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Publication 590
Individual Retirement Arrangements (IRAs)

For use in preparing 2002 Returns

Are My Employer's Contributions Taxable?

Your employer's contributions to your SEP-IRA are excluded from your income rather than deducted from it. This means that, unless there are excess contributions, you do not include any contributions in your gross income; nor do you deduct any of them.

Your employer's contributions to your SEP-IRA should not be included in your wages on your Form W-2 unless there are contributions under a salary reduction arrangement (explained later).

Excess employer contributions.   If your employer contributes more than is allowed, you must include the excess in your gross income, without any offsetting deduction.

Excess employer contributions you withdraw before your return is due.   If your employer contributes more to your SEP-IRA than 25% of your compensation or $40,000 for 2002, whichever is less, you will not have to pay the 6% tax (discussed in chapter 1 under Excess Contributions) on it if you withdraw this excess amount (and any interest or other income earned on it) from your SEP-IRA before the date for filing your tax return, including extensions. However, you may have to pay an additional 10% tax (discussed in chapter 1 under Early Distributions) on the early distribution of the interest or other income earned on the excess contribution.

Excess employer contributions you withdraw after your return is due.   If employer contributions for the year are $40,000 for 2002 or less, you can withdraw any excess employer contributions from your SEP-IRA after the due date for filing your tax return, including extensions, free of the 10% tax on early distributions, discussed earlier. However, the excess contribution is subject to the annual 6% excise tax. Also, you may have to pay the additional 10% tax on the early distribution of interest or other income earned on the excess contribution.

Can I Contribute to My SEP-IRA?

You can make contributions to your SEP-IRA independent of employer SEP contributions. You can deduct them the same way as contributions to a regular IRA. However, your deduction may be reduced or eliminated because, as a participant in a SEP, you are covered by an employer retirement plan. See How Much Can I Deduct? in chapter 1.

TAXTIP: You may be able to claim a credit for contributions to your SEP-IRA. For more information, see chapter 5.

Excess contributions you make.   For information on excess contributions you make to your SEP-IRA independent of employer SEP contributions, see What Acts Result in Penalties or Additional Taxes? in chapter 1.

Self-employed individuals.   If you are self-employed (a sole proprietor or partner) and have a SEP plan, take your deduction for employer contributions to your own SEP-IRA on line 31, Form 1040. If you also make deductible contributions to your SEP-IRA (or any other IRA you own) independent of your employer contributions, take your deduction on line 24, Form 1040.

For more employer information on SEP-IRAs, get Publication 560.

What Is a Salary Reduction Arrangement?

A salary reduction arrangement is an arrangement under which you can elect to have your employer contribute part of your pay to your SEP-IRA. Only the remaining portion of your pay is currently taxable. The tax on the contribution is deferred. The amount contributed under the arrangement is called an elective deferral.

Limits on deferrals.   In general, elective deferrals on your behalf to all retirement plans cannot be more than $11,000 for 2002 ($12,000 for 2003). This limit applies only to the amounts that represent a reduction from your salary, not to any contributions from employer funds.

Additional elective deferrals can be contributed to your salary reduction arrangement SEP-IRA if:

  • You reached age 50 by the end of 2002, and
  • No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

The most that can be contributed in additional elective deferrals to your salary reduction arrangement SEP-IRA is the lesser of the following two amounts.

  1. $1,000 for 2002 ($2,000 for 2003), or
  2. Your compensation for the year reduced by your other elective deferrals for the year.

The additional deferrals are not subject to any other contribution limit and are not taken into account in applying other contribution limits. The additional deferrals are not subject to the nondiscrimination rules as long as all eligible participants are allowed to make them.

Excess deferrals.   Excess elective deferrals not withdrawn by April 15 are considered regular IRA contributions and are subject to the IRA contribution limits.

Overall limits on SEP contributions.   Contributions, including elective deferrals, made by your employer to the SEP-IRA are subject to the overall limit of 25% of your compensation or $40,000, whichever is less.

When Can I Withdraw
or Use Assets?

Your employer cannot prohibit distributions from your SEP-IRA. Also, your employer cannot condition contributions to a SEP-IRA on your keeping any part of them in the account.

Distributions (withdrawals) from a SEP-IRA are subject to traditional IRA rules. For information on these rules, including tax treatment of distributions, tax-free rollovers, required distributions, and income tax withholding, see Can I Move Retirement Plan Assets? and When Can I Withdraw or Use IRA Assets? in chapter 1.

Savings Incentive Match Plans for Employees (SIMPLE)

Important Changes for 2002

Increase in limit on salary reduction contributions under a SIMPLE.   For 2002, salary reduction contributions that your employer can make on your behalf under a SIMPLE plan are increased to $7,000 (up from $6,500 in 2001). For more information, see How Much Can Be Contributed on My Behalf? in this chapter.

Additional salary reduction contributions to SIMPLE IRAs for persons 50 and older.   For contributions made after 2001, additional salary reduction contributions of $500 for 2002 can be made to your SIMPLE IRA if:

  • You reached age 50 by the end of 2002, and
  • No other salary reduction contributions can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

See How Much Can Be Contributed on My Behalf? in this chapter.

Rollovers from SIMPLE IRAs.   For distributions after 2001, you may be able to roll over, tax free, a distribution from your SIMPLE IRA to a qualified plan, a tax-sheltered annuity (section 403(b) plan), or deferred compensation plan of a state or local government (section 457 plan). For more information, see When Can I Withdraw or Use Assets? in this chapter.

Self-employment earnings for purposes of SIMPLEs.   Beginning after 2001, for purposes of the limit on deductions for contributions to a self-employed person's SIMPLE IRA, net earnings from self-employment include services performed while claiming exemption from self-employment tax as a member of a group conscientiously opposed to social security benefits. For more information, see Self-employed individual compensation under What Is a SIMPLE Plan? in this chapter.

Credit for salary reduction contributions.   For tax years beginning after 2001, if you are an eligible individual, you may be able to claim a credit for a percentage of your qualified retirement savings contributions, such as salary reduction contributions to your SIMPLE. To be eligible, you must be at least 18 years old as of the end of the year, and you cannot be a student or an individual for whom someone else claims a personal exemption. Also, your adjusted gross income (AGI) must be below a certain amount.

For more information, see chapter 5.

Important Changes for 2003

Increase in limit on salary reduction contributions under a SIMPLE.   For 2003, salary reduction contributions that your employer can make on your behalf under a SIMPLE plan are increased to $8,000 (up from $7,000 in 2002).

For more information about salary reduction contributions, see How Much Can Be Contributed on My Behalf? in this chapter.

Additional salary reduction contributions to SIMPLE IRAs for persons 50 and older.   For 2003, additional salary reduction contributions can be made to your SIMPLE IRA if:

  • You will be 50 or older in 2003, and
  • No other salary reduction contributions can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

For 2003, the amount is the lesser of the following two amounts.

  1. $1,000 (up from $500 for 2002), or
  2. Your compensation for the year reduced by your other elective deferrals for the year.

For more information, see How Much Can Be Contributed on My Behalf? in this chapter.

Introduction

This chapter is for employees who need information about savings incentive match plans for employees (SIMPLE plans). It explains what a SIMPLE plan is, contributions to a SIMPLE plan, and distributions from a SIMPLE plan.

Under a SIMPLE plan, SIMPLE retirement accounts for participating employees can be set up either as:

  • Part of a 401(k) plan, or
  • A plan using IRAs (SIMPLE IRA).

This chapter only discusses the SIMPLE plan rules that relate to SIMPLE IRAs. See Publication 560 for information on any special rules for SIMPLE plans that do not use IRAs.

TAXTIP: If your employer maintains a SIMPLE plan, you must be notified, in writing, that you can choose the financial institution that will serve as trustee for your SIMPLE IRA and that you can roll over or transfer your SIMPLE IRA to another financial institution. See Rollovers and Transfers Exception, later under When Can I Withdraw or Use Assets.

What Is a SIMPLE Plan?

A SIMPLE plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. See Publication 560 for information on the requirements employers must satisfy to set up a SIMPLE plan.

A SIMPLE plan is a written agreement (salary reduction agreement) between you and your employer that allows you, if you are an eligible employee (including a self-employed individual), to choose to:

  • Reduce your compensation by a certain percentage each pay period, and
  • Have your employer contribute the salary reductions to a SIMPLE IRA on your behalf. These contributions are called salary reduction contributions.

All contributions under a SIMPLE IRA plan must be made to SIMPLE IRAs, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account or an individual retirement annuity, described in chapter 1. Contributions are made on behalf of eligible employees. (See Eligible Employees, later.) Contributions are also subject to various limits. (See How Much Can Be Contributed on My Behalf, later.)

In addition to salary reduction contributions, your employer must make either matching contributions or nonelective contributions. See How Are Contributions Made, later.

TAXTIP: You may be able to claim a credit for contributions to your SIMPLE. For more information, see chapter 5.

Eligible Employees

You must be allowed to participate in your employer's SIMPLE plan if you:

  • Received at least $5,000 in compensation from your employer during any 2 years prior to the current year, and
  • Are reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made.

Self-employed individual.   For SIMPLE plan purposes, the term employee includes a self-employed individual who received earned income.

Excludable employees.   Your employer can exclude the following employees from participating in the SIMPLE plan.

  • Employees whose retirement benefits are covered by a collective bargaining agreement (union contract).
  • Employees who are nonresident aliens and received no earned income from sources within the United States.
  • Employees who would not have been eligible employees if an acquisition, disposition, or similar transaction had not occurred during the year.

Compensation.   For purposes of the SIMPLE plan rules, your compensation for a year generally includes the following amounts.

  • Wages, tips, and other pay from your employer that is subject to income tax withholding.
  • Deferred amounts elected under any 401(k) plans, 403(b) plans, government (section 457(b)) plans, SEP plans, and SIMPLE plans.

Self-employed individual compensation.   For purposes of the SIMPLE plan rules, if you are self-employed, your compensation for a year is your net earnings from self-employment (line 4, Section A of Schedule SE (Form 1040)) before subtracting any contributions made to a SIMPLE IRA on your behalf.

For purposes of the limit on deductions for contributions to a self-employed person's SEP-IRA, net earnings from self-employment include services performed while claiming exemption from self-employment tax as a member of a group conscientiously opposed to social security benefits.

How Are Contributions Made?

Contributions under a salary reduction agreement are called salary reduction contributions. They are made on your behalf by your employer. Your employer must also make either matching contributions or nonelective contributions.

Salary reduction contributions.   During the 60-day period before the beginning of any year, and during the 60-day period before you are eligible, you can choose salary reduction contributions expressed either as a percentage of compensation, or as a specific dollar amount (if your employer offers this choice). You can choose to cancel the election at any time during the year.

Salary reduction contributions are also referred to as elective deferrals.

Your employer cannot place restrictions on the contributions amount (such as by limiting the contributions percentage), except to comply with the salary reduction contributions limit, discussed under How Much Can Be Contributed on My Behalf, later.

Matching contributions.   Unless your employer chooses to make nonelective contributions, your employer must make contributions equal to the salary reduction contributions you choose (elect), but only up to certain limits. See How Much Can Be Contributed on My Behalf, later. These contributions are in addition to the salary reduction contributions and must be made to the SIMPLE IRAs of all eligible employees (defined earlier) who chose salary reductions. These contributions are referred to as matching contributions.

Matching contributions on behalf of a self-employed individual are not treated as salary reduction contributions.

Nonelective contributions.   Instead of making matching contributions, your employer may be able to choose to make nonelective contributions on behalf of all eligible employees. These nonelective contributions must be made on behalf of each eligible employee who has at least $5,000 of compensation from your employer, whether or not the employee chose salary reductions.

One of the requirements your employer must satisfy is notifying the employees that the election was made. For other requirements that your employer must satisfy, see Publication 560.

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