The SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) can be an attractive option for self-employed and small business owner clients who have fewer than 100 employees. SIMPLE IRAs share many of the same characteristics and benefits of other tax-deferred plans — allowing small business owners the opportunity to save for their own retirement and help their employees do the same.

The rules governing SIMPLE IRAs are also unique — from lower contribution limits and restrictions on participant loans to the terms for rollovers and withdrawals in the event a plan participant changes jobs or wants to cash out early.

Here’s what advisors should be aware of in these scenarios:

1. The SIMPLE 2-year rule 

As with many other retirement plan types, assets in a SIMPLE IRA can be rolled over or transferred tax-free to another IRA or employer plan — but only after 2 years of participation in the SIMPLE IRA plan. The 2-year window starts with the first day an employer contributes to an employee’s account. Keep in mind, rollovers and transfers from one SIMPLE IRA to another SIMPLE IRA are exempt from the 2-year rule and are treated as tax-free rollover contributions.

What happens if an employee leaves their company before hitting the 2-year mark? To avoid a taxable event, they have two options:

1. Keep the funds where they are through the 2-year waiting period; or
2. Roll over the assets to another SIMPLE IRA plan at another institution.

2. Are rollovers a SIMPLE switch? 

Once 2 years have elapsed, employees can roll over assets from their SIMPLE IRA to several other qualified employer-sponsored and government retirement plans as well as non-Roth IRAs, without tax consequences. If rollovers are made to a Roth IRA, however, any untaxed money must be included in the account owner’s taxable income.

The Internal Revenue Service’s rollover chart¹ outlines accounts eligible to receive SIMPLE IRA funds and the guidelines for each:

The 2-year rule also applies to accepting rollovers to SIMPLE IRAs. Funds from traditional and SEP IRAs, and employer plans including 401(k), 403(b), and 457(b)s, can be transferred one time per account in a 1-year period. Rollovers of Roth IRAs or designated Roth accounts of employer plans to SIMPLE IRAs are not allowed.

3. Tax consequences for the SIMPLE withdrawal

Withdrawals from SIMPLE IRAs are considered taxable income. In general, the plans are designed with the intention that funds remain there until participants reach the age of 59 ½, and as with other retirement plans, the IRS sets restrictions on when participants can cash out without penalty. While there’s no requirement that a participant demonstrate hardship if they want to make a withdrawal before age 59 ½, there’s also no loan provision — so if participants opt to tap into retirement savings early, they’ll face a 10% penalty on top of the regular taxes. The two-year rule applies to distributions as well: If the withdrawal is made before closing on two years of participation in the plan, that 10% penalty jumps to 25%.

There are exceptions to the 10% tax on early withdrawals³ under certain circumstances, including:

• Unreimbursed medical expenses that are greater than 10% of the participant’s adjusted gross income (or 7.5% if their spouse is over 65)
• The costs of medical insurance premiums in the event of unemployment
• Qualified higher education expenses
• The cost of a first home purchase, build, or rebuild
• Withdrawals in the form of an annuity
• Qualified reservist distributions
• Disability
• Death beneficiaries
• IRS levies 

The SIMPLE facts

Before determining whether a SIMPLE IRA is the right choice for small business clients, it’s a good idea to brush up on everything from the basics to the nuances to how they stack up against other plans.