If you own a company with 100 employees or fewer, you can operate a pension plan known as a Savings Incentive Match Plan for Employees Individual Retirement Arrangement, also known as a SIMPLE IRA. These accounts share some of the hallmarks of other employer sponsored plans such as a 401(k) plan. However, when it comes to making withdrawals, SIMPLE IRAs are more reminiscent of other types of IRAs.
About SIMPLE IRAs
SIMPLE IRAs, like 401(k) plans, are employer sponsored, which means that the business owner rather than the employees, must establish the account. You can make contributions to a SIMPLE IRA on behalf of an employee, and your employee can also make contributions to the account. The money inside the SIMPLE IRA, grows tax-deferred.
The money you contribute on the employees' behalf belongs to your employees from the day of the deposit. In this respect, SIMPLE IRAs differ from a 401(k) because on those plans, employer contributions do not become the employees' property until the vesting period has reached. Therefore, like regular IRAs, all of the money in the account belongs to your employees, which means an employee can access all of the funds by cashing in the account.
SIMPLE IRA Withdrawal Rules
Generally, employees cannot cash in retirement accounts while they are still employed. However, the federal tax code states that an employer cannot prevent an employee from accessing the funds inside a SIMPLE IRA. Therefore, your employees can cash in their SIMPLE IRAs at any time. You cannot impose any kind of sanctions or penalties on employees who choose to liquidate their accounts.
SIMPLE IRA Tax Rules
Distributions from SIMPLE IRAs incur the same taxes as distributions from other types of IRAs. You must pay state and federal income tax on the entire amount of the withdrawal. If you are younger than 59 1/2, you also incur a 10 percent premature withdrawal penalty.
However, SIMPLE IRA participants also have to contend with an even heftier penalty. According to the IRS, you must pay a 25 percent penalty if you cash in your SIMPLE IRA, or make a partial withdrawal within two years of your employer first funding the account. If applicable, you'll pay the 25 percent penalty instead of the standard 10 percent penalty.
Additional Considerations to Avoid Penalties
You can avoid paying the premature withdrawal penalty if you liquidate your SIMPLE IRA and take the proceeds as a series of payments that you structure to last for your life expectancy. You can also avoid the penalty if you cash in the account to cover medical costs and certain other qualified expenses.
Once you reach the age of 72 (70 1/2 in 2019 and prior), you have to begin making annual withdrawals from the account based on your life expectancy, reveals the IRS. You'll pay a penalty that amounts to 50 percent of your required withdrawal if you do not take your annual distributions, so it's important that you pay attention to this date.