According to IRS provisions it is possible for an individual employee to execute in-service trustee-to-trustee exchanges to a fiduciary of the employee’s choosing. This can be an attractive option if the SIMPLE-IRA’s designated financial institution offers high-cost mutual funds.
General withdrawal and transfer rules
SIMPLE IRA contributions and employer matches are made with pre-tax dollars. Thus a withdrawal from the plan is subject to income tax.
In addition, if you are under age 59½ a withdrawal made within the first two years of plan participation is subject to a 25% penalty tax (unless the withdrawal qualifies for an exception). After two years of participation, the penalty tax drops to 10%.
The IRS specifies that a SIMPLE IRA can be transferred without being taxed if the transfer is a direct trustee-to trustee transfer. During the first two years of participation the transfer must be made to another SIMPLE-IRA plan.
After two years of participation, a trustee-to trustee transfer can be made to a traditional IRA account.
Types of plans
The first consideration in the selection of a SIMPLE-IRA fiduciary is to determine the type of SIMPLE IRA an employer has established. A SIMPLE IRA can be either an IRS Form 5304-SIMPLE or similar type plan, or an IRS Form 5305-SIMPLE or similar type plan.
- IRS Form 5304-SIMPLE: this and similar forms of a SIMPLE IRA permit each employee to choose the financial institution for receiving contributions. The employer is required to send contributions on behalf of the employee directly to the financial institution of the employee’s choice. Most participants are unaware of this option, so you should check with your employer to see what form was used to create the plan. Obviously, if you have this type of SIMPLE-IRA you can choose a low cost provider and all your salary deferral and employer matches can be invested in low cost funds.
- IRS Form 5305-SIMPLE: this and similar forms of SIMPLE IRA require all contributions to be deposited initially at a designated financial institution of the employer’s choosing. If you want to use your own financial institution you must execute trustee-to-trustee transfers. During the first two years of SIMPLE IRA participation, a transfer can only be made to another SIMPLE IRA. After two years (dated from the first contribution into the plan) transfers can be made into a traditional IRA.
If you are locked into your employer’s choice of investment manager, you should consider making transfers to a preferred manager.
Here are some things to consider:
- To reduce the costs of transfers you should select the lowest cost funds in your employer’s plan. For most load-fund groups, the only no-load offering is a money market fund. Keep in mind that although you can make transfers, your ongoing salary deferrals and employer matches will continue to be directed to the employer’s designated financial institution. You will want to avoid upfront commissions or back-end redemption fees.
- Contact your preferred fund provider and ask about how to transfer your plan balances, making sure you comply with the firm’s proper transfer procedures and paper work requirements. You should also contact your employer’s designated financial institution to ascertain if it imposes any special transfer requirements. Usually, mutual fund to mutual fund transfers are routine.
- You are usually not limited to the number of transfers you can make in a year but you may find it more convenient to take regular quarterly, semi-annual, or annual transfers.
- If you are interested in making transfers of SIMPLE-IRA balances to a Roth IRA, you must first transfer the SIMPLE balance to a traditional IRA and then convert it to a Roth IRA.
- If you change jobs, after the two year holding period is passed, you can also make a tax-free transfer to your new employer’s plan offering, such as a qualified plan, a tax-sheltered annuity plan (section 403(b) plan), or deferred compensation plan of a state or local government (section 457 plan).