Tax Information for Withdrawing From a SIMPLE IRA
Original post by Mark Kennan of Demand Media
SIMPLE (savings incentive match plan for employees) IRAs offer small employers the ability to contribute to their employees' retirement plans. Only employers with fewer than 100 employees may offer a SIMPLE plan. When you take a distribution from a SIMPLE IRA, you need to know the tax consequences so you can plan for paying your increased tax liability.
SIMPLE IRAs follow the same rule as traditional IRAs when taking qualified distributions, which means you must be at least 59 1/2 years old before you remove the money. When you take a qualified distribution, you include the amount of the distribution in your taxable income and pay taxes on it at your marginal income tax rate. However, you do not pay any penalties on the distribution.
Any withdrawal before age of 59 1/2 counts as an early distribution from a SIMPLE IRA, which results in a 10 percent early distribution penalty unless an exception applies. SIMPLE IRAs also have a two-year rule that prevents you from rolling over funds or taking withdrawals for two years unless you pay a 25 percent early withdrawal penalty. The two-year period begins the first day a contribution goes into the SIMPLE IRA. This penalty replaces the 10 percent early withdrawal penalty, but not the income taxes on the distribution.
Early Withdrawal Tax Penalty Exceptions
Like traditional IRAs, the IRS also waives the early withdrawal penalty in select cases ranging from medical insurance premiums while you are out of work, to college tuition for you or a dependent or up to up to $10,000 for a first home. You can also avoid the penalty if you suffer a permanent disability or if you use the money to pay medical expenses above 7.5 percent of your adjusted gross income. The waiver only applies to the penalty, not your income taxes. You must still include the amount of the SIMPLE IRA as part of your taxable income.
When you take a distribution from your SIMPLE IRA, you must report it correctly on your income taxes. Your SIMPLE IRA custodian mails you a Form 1099-R that shows the size of your distribution as well as the amount of federal income tax withheld from the amount paid to you. On your income taxes, file with Form 1040 or 1040A and report the amount of the distribution as a taxable IRA. Also report the amount withheld as federal income tax withholding. If you owe an early withdrawal penalty, you also have to complete Form 5329 and attach it to your return.
- IRS.gov: Publication 590
- IRS.gov: Retirement Plans FAQs Regarding SIMPLE IRAs
- IRS.gov: Form 5329 Instructions
About the Author
Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.