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March 3, 2009

Tutorial: SIMPLE IRA Distributions, Rollovers and Transfers

SIMPLE IRA Distributions, Rollovers and Transfers
For the most part, SIMPLE IRAs are subject to the same distribution rules that apply to traditional IRAs. For rollovers and transfers, the differences are more pronounced as both types of accounts can be transferred to the same types of retirement plans, but the rules for receiving rollovers and transfers are markedly differently.
Similar to traditional IRAs, a participant can make withdrawals from his SIMPLE IRA at anytime. And, up until he reaches age 70 ½, distribution are optional. Beginning the year he reaches age 70 ½, he must start withdrawing required minimum distribution (RMD) amounts. The RMD amount must be withdrawn each year, and is any balance remains after his death; his beneficiaries must continue to withdraw RMD amounts from the balance that they inherit.
Distributions are generally treated as ordinary income.  The following are some age specific rules.
Pre-Age 59 ½ Distributions
Distributions that occur before the participant reaches age 59 ½ are subject to a 10% early distribution penalty, unless an exception applies. If the distribution occurs before the end of the two-year period, the penalty is increased to 25%. The exceptions to the early distribution penalty are as follows:
§ The participant has unreimbursed medical expenses that are more than 7.5% of his adjusted gross income. The distributions exempted from the penalty is limited to the amount paid for unreimbursed medical expenses during the year of the distribution, minus 7.5% of the participant’s adjusted gross income for the year of the distribution. Only unreimbursed medical expenses that would be eligible to be included in figuring a deduction for medical expenses on Schedule A, Form 1040 can be taken into account. The participant does have to itemize deductions to take advantage of this exception to the penalty. Note Adjusted gross income is the amount on Form 1040, line 38; Form 1040A, line 22; or Form 1040NR, line 36.
§ The distributions are not more than the cost of the participant’s medical insurance. The distribution amount that is exempted from the penalty is limited to distributions during the year that are not more than the amount paid during the year for medical insurance for the participant, his spouse and his dependents. He will not have to pay the tax on these amounts if all of the following conditions apply.
§ He lost his job.
§ He received unemployment compensation paid under any federal or state law for 12 consecutive weeks because he lost his job.
§ He received the distributions during either the year he received the unemployment compensation or the following year.
§ He receive the distributions no later than 60 days after he have been reemployed.
§ He is disabled. If he becomes disabled before he reaches age 59½, any distributions from his SIMPLE IRA because of the disability are not subject to the 10% additional tax. He would be considered to be disabled if he can furnish proof that he cannot do any substantial gainful activity because of his physical or mental condition. A physician must determine that his condition can be expected to result in death or to be of long, continued, and indefinite duration.
§ He is deceased and the distributions are taken by his beneficiaries
§ He is receiving distributions under a substantially equal periodic payment (SEPP) program. Under this program, distributions are required to be taken for five years or until he reaches age 59 ½, whichever is longer. The distribution amounts that must be taken each year are required to be determined under an IRS approved formula. The details of this program are beyond the scope of this material.
§ The distributions are not more than his qualified higher education expenses. Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses. Other limitations apply and are beyond the scope of this material
§ He uses the distributions to buy, build, or rebuild a first home. He will not have to pay the 10% early distribution penalty on up to $10,000 of distribution used to receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.
§ It must be used to pay qualified acquisition costs before the close of the 120th day after the day he received it.
§ It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer who is any of the following.
oHis spouse.
oHis or his spouse’s child.
oHis or his spouse’s grandchild.
oHis or his spouse’s parent or other ancestor.
§ When added to all of his prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.
§ The distribution is due to an IRS levy of the SIMPLE IRA.
§ The distribution is a qualified reservist distribution. A distribution is a qualified reservist distribution if the following requirements are met.
§ The participant was ordered or called to active duty after September 11, 2001
§ He was ordered or called to active duty for a period of more than 179 days or for an indefinite period because he is a member of a reserve component.
§ The distribution is from an IRA or from amounts attributable to elective deferrals under a section 401(k) or 403(b) plan or a similar arrangement.
§ The distribution was made no earlier than the date of the order or call to active duty and no later than the close of the active duty period.
Required Minimum Distributions at age 70 ½
Beginning the year the participant reaches age 70 ½ , he is required to start taking required minimum distribution (RMD) amounts from his SIMPLE IRA. The RMD amount for the current year is determined by dividing the previous year-end fair market value of the SIMPLE IRA, by his distribution period. The distribution period is based on his age and the age of his beneficiary. The age of his beneficiary defaults to being two years younger than he, unless his wife is his sole primary beneficiary and she is more than en years younger than her. If such is the case her real age is used.
The first RMD amount is due for the year he reaches age 70 ½, and he must continue to take RMD amounts from his IRA for every subsequent year during his life-time. If he die and leave a remaining balance in the SIMPLE IRA his beneficiaries are required to continue taking RMD amounts from the SIMPLE IRA balance that they inherit.
The details of the RMD rules including those that apply to beneficiaries are beyond the scope of this book, and are available in IRA Distributions Made E-Z.
Distributions from SIMPLE IRAs can be rolled over to another SIMPLE IRA or another eligible retirement plan. However, a rollover to another retirement plan that is not a SIMPLE IRA can occur only after the two-year period has expired. For this purpose, an eligible retirement plan includes :
  • A traditional IRA
  • A qualified plan, including a 401(k) plan, profit sharing plan, money purchase pension plan, and a defined benefit plan
  • A 403(b) plan
  • A 457(b) plan, and a
  • A qualified employee annuity plan under section 403(a).
SIMPLE IRA assets can be rolled over to another SIMPLE IRA at anytime, providing the distribution amount is rollover eligible Similar to other retirement plans, SIMPLE IRAs are subject to the 60-day rollover rule, which requires rollover eligible amounts to be deposited to the receiving retirement account within 60-days of the participant receiving the distribution amount. Similar to other IRAs, a SIMPLE IRA is subject to a limit of one 60-day rollover during a 12-month period.
SIMPLE IRA assets can also be converted to a Roth IRA after the two-year period.
The only assets that can be rolled over to a SIMPLE IRA are distributions from another SIMPLE IRA.
SIMPLE IRA assets can be transferred to another SIMPLE IRA, a traditional IRA or a SEP IRA. However, the transfer to a traditional IRA or a SIMPLE IRA can occur only after the two-year period. Transfers from one SIMPLE IRA to another SIMPLE IRA can occur at anytime.
Two-Period Violated
If the two year period is violated, the amounts that is rolled over or transferred to another retirement plan that is not a SIMPLE IRA is treated as distribution from the SIMPLE IRA and a contribution to the receiving retirement account. The contribution to the receiving account is subject to the contribution limits that apply to the account and can result in an excess contribution to the account.
John transferred $10,000 from his SIMPLE IRA to his traditional IRA before the two year period has expired. While a transfer is usually non-reportable and nontaxable, that is not the case with this transfer as it did not satisfy the two-year rule. As such, it is treated as a distribution from John’s SIMPLE IRA and he is required to include the amount as ordinary income for the year the amount was withdrawn from his SIMPLE IRA.
The credit to his traditional IRA is treated as a regular IRA contribution, which is limited to $5,000. As a result, John has an excess IRA contribution of $5,000 in his traditional IRA. If he had already made his regular IRA contribution for the year, the excess is increased by the IRA contribution amount that he already made
The Two- Year Period
The two-year period begins on the day the first contribution is deposited to a participant’s SIMPLE IRA and ends two years after that date. The financial institution may use the information that is made available to determine whether the two-year period has been satisfied. However, they are not required to rely on the information that is provided. Instead, they can choose to use the information for contributions that were made to the SIMPLE IRA while they served as trustee/custodian.
John established SIMPLE IRA # 1234 with custodian XYZ. The first SIMPLE contribution was made to John’s SIMPLE IRA on April 1, 2008. John transferred the assets to SIMPLE IRA # 5678 at Custodian PQR in December 2008, and a SIMPLE IRA contribution was made to account # 5678 on January 15, 2009. If John decides to take am distribution form SIMPLE IRA # 5678 on May 1, 2010, and he is under age 59 ½, he will owe the IRS an early distribution penalty of 10% of the amount withdrawn. Custodian PQR would report the amount as a SIMPLE IRA distribution before the two-year period, because their records shows that the first contribution was made to the account on January 15, 2009, resulting in a report to the IRS that the amount is subject to a 25% penalty, instead of the 10%. However, Custodian PQR may accept copies of the statements for SIMPLE IRA # 1234, showing the contribution being made on Mary 1, 2008 and the transfer being made to SIMPLE IRA # 5678, and use that as basis for reporting the SIMPLE IRA distribution as one that occurred after the two-year period. However, they have the right to choose not to accept the documentation and process the distribution based on their own records.
Loans cannot be made from SIMPLE IRAs.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.


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