By Sarah Brenner, JD
SIMPLE IRAs are not so simple. One factor that makes SIMPLE IRAs tricky is that they are subject to unique rules, found nowhere else in the tax code, such as the two-year holding period.
Two-Year Holding Period
When does the two-year holding period begin? This is a question that often creates confusion. The two-year holding period begins with the date the employee’s first contribution is deposited to the SIMPLE IRA. It is not the date employment begins or even the date you become eligible to participate in the SIMPLE IRA plan.
25% Early Distribution Penalty
Distributions taken from a SIMPLE IRA before age 59 ½ are subject to an early withdrawal penalty of 25% when withdrawn during the two-year holding period. Note this difference vs. the standard 10% early distribution penalty on IRA accounts.
The exceptions to the 10% early distribution penalty that apply to IRAs also apply to the 25% penalty on SIMPLE distributions. For example, if you are under 59 ½ but using the funds from your SIMPLE IRA distribution during the two-year holding period to pay for your child’s college tuition, the 25% penalty would not apply to the distribution. That is because there is an exception to early withdrawal penalty for distributions from an IRA used for qualified higher education expenses.
Rollovers and Transfers
During the two-year holding period, SIMPLE IRA funds may only be rolled over or transferred to other SIMPLE IRAs. SIMPLE IRA funds may not be rolled over or transferred to a traditional IRA or rolled over to an employer plan until the two-year holding period ends.
It used to be that a SIMPLE IRA could only accept rollovers and transfers from another SIMPLE IRA. The Protecting Americans from Tax Hikes (PATH) Act of 2015 changed this rule. During the 2-year holding period a SIMPLE IRA still can only accept a transfer or a rollover from another SIMPLE IRA. However, after the 2-year holding period ends, funds from traditional IRAs and employer plans can be rolled into a SIMPLE IRA.