SIMPLE IRA rollover
I am a little confused by everything I have been reading on SIMPLE IRA’s. From what I understand, once a company starts a SIMPLE IRA, there is basically a two-year clock that starts before anyone can take withdrawals (i.e. rollover from SIMPLE to traditional IRA). Is this true for every individual? What is the penalty if the employee is 60 years old for rolling money out to a traditional IRA early (prior to the two-year clock)?
Second question…. A company can start a SIMPLE any time between 1/1 and 10/1 but I assume they need to set the date such that they provide 90 days notice to employees? In other words, if a company is thinking about starting a SIMPLE IRA now, they would ideally need to set the start date for 3/31 or 4/1 to enable the company to provide notice to the employees. Is that a correct reading of the rules?
Last question – I have been seeing a few posts/questions regarding high fees in SIMPLE IRAs and I have no doubt many exist. As an RIA, I have a client that is in his company’s SIMPLE IRA plan and the custodian is an insurance company with captive mutual funds for which the broker is charging 3+% per transaction to purchase these very mediocre performing funds. My client wanted to roll most of the balance out to me which I understand but I don’t believe he has been in the plan long enough and wanted to make sure that my understanding is correct. Also, I assume that SIMPLE IRA plans do exist with low fees such as NTF mutual funds (no transaction fee) and a reasonable fee charged by whomever is managing the plan / advising the participants. Is that a fair assumption?
Permalink Submitted by Alan - IRA critic on Sun, 2021-12-19 21:38
There are two basic SIMPLE IRA provider options – an employer selected DFI (designated financial institution) where all employee SIMPLE accounts must be held with the designated custodian. Form 5305-SIMPLE is the adoption form used for these plans, and they are the ones that typically carry high fees and loads. Form 5304-SIMPLE is the other option for plans that allow employees to select their own SIMPLE IRA Custodian and therefore the employee can control the fees. However, this form presents more work for the employer in making contributions to several different custodians.
Until 2 years has passed, the only transfer of funds allowed is a direct trustee transfer to another SIMPLE IRA. Any distribution is not eligible for rollover and will be taxable and subject to penalty of 25%, but the penalty only applies to employees under 59.5. Therefore, for those over 59.5, the tax and loss of tax deferral is the fallout from taking a distribution and not being able to roll it over. Nonetheless, a few employees do take advantage of the direct transfer to another SIMPLE IRA (referred to as a “transfer SIMPLE IRA” at a non DFI institution. The DFI must comply with the transfer request without fee or penalty. Once the 2 years have passed, funds can be rolled to a TIRA or Roth IRA or distributed with a penalty of 10% if under 59.5. There are no longer any distribution restrictions after the 2 year period. Most employees that are not happy with the high fees or limited investment options end up waiting for the 2 year period to end, and then do transfers to TIRAs or Roth IRAs to avoid the continued high fees.
Regarding establishment of a new SIMPLE IRA plan for existing employers with a current SIMPLE IRA, generally these are calendar year plans for which the annual notification must be made no later than 11/2 of the prior year. For an initial SIMPLE IRA for a current employer, the plan can be effective anytime between 1/1 and 10/1, with the 10/1 deadline not applying to new employers being established. Employee notification forms must be sent a min of 60 days prior to effective date unless the employer adopts a 90 day or other notification period.
Permalink Submitted by Alan Myers on Sun, 2021-12-19 22:34
Thank you for the clarification, Alan (as an aside, I am Alan, as well). I thought I was reading that pesky two-year rule right but just wanted to make sure. Just to clarify the last point – if a company wants to start a new SIMPLE IRA plan (no current plan in place), they can do it at any point during the year between 1/1 and 10/1 but there needs to be 60 days notification prior to the effective date. So if the company started notifications on Dec 31 of this year, the effective date could be March 1 of next year (just as an example).
Another question now arises…. I have a client currently in his company’s SIMPLE IRA plan. The plan is a non-degignated financial institution plan (i.e. the company filed SIMPLE 5304 instead of 5305 as the HR person apparently intended but had zero clue about). Given that, my client can choose to open a SIMPLE IRA with my custodian and then roll the balance from his current SIMPLE IRA over to the new one without any penalty. Am I correct in my assumption here? I would assume the company, if they wanted to “fix” the NDFI problem would need to amend the plan which which means giving notification which means nothing could be done (since no notification currently) could not be done until next year (2023) at the earliest.
Permalink Submitted by Alan - IRA critic on Sun, 2021-12-19 23:44
First point, yes that is correct.
Example 2 on p 19 of Notice 98-4 provides an example similar to this situation. With the 5304, there is no agreement that the institution is actually a DFI even if there might have been a general understanding that they were. Not being a DFI means that the employee could request a transfer of their SIMPLE account, however the institution has not agreed to transfer it and cannot be required to agree to transfer it without cost or penalty. The employee would then be forced into considering a distribution (likely with fees or penalties) which could be rolled into an another SIMPLE IRA within 60 days. Such a rollover would be subject to the one rollover limit within a 12 month period. Accordingly, it appears that the ideal direct transfer without tax or penalty in the first 2 years is not possible without the 5305 SIMPLE in place. But the funds could be rolled over to another SIMPLE IRA subject to fees or penalties of the custodian.
not98-4.pdf (irs.gov)
Permalink Submitted by Alan Myers on Mon, 2021-12-20 04:20
I see what you mean in point 2 above. I wonder, though, if the employees were not told they could choose whatever financial institution they wanted (whether accidentally or on purpose) might that change things? If my client had known he could choose any financial institution, he might have originally chosen to open his SIMPLE IRA account with me rather than the “default” institution he went with. I did have a conversation with the HR director of the company and she was completely unaware the plan was a non-DFI plan! I guess the custodian could tell the participant “too bad, so sad. You shoulda read the documentation” and charge a fee or penalty to make the transfer. I assume it would take a conversation with the custodian and the financial rep (or, more likely, his boss) to figure out if the plan would allow for a penalty-free rollover to another SIMPLE account. Thanks for all of your insight and help here! You have been invaluable!
Permalink Submitted by William Tuttle on Mon, 2021-12-20 14:45
There is unlikely to be a significant cost for the rollover itself. Typically, these are $25 – $50 if there is any rollover fee. The real potential cost is if the client’s assets are in back-end load mutual funds.
Is the 3%+ per transaction a commision or a front-end load. If the latter, it is very rare for there to be both front and back end loads on a mutual fund. A simple question to the custodian should answer this. Not to mention in this day and age, any employer who adopts/maintains a retirement plan that subjects their employees to a 3%+ acquisition fee is in fundamental breach of their fiduciary duty.
At a minimum, the client should elect a new SIMPLE IRA custodian for future contributions during the annual notice/enrollment period which ends on 12/31. The employer or current custodian must allow this in a 5304-SIMPLE.
E-Trade, Fidelity, Schwab, TD Ameritrade and Vanguard are examples of custodians offering SIMPLE IRAs with the vast majority of Mutual Funds offerings no-load. Also, most have full brokerage access with little to no transaction fees. They have little to no yearly administrative fees.
Permalink Submitted by Alan Myers on Mon, 2021-12-20 23:03
The 3% is a per transaction fee. The account is using A shares so there should be no back-end fees. As much as I agree with you that a 3% brokerage fee per transaction is a breach of fiduciary duty, isn’t that one of the attractive things about SIMPLE IRAs for businesses – no fiduciary oversight versus a 401(k) plan?
The client is going with a new SIMPLE at TD Ameritrade where I custody my client accounts. I know that it is now allowed to roll IRAs over into SIMPLE IRAs (though given some of the drawbacks of SIMPLE IRAs, it seems most people want to go the other way). We will probably combine his IRA and SIMPLE IRA and then roll over the balance from his current SIMPLE custodian to get everything in one place. Given that I will use no transaction fee funds in his account and, based on the size of his assets, his fees to me will top out around 0.90%, he will be in a far better position, I think.
Thank you again for all of your help!
Permalink Submitted by Alan Myers on Tue, 2021-12-21 23:56
My client was able to open a SIMPLE IRA at TD Ameritrade. We will roll over the balance in his curren SIMPLE once we are into the new year which will allow him access to much better funds that are cheaper and have better performance.
I do have a question – the HR director sent my client the entire form 5304 with the section for Model Salary Reduction Agreement fillable so he could enter the information there and DocuSign it for them. However, since she sent the entire form, it also includes the Model Notification to Eligible Employees that she filled out. As I read Article II, Section 2a, an employee can modify their election (or change designated financial institutions) “during the 60-day period immediately preceding January 1” of any calendar year. In the Model Notification section, she indicated that employees who wanted to make changes for the 2022 calendar year were to return the agreement to her by 12/17/2021 which does not seem right. I understand her wanting some time to get these things entered, but can she legally cut the deadline off two weeks before the Jan 1 deadline specified in the original agreement?
Permalink Submitted by Alan - IRA critic on Wed, 2021-12-22 00:54
Notice 98-4, QA E-1 clearly states that employees have the right to modify their salary reduction agreements without restriction in the 60 day period. Therefore, the 12/17 date is not enforceable and was probably specified as a desirable deadline by this plan simply to expedite processing of elections on a timely basis.