Fri, August 28, 2009
SIMPLE IRAs: Rollovers/Distributions Are Not So Simple
SIMPLE IRA plans give small employers an easy way to make employer matching contributions to an employee's retirement plan. The administration of these plans is much simpler for employers than most other retirement plans, but SIMPLE IRAs involve twists and turns that can be confusing for the employees who own the accounts.
Unlike ROTH and Traditional IRAs, SIMPLE IRAs must be set up by the employer, not by the saver. The name is actually an acronym for “Savings Incentive Match Plan for Employees.,” but the connotation of simplicity is deliberate. The plans have higher annual savings limits than regular IRAs; in 2009, the SIMPLE IRA limit is $11,500 + a $2,500 “catch-up” contribution for employees over 50. Contributions are pre-tax and employers are required to make an annual contribution.
The aspect of the SIMPLE IRA that causes the most confusion for account holders is the “two-year” rule that applies to rollovers and distributions. Under it, some actions that wouldn’t be counted as distributions under a different kind of plan become distributions when made from a SIMPLE IRA.
It’s common for someone who leaves an employer to roll his retirement account into an IRA or a new employer’s retirement plan, and normally this can be done straightforwardly. But the SIMPLE IRA rules in this area are more restrictive than those for other retirement plans.
If the rollover is made from one SIMPLE IRA to another, there’s no problem. But any rollover done to some other type of plan within two years after the first SIMPLE IRA contribution was made is treated as an early distribution and is subject to a stiff 25% tax. Also, SIMPLE IRAs cannot receive rollover funds from SEP IRAs or Traditional IRAs.
Distributions made within two years of first opening a SIMPLE IRA also run afoul of the rules and are hit with the elevated 25% distributions penalty. The tax applies even if the distribution is being made because an employer has terminated its SIMPLE IRA plan. In that instance, the tax can only be avoided by keeping the account until the two-year window has passed, transferring to another SIMPLE IRA plan, or qualifying for a distribution exemption.
SIMPLE IRA Distribution exemptions
There are a number of ways to make a distribution from a SIMPLE IRA without incurring a penalty. Distributions made
after the account participant is 59 1/2 years old,
after the participant is disabled,
for unreimbursed medical expenses that exceed 7.5% of adjusted gross income,
for an amount no greater than the cost of medical insurance,
to pay for qualified higher education expenses,
to buy a first home, or
in the form of an annuity
are exempt from distribution penalties.
SIMPLE IRA account owners need to pay attention to the two-year rule, since it carries a sizeable tax bite that can often be avoided with some planning.
You should always consult a tax or financial advisor if you don’t have sufficient knowledge of the tax laws to determine accurately the financial impact of a rollover or distribution.
