The SIMPLE IRA has a couple of unique characteristics compared to other traditional or Roth individual retirement arrangements, such as your employer contributing to your plan as well, but the Internal Revenue Service is still picky about when you can access your money. To avoid unwanted tax obligations and penalties, it is important to understand the rules surrounding distributions, and what is considered qualified and unqualified.
The IRS has a set of general distribution rules for all traditional IRAs, with the primary one being you must be of age 59 1/2 to be considered retirement age and eligible to pull money from your IRA without penalty. The same applies to the SIMPLE IRA. You cannot begin taking qualified distributions from your SIMPLE plan until you’ve reached age 59 1/2. The Roth IRA is the only exception in that you can remove your contributions -- not your earnings -- at any time because you’ve already paid taxes on them.
Early Distribution Penalty
The IRS also has a set early distribution penalty of 10 percent should you decide to pull your money out of your IRA early -- that is, unless your IRA is a SIMPLE plan. A special tax penalty of 25 percent applies to any early distribution from the SIMPLE IRA within the first two years of a newly-opened account. So, if your employer deposited the first contribution into your SIMPLE IRA on Jan. 1, 2013, and you pull money out on Dec. 31, 2014, you’ll get hit with a 25-percent early distribution penalty instead of the standard 10 percent. Pull the money out Jan. 2, 2015 and you’ll pay the 10-percent early distribution fee.
The SIMPLE IRA is a tax-deferred plan just like the traditional IRA. Your money goes into the plan tax-free, and you are expected to pay taxes on the income once you start receiving distributions, qualified or unqualified. The amount of income tax depends on your tax bracket at distribution time. Ideally, you want to be in a lower tax bracket at retirement time, so you are paying fewer taxes on your distributions than you would have paid on your contributions when you deposited them while working.
Like other IRAs, you might encounter a special circumstance where you need to pull money out of your SIMPLE IRA early and won’t get penalized. You may draw from your SIMPLE early if you must pay medical expenses, not reimbursed, exceeding 7.5 percent of your adjusted gross income; you lose your job and must pay for your medical insurance coverage; you lose your job due to permanent disability; you want to buy your first home; or you want to pay for education expenses for you, your spouse, your child or grandchild. Although you won’t get dinged with an early distribution penalty, you still need to pay regular income taxes on the special distributions.
Although the IRS does allow early distributions under special conditions, if you can avoid pulling money out of your SIMPLE IRA prior to your retirement, you should. Aside from the income taxes you must pay and any applicable tax penalty, your money isn’t in the account earning tax-deferred interest; the more money in your SIMPLE IRA, the more money building up your nest egg for your golden years, which really should be the best years of your life.