determine how Dana’s case goes and that is why you look at pay records instead of simply looking at years of service (tenure). A single year short of $5,000 will break the count, but if there were two good years several years ago then the count would still meet this criteria.

Are part-time and seasonal workers eligible?

A widely held, and costly, misconception is that part-time, seasonal, or temporary employees are excluded from participation in a SIMPLE IRA. This is an incorrect assumption and a frequent source of IRS correction filings. The eligibility test measures only dollars of compensation (not hours worked) so a long tenured part time employee who earned $5,000 or more in two prior years as he is expected to do this year is eligible to participate whether he works one day per week or five days. The rules for employers give the plan no hour based screening similar to a 401(k) using a 1,000-hour rule. Review your seasonal and part time payroll every year. If you miss a part timer, correcting him via IRS EPCRS will cost you both the make-up contribution plus all of the full match and earnings.

Which employees can you exclude?

You may exclude only two groups of employees. All others are included. Those you can exclude are nonresident aliens who have received no wages from you which are U.S.-source, since there is no U.S. compensation for them to test against.^[1] You may also exclude certain employees covered under a collective bargaining agreement (CBA), if the CBA was negotiated in good faith as to their retirement plans, and this includes airline pilots. All other employees that meet the $5,000 two-year test will be counted in:

You cannot make up your own exclusions. There's no box in the plan document to carve out a spouse, a manager, or a new employee (probationary hire).

Does your business qualify to sponsor a SIMPLE IRA?

Before employers can begin to address employee questions regarding their plans, they first have to get through the business's gate. Only an employer with 100 or fewer employees (who made $5,000 or more in the previous calendar year) may create or continue a SIMPLE IRA under 26 U.S.C. 408(p).^[2] Employees below $5,000 do not count toward the 100. For example, if an employer has 130 total employees but only 95 are above $5,000, then the employer would still qualify to fund a SIMPLE IRA. However, if an employer exceeds this limit, there is a two-year grace period during which time the employer can continue to fund the SIMPLE IRA, however, when an acquisition or disposition occurs, it is subject to its own transition rule.^[2] The other half of the gate is exclusivity: you cannot maintain another qualified plan, SEP, or 403(b) for the same group of employees in any one given year that you run the SIMPLE, a rule IRS Publication 560 spells out.^[3]

Can you make the rules less restrictive?

You can lower the $5,000 and two-year numbers, that is your flexibility which many employers do not understand. An employer can be less restrictive for participation than the law allows but never more restrictive.^[1] This will be established on the Plan Document under Article I, Employee Eligibility Requirements, of Form 5304-SIMPLE and Form 5305-SIMPLE.^[4] You determine whether to include everyone with no minimum (Box 1a) or limit eligibility (Box 1b). If you choose to limit eligibility, you enter a current year figure up to $5,000 and either 0, 1, or 2 years prior to current year. If you loosen employee eligibility requirements, you expand the group of participants who receive your employer match or nonelective contribution therefore increase cost. However, you eliminate tracking each participant for two years.

The eligibility election governs the whole plan year, and it feeds the annual notice that all eligible employees must receive by November 1 of every year, before the 60-day election window that runs November 2 through December 31. As the compensation test is reset each year, you should view this as a continuing (recurring) January activity tied into your W-2 run.

The Bottom Line

SIMPLE IRA eligibility is determined by a single number called $5,000. Cover any employee you expect will earn at least that amount this year (and did in two prior years), regardless of their age, work hours, or job classification. To qualify as an employer under the SIMPLE IRA rules, your company needs to have 100 or less $5,000 employees and no other plan in effect. You may choose to make either requirement easier than those listed above but you may never make either of them stricter. Therefore, elect for each term on your plan document and check the list annually in January.

This guide is educational and summarizes IRS SIMPLE IRA eligibility rules. It is not investment, legal, or tax advice. Your plan documents and current IRS limits control. Talk to your tax advisor about your business's circumstances.