SIMPLE 401(k) Plan For Caterpillar Employees

What Is It?

In General

According to a recent survey conducted by Bankrate, 60% of American adults aged 55 and older have not saved enough for retirement. The survey also revealed that 1 in 5 adults in this age group have no retirement savings at all, while only 16% have saved enough to retire comfortably. These statistics may serve as a wake-up call for those who have not yet taken action towards securing their financial future.

With that under consideration, Caterpillar employees soon to be leaving the workforce are probably interested in finding ways to save for retirement. If you are employed at Caterpillar and own a business on the side, you may also be concerned about attracting and retaining qualified employees. You may be able to pursue both of these goals by establishing a savings incentive match plan for employees (SIMPLE) 401(k) plan. For business owners working for Caterpillar, a SIMPLE 401(k) is a retirement plan for certain self-employed persons and small businesses. 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. A SIMPLE 401(k) plan is structured as a 401(k) cash or deferred arrangement. The SIMPLE 401(k) plan was created in conjunction with the SIMPLE IRA, so these plans share certain characteristics.

Caution:  Except as described below, SIMPLE 401(k) plans are generally subject to the same rules that apply to traditional 401(k) plans.

Eligible Employees Can Defer Up To $13,500 In 2020

The SIMPLE 401(k) allows eligible employees — including Caterpillar retirees who are now self employed — to defer up to $13,500 of their wages to the plan in 2020 (up from $13,000 in 2019). In addition, employees age 50 and older may contribute an additional $3,000 pre-tax in 2020 (unchanged from 2019). All employees who are age 21 or older and have completed one year of service with the employer must be eligible to participate in the plan.

The Employer Must Make Contributions to the Plan

For Caterpillar employees who own a business, you must make either a matching contribution or a nonelective contribution every year. A matching contribution must match the amount that each employee contributes up to a maximum of 3% of the employee's annual compensation. Because the maximum employee deferral for 2020 is $13,500 ($16,500 if age 50 or older), your maximum employer matching contribution for an employee is effectively the lesser of $13,500 ($16,500 if age 50 or older) or 3% of the employee's compensation.

If you choose instead to make a nonelective contribution, you must contribute 2% of each employee's annual compensation whether or not the eligible employee chooses to contribute to the plan. No other employer contributions to the SIMPLE 401(k) plan are permitted.

Caution:  The compensation on which both the 2% nonelective contributions and the 3% matching contributions are made may not exceed $285,000 in 2020 (up from $280,000 in 2019).

Quick Comparison with SIMPLE IRA And Traditional 401(K)

Despite the similarities the SIMPLE 401(k) shares with the SIMPLE IRA, there are significant differences between these two retirement vehicles that business owners working for Caterpillar should know. 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	100 or fewer employees earning at least $5,000
Maximum deferral	$19,500 in 2020, $26,000 if 50 or older (up from $19,000 and $25,000 in 2019)	$13,500 in 2020, $16,500 if 50 or older (up from $13,000 and $16,000 in 2019)	$13,500 in 2020, $16,500 if 50 or older (up from $13,000 and $16,000 in 2019)
Required employer contribution	None, unless plan is top-heavy, is a safe-harbor plan, or includes a qualified automatic contribution arrangement (QACA)	Dollar-for-dollar match up to 3% of pay, or 2% of pay for all eligible participants; pay for both limited to $285,000 in 2020 (up from $280,000 in 2019)	Dollar-for-dollar match up to 3% of pay (unlimited), or 2% of pay (up to $285,000 in 2020, up from $280,000 in 2019) for all eligible participants (3% of pay match may be reduced to as little as 1% in any two of five years)
Roth contributions permitted?	Yes	Yes	No
ADP/ACP discrimination testing?	Yes (unless safe-harbor plan, or qualified automatic contribution arrangement (QACA))	No	No
Early withdrawal penalty	10%	10%	25% first two years of participation, then 10%
Withdrawal of employee pre-tax contributions	Restricted	Restricted	Unrestricted
Excludible 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 two prior years, or who are not expected to earn at least $5,000 in the current year certain collectively bargained employees and nonresident aliens
Vesting schedule	For employer contributions only	No, all contributions 100% vested	No, all contributions 100% vested
Federal reporting by employer	Same as other qualified plans	Same as other qualified plans	None
May the employer have other plans?	Yes	No	No
Are loans allowed?	Yes	Yes	No

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Who Can Establish A SIMPLE 401(K) Plan?

For Caterpillar employees potentially owning a business, you can establish a SIMPLE 401(k) plan if you're self-employed or have a qualified operation, but only if you don't maintain another employer-sponsored retirement plan.

Self-Employed

For Caterpillar employees who have a side business without any workers, you can set up a SIMPLE 401(k) plan for yourself and make contributions to the plan. You're considered to be self-employed if you're a sole proprietor or are otherwise in business for yourself. For Caterpillar employees, self-employment income can also involve part-time work.

Qualified Small Business

If you are employed at Caterpillar and own a qualified small business, you may want to consider setting up a SIMPLE 401(k). You will be eligible if you employed 100 or fewer employees in the past year 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 example, say you employed 97 employees earning over $5,000 in January. Two months later, seven employees left and were replaced by seven 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.

Tip:  See Questions & Answers below 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 example, 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.

Tip:  A tax-exempt employer may adopt a SIMPLE 401(k) plan if it meets the 100-employee test described above. Government employers generally can't have SIMPLE 401(k) plans, but can adopt SIMPLE IRA plans.

Cannot Maintain Another Employer-Sponsored Retirement Plan

For Caterpillar employees and potential business owners, you must not maintain any other employer-sponsored retirement plan [such as a 401(k) plan, a tax-sheltered annuity, or a simplified employee pension plan] that benefits any of your employees eligible to participate in the SIMPLE 401(k).

What Are Some Advantages of Establishing a SIMPLE 401(K)?

The Plan Is Not Subject to the Federal Nondiscrimination Tests That Usually Govern 401(K) Plans

For Caterpillar employees intending to open or already owning an existing business, as long as you follow the vesting and SIMPLE plan requirements, your plan is assumed to have met the complicated rules under the Internal Revenue Code that prohibit discrimination in favor of highly compensated employees.

Pre-Tax Dollars Are Contributed and Grow Tax Deferred

The dollars invested in the plan are pre-tax dollars and grow tax deferred. That means that your employees can exclude the contributions from their gross income.

Your Business May Deduct Its Contributions to The Plan

For Caterpillar employees owning a business, your business can deduct its matching or nonelective contributions to employees for the calendar year in which they are made.

Participants Are Allowed To Take Out Plan Loans

Participant loans are permitted in accordance with the rules governing traditional 401(k) plans. This is in contrast to SIMPLE IRAs, which do not permit loans.

Creditor Protection

Funds held in a SIMPLE 401(k) plan are fully shielded from your employee's creditors under federal law in the event of the employee's bankruptcy. If your SIMPLE 401(k) plan is covered by the Employee Retirement Income Security Act of 1974 (ERISA), plan assets are also fully protected under federal law from the claims of both your employees and your creditors, even outside of bankruptcy (some exceptions apply — for example, qualified domestic relations orders and IRS liens).

Caution:  If your plan covers only you, or you and your spouse, ERISA will generally not apply to your plan. In this case, whether or not plan assets are protected outside of bankruptcy depends on the laws of your state. Consult a professional if asset protection is important to you.

Roth Contributions Permitted

Unlike SIMPLE IRA plans, SIMPLE 401(k) plan can permit Roth contributions.

What Are Some Drawbacks of Establishing A SIMPLE 401(K) Plan?

You Are Required to Follow the Standard Reporting and Disclosure Requirements of a Regular 401(K)

One of the more favorable aspects of the SIMPLE IRA is the lack of reporting and disclosure requirements. In contrast, the SIMPLE 401(k) has the same reporting and disclosure requirements of a regular 401(k). That can be time-consuming and cumbersome for those working at Caterpillar company and simultaneously owning a business.

You Are Required to Make a Contribution Every Year You Maintain the Plan

If you work at Caterpillar and own a business, even if your business is doing poorly in a given year, you must make an employer contribution (either matching or nonelective) to the plan. In addition, you don't have much flexibility regarding the amount of your contribution. You must contribute either the 2% nonelective contribution or the 3% match. If the 3% match option is chosen, you don't have the flexibility to reduce the match in some years to less than 3% (the SIMPLE IRA allows a reduced match in any two of five years).

Your Employees Are Immediately Vested In the Plan

Your employees don't have to be employed for a certain number of years in order to have full ownership of your contributions. In other words, employees are 100% vested in all plan contributions and investment earnings. Conversely, with a regular 401(k), you can require employees to remain employed for a certain period of time before they are vested in employer contributions.

Tip:  The SIMPLE 401(k) might not be a good choice if your goal is to induce employees to remain with your company.  Furthermore, immediate vesting can be costly if you have high turnover.

The Annual Contribution Amount for Employees Is Limited

The SIMPLE 401(k) annual contribution limit is $13,500 in 2020 (up from $13,000 in 2019) or $16,500 if age 50 or older. That's significantly lower than the annual contribution limit for a regular 401(k), which is $19,500 in 2020 (up from $19,000 in 2019), or $26,000 if age 50 or older. With that under consideration, it is important for Caterpillar employees to understand how highly compensated employees and business owners hoping to save considerable money for retirement usually prefer a regular 401(k).

Caution:  An employee who has several jobs with different employers and participates in several plans can't make total elective deferrals in excess of $19,500 in 2020 (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.

You Cannot Maintain Other Retirement Plans That Benefit Employees Eligible to Participate In the SIMPLE 401(K)

You can't maintain a SIMPLE 401(k) plan if, during any part of the calendar year, you maintain any other employer-sponsored retirement plan that benefits employees eligible to participate in the SIMPLE 401(k). Consequently, the SIMPLE 401(k) plan will not be appropriate if you want to maintain two or more retirement plans, or if you have groups of employees with different plan needs. Therefore, for Caterpillar employees who own a business, it is important to plan ahead as to avoid conflicts between benefits.

You Must Determine In Advance the Type of Contribution You Will Make for the Year

Before the start of your plan year, If you work at Caterpillar and own a business, you need to give your employees a 60-day election period to determine how much of their wages, if any, they wish to defer to the plan. Consequently, you need to advise employees of the type and amount of your contribution within a reasonable period of time before the 60-day election period. This generally means that you need to communicate with your employees at least 61 days before the beginning of the calendar year.

Early Withdrawals May Result In Significant Penalties

Distributions from a SIMPLE 401(k) are generally subject to the same distribution rules that apply to traditional 401(k) rules. So, if you make a withdrawal before age 59½ (55 in certain cases), you'll be subject to the 10% premature penalty tax (unless you meet one of the exceptions).

How Do You Establish A SIMPLE 401(K) Plan?

If You Currently Have A 401(K) Plan, You Can Adopt the SIMPLE 401(K) Provisions

The IRS has provided a model amendment that can be used to modify an existing 401(k) to function as a SIMPLE 401(k). This amendment, which is available in Rev. Proc. 97-9 in Cumulative Bulletin 1997-2, may be used only for plans that have been approved by the IRS. Furthermore, your plan must operate on a calendar year basis, not a fiscal year basis. Seek assistance from a retirement plan specialist.

If You Do Not Already Have A 401(K), Contact a Retirement Planning Specialist To Set Up A SIMPLE 401(K)

As with other types of retirement plans, the rules governing 401(k) plans generally require the expertise of a professional in the field of qualified benefit plans.

Follow the Reporting and Disclosure Requirements That Govern Traditional 401(K) Plans

Once you have established your SIMPLE 401(k) plan, you need to follow the annual reporting and disclosure requirements that govern traditional 401(k) plans. Consult a professional in the field of qualified benefit plans.

What Are The Federal Income Tax Considerations?

Employer Contributions to a SIMPLE 401(K) Can Be Deducted from Business Income

If you work at Caterpillar and own a business, your business can deduct matching or nonelective employer contributions for the calendar year in which they are made. If you don't use a calendar year, contributions are deductible for the tax year that includes the end of the calendar year for which contributions are made.

SIMPLE 401(K) Accounts Grow Tax Deferred

Your matching or nonelective employer contributions and the employees' contributions are excludable by the employee for income tax purposes, and earnings on the contributions grow tax deferred. However, the employees' contributions (but not your matching or nonelective contributions) are subject to payroll taxes under the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and Railroad Retirement Act.

You (Or Your Employees) May Be Assessed A Penalty for Early Withdrawal

Generally, employees are subject to the same penalties for early withdrawals from SIMPLE 401(k)s as they are for early withdrawals from traditional 401(k)s. Therefore, if you make a taxable withdrawal from your SIMPLE 401(k) before age 59½ (age 55 in certain cases), you may be subject to a 10% premature penalty tax (unless you meet an exception).

Your Business May Qualify for the Small Employer Pension Plan Start-Up Tax Credit

If you work at Caterpillar and establish a new SIMPLE 401(k) plan, you may be eligible to receive a business tax credit for 50% of the 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. The amount of the credit is limited in each of the three years to $500 to $5,000, depending on the number of employees.

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 401(k) plans and certain other employer-sponsored retirement plans.

Analogy:

Investing in your retirement is like planting a tree. Just as it takes time for a tree to grow and bear fruit, investing for retirement requires a long-term approach. You need to start early, choose the right investments, and tend to your portfolio over time to ensure it grows into a strong and fruitful retirement plan. With proper care and attention, your retirement portfolio can provide you with a bountiful harvest that will sustain you for years to come.

Questions & Answers

What Happens If You Exceed The 100-Employee Limit After Setting Up A SIMPLE 401(K)?

You have a two-year grace period after you exceed the limit. That is, you may continue to maintain the SIMPLE 401(k) 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 2016. The firm grew at a very rapid rate, and in 2017, the number of employees totaled 110. As a result, the next two years (2018-2019) were considered a grace period in which the firm could continue the SIMPLE plan. During those years, the firm employed 108 employees in 2018 and 95 employees in 2019. In 2020, Smith and Sons is allowed to continue to maintain a SIMPLE plan, because in the prior year (2019), the firm employed less than 100 employees.

If the failure to satisfy the 100-employee limitation is due to an acquisition, special rules may apply.

What Are the Eligibility Requirements for Employee Participation?

All employees who are age 21 or older and have completed one year of service with the employer must be eligible to participate. You may relax these requirements as long as you do so for all employees.

What Counts As Compensation for SIMPLE 401(K) 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 401(k) on behalf of the self-employed individual. The compensation on which both the 2% nonelective contributions and the 3% matching contributions are made may not exceed $285,000 (in 2020, up from $280,000 in 2019).

May an Employee Terminate Participation In The Salary Reduction Election Outside Of The Plan's Normal Election Period?

An employee may terminate participation in the salary reduction election at any time during the year. Your plan, however, may provide that an employee who terminates may not be allowed to resume participation until the next year.