By Denise Appleby
Distributions from SIMPLE IRAs must occur eventually. Until the required minimum distributions (RMDs) rules apply, distributions are usually elective . The tax and penalty treatment of distributions are determined by the SIMPLE IRA owner's age at the time of distribution.
During the first two years after an employee's SIMPLE IRA is established, assets held in the SIMPLE IRA must not be transferred or rolled to another retirement plan. This two-year period begins the first day the employer deposits a contribution to the SIMPLE IRA. After the two-year period, assets in a SIMPLE IRA may be moved to another eligible retirement plan by means of a transfer, rollover or as a Roth conversion.
The two-year waiting period does not apply to transfers or rollovers between two SIMPLE IRAs.
Distributions that occur during the two-year period are subject to an early-distribution penalty of 25% if the SIMPLE IRA owner is under age 59.5 when the distribution occurs. If an exception applies, however, the 25% penalty is waived. Distributions that occur when the SIMPLE IRA holder is age 59.5 or older are not subject to the early-distribution penalty, even if the distribution occurs within the two-year period.
Distributions That Occur Before Age 59.5
Distributions that occur before the individual reaches the age of 59.5 are subject to a 10% early-distribution penalty. For SIMPLE IRAs, this 10% penalty is increased to 25% if the individual receives a distribution within two years of the first contribution made to his or her SIMPLE IRA account. The 10% penalty is in addition to any income tax owed on the amount. There are certain instances where the IRS will waive the early-distribution penalty and the 25% penalty for distributions that occur during the two-year period. The IRS waives the penalty when distributions are used for reasons which include the following:
For Unreimbursed Medical Expenses
If the distribution is used to pay unreimbursed medical expenses, the amount that exceeds 7.5% (10% after 2012) of the individual's adjusted gross income (AGI) for the year of the distribution will not be subject to the early-distribution penalty. In other words, the amount paid for the unreimbursed medical expenses minus 7.5% of the individual's adjusted gross income for the year of the distribution can be distributed penalty free.
Example: SIMPLE IRA Distributions for Medical Expenses
Jack\'s AGI is $25,000, and he paid $4,000 for unreimbursed medical expenses.
To Pay Medical Insurance
Individuals can make a penalty-free distribution to pay medical insurance for themselves, their spouses and dependents, provided the distribution occurs under the following four conditions:
- The individual has lost his or her job.
- The individual has received unemployment compensation paid under any federal or state law for 12 consecutive weeks.
- The individual receives the distributions during either the year he or she receives the unemployment compensation or the following year.
- The individual receives the distributions no later than 60 days after he or she has been re-employed.
For a Disability
If an individual becomes disabled before age 59.5 and makes a distribution from his or her Traditional IRA because of the disability, the distributions are not subject to the early-distribution penalty. Individuals are considered disabled if they furnish proof that a physical or mental condition inhibits them from engaging in substantial gainful activities. A physician must determine that this condition can be expected to result in death or to continue for an indefinite duration.
As Distributions to the IRA Beneficiary
Amounts distributed from the IRA by the designated beneficiary , after the IRA owner's death, are not subject to penalty.
As Part of an SEPP Program
For penalty-free distributions that are part of a series of substantially equal payments over the life of the IRA holder and or his or her beneficiary, the payments must last five years or until the IRA owner reaches age 59.5 - whichever is longer - and the payments must also follow certain IRS-approved methods.
For Qualified Higher Education Expenses
Amounts are penalty free if they must go toward qualified higher-education expenses of the IRA owner and/or his or her dependents. These qualified education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution. An eligible educational institution is any college, university, vocational school or other post-secondary educational institution eligible to participate in the student aid programs administered by the Department of Education. These eligible educational institutions include virtually all accredited post-secondary institutions, whether public, nonprofit or proprietary (privately owned and profit making). The educational institution should be able to indicate whether it is an eligible educational institution.
To Purchase a First Home
The IRA owner can make penalty-free distributions to purchase, build or rebuild a first home:
- For the IRA owner
- For the IRA owner's spouse
- For a child of the IRA owner or of the IRA owner's spouse
- For a grandchild of the IRA owner or of the IRA owner's spouse
- For a parent or other ancestor of the IRA owner or of the IRA owner's spouse
The first-time homebuyer distribution must be used to pay qualified acquisition costs before the end of the 120th day after the IRA owner receives the distributed assets.
The total distribution the IRA owner uses for first-time home purchases cannot exceed $10,000 during the IRA owner's lifetime. For married individuals, the $10,000 applies separately to each spouse, which means that the total for both is $20,000.
For Payment of an IRS Levy
The IRS may levy against an IRA, resulting in a distribution. The distributed amount is subject to income tax, but the early-distribution penalty is waived.
The early-distribution penalty does not apply to amounts that are not subject to income tax. These include amounts distributions that occur after the two-year period and are later deposited to an eligible retirement plan as a rollover contribution within 60 days of receipt.
Distributions That Occur on or After Age 59.5
Distributions that occur on or after the SIMPLE IRA owner reaches age 59.5 may be subject to income tax, but will not be subject to any early-distribution penalty. These distributions are also subject to the two-year rule and cannot be rolled over to an eligible plan during the first two years after the SIMPLE IRA is established.
Required Minimum Distributions
Traditional IRA distributions cannot be deferred indefinitely. An IRA owner must begin RMDs for the year he or she reaches age 70.5, at which time the IRA owner may distribute the full balance of the IRA or distribute a minimum amount each year. (For background reading, check out 6 Important Retirement Plan RMD Rules.)
The first RMD must be distributed by April 1 of the year after the IRA owner reaches age 70.5. For example, an IRA owner who reaches age 70.5 in June of 2013 must take his or her first RMD by April 1, 2014. RMDs for subsequent years must be distributed by December 31 of the year for which they are due. This means that if the IRA holder defers the first RMD until April 1 of the next year after he or she turns 70.5, the IRA holder will be required to take a second RMD amount in this next year, which counts as the second year of the RMD.
Example: RMD Distribution Rules
Jill turns 70.5 in June of 2012, and she decides to defer her first RMD until April 1, 2013.
Generally, the IRA custodian/trustee will calculate the RMD amount and send the notification to the IRA holder. Alternatively, the IRS custodian/trustee may send an RMD reminder to the IRA holder with an offer to calculate the RMD amount upon request.
RMD amounts not distributed from the IRA by the due date are subject to a 50% excess-accumulation penalty.
Example: IRA Excess Accumulation Penalty
John is 75 years old and his RMD for 2013 is $5,000. By December 31, 2013, John has only distributed $4,000 from his IRA. Because John\'s RMD was short by $1,000, he must pay the IRS a 50% excess-accumulation penalty ($1,000 x 50% = $500).
The excess-accumulation penalty must be paid when the individual files his or her federal tax return. If the individual feels that the failure was due to reasonable circumstances, he or she may write to the IRS and request that the penalty be waived. In such cases, the penalty should not be paid unless the IRS denies the request for the waiver.
SIMPLE IRAs: Conclusion
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