What Are the Consequences of Borrowing From a SIMPLE IRA?

What Are the Consequences of Borrowing From a SIMPLE IRA?
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If you work in a company with less than 100 employees, your employer may be able to set up a SIMPLE IRA for retirement savings. The SIMPLE (Savings Incentive Match Plan for Employees) works much like a traditional IRA, in which you can contribute money each year and deduct the contribution from your taxable income. With a SIMPLE IRA, however, your employer may also contribute, allowing your savings to grow even faster. If you borrow from this account, however, there may be serious consequences.

Tax Rules

The Internal Revenue Service allows employers and employees to contribute to a SIMPLE account. The money is excluded from your taxable income; your employer does not report it on your annual W-2. In addition, the savings grows without taxes, which are payable only when you withdraw the money. Technically, you may not borrow from the account; but you may take an early withdrawal that will incur taxes and penalties if you do not return the money within 60 days. In effect, you are allowed an interest-free, tax-free loan from the account, but you must repay the loan within 60 days.

Early-Withdrawal Penalty

Like a traditional IRA, a SIMPLE account allows you to take distributions before you reach the age of 59 1/2. If you take a distribution before that age, however, you will incur an early-withdrawal penalty in the amount of 10 percent of the amount you withdrew. The plan administrator reports all distributions from the IRA and withholds income taxes at the rate of 20 percent. You figure and pay the penalty with your income-tax return that you must file in the following year.

Two-Year Rule

If you have enrolled in a SIMPLE IRA, you are subject to an increased penalty of 25 percent if you take a distribution within two years of the start of your account. The IRS still allows a temporary distribution, but if you don't get the money back into the account within 60 days, you will pay the penalty of 25 percent in addition to income taxes on the distribution. The two-year period also applies to rollovers.


The IRS makes exceptions for early-distribution penalties. You may take an early distribution for a rollover to a new retirement account, as long as you place the money in the second account within 60 days. Also, if you are permanently disabled, paying for higher-education expenses for yourself or a dependent, or paying for health insurance while unemployed, the IRS waives the penalty. You may also take an early distribution if you are purchasing your first home or paying for medical expenses that exceed 7.5 percent of your gross income. Although they are penalty-free, these distributions are still subject to income tax on the investment gain.