Your Questions Answered: What to do with Simple IRA After Leaving Job?
Updated: Dec 15, 2020
In the USA, the workforce and employers are responsible for helping their employees plan for retirement. One major aspect of a retirement plan is having a type of retirement account. This is usually an IRA or 401 K. Some employers offer a Simple IRA. Simple IRAs are employer-sponsored, tax-free, and often used by small businesses. If you're thinking about resigning from your current employer, you might be wondering how this may affect your Simple IRA.
There are tax rules surrounding Simple IRAs that make them somewhat different from other types of IRA. This is especially true when you resign. Depending on your employer and personal circumstances, you may need to wait before being able to use or transfer the funds in your Simple IRA. Employees must usually wait a two-year stretch if they aren't at retirement age. This article discusses the options you have if you resign with a Simple IRA.
What is a Simple IRA?
As discussed above, a Simple IRA is an employer-sponsored IRA that is largely used by small businesses. In many respects, it supports employees in the same way as other types of IRA account. Part of your salary is used to contribute to your retirement plan. Tax does not apply. These contributions are used by a financial institution to make investments. A portion of the profits from these investments is then paid back into your Simple IRA account. The money in this account is intended to gradually accumulate until employees reach retirement age.
There is a limit on how much employees may contribute to an employer-sponsored Simple IRA plan over the years. In 2021, the limit is $13,500 annually. Your employer generally chooses how much of your salary is made as a contribution, though. The employer may pay a flat contribution of 2% every financial year or match your salary up to 3% each year. Matching contributions are the most common way for employers to manage Simple IRAs. As such, an employee can expect to be part of a contribution match plan for employees if you work for a small business. Your employer likely makes matching contributions to Simple IRAs every tax year.
In order for an employee to be eligible for a Simple IRA plan, they must have earned at least $5,000 in the previous year. Your employer must also expect that you earn at least $5,000 in the upcoming year. Once your employer has set up a Simple IRA for you, a contribution must be made every year. The only way to be exempt from this is by canceling the plan altogether. However, your employer may choose to alternate between the rate at which contributions are made into your Simple IRA.
While a Simple IRA allows many employees to have a stronger retirement plan than they otherwise could, the plan does have some drawbacks. One of these is that the Simple IRA contribution rate is lower than for a Roth or Traditional IRA or Roth IRA. As such, one generally saves less with a Simple IRA than other types of IRAs. Also, you can't transfer the funds from your Simple IRA into another IRA. You may do this with a conventional 401 k plan. As such, it may be wise for you to consider the kinds of retirement plans that would suit you best when looking for work. If you're an employee of a small business, a Simple IRA plan might be the only option for you. We recommend that you think about whether this type of retirement account is best for your retirement plans.
When you Leave Your Employer
Sometimes things don't work out, and you resign from your employer before retirement. In this case, you might be wondering what to do with your IRA. Generally speaking, there is a two year period that applies when you leave an employer with a Simple IRA plan. This means that you usually need to wait two years before you may transfer the money into another account.
After the first two years have passed, you have more options with the money in your Simple IRA plan.
The Two-year Rule
As addressed above, you generally cannot do anything with the money in your Simple IRA plan for the first 2 years after resigning without facing a penalty. If you decide to transfer the money from your account during this two year period, you may expect a reduction of 25%. A Simple IRA plan is also different from a Roth or Traditional IRA because it has more restrictions. With a Simple retirement plan, you can't move the money into another Simple IRA account during this two year period. If you had a Roth IRA, for example, you would be able to pay the money into another IRA account after resigning.
After Two Years
Once the two-year period has passed, you have more options for handling the money in your IRA. Simple IRAs can be cashed out after two years. If you have waited out the two-year period, you can move the money into another IRA or a regular account with an eligible financial institution.
Making Withdrawals from Your Simple IRA
As an employee of a small business, you might be wondering if you can open another simple IRA or transfer your income to another retirement account. Small business employees need to be aware of the 2 year rule that comes with a Simple IRA plan. You should know that there are also penalties for making a transfer to another account if you are not at retirement age. If you're a small business employee, you must wait out the 2 year period before you transfer any of your income to other IRAs. Otherwise, the compensation you can get may be affected by a reduction of up to 25%.
Transfers and Rollovers
If you wish to make a rollover from your account to other IRAs, you still need to wait until you are eligible. Otherwise, the amount that you receive in compensation from your employer is affected by a reduction. This may be frustrating as the employee of a small business. Employees of larger companies don't need to worry about this.
Simple IRA and Your Taxes
It's important to understand the relationship between tax and contributions. Contributions made to your Simple IRA plan are usually not affected by tax rules, similar to a non-deductible contribution to your IRA. Tax only applies if you try to rollover or withdraw from your account before two years have passed. Otherwise, your income is tax-free once it's in your account. This is the same as Roth or Traditional IRAs. The salary that your employers decide to match is not affected by tax rules, either. This tax reduction for Simple IRAs is only withdrawn if you rollover the funds from your account to another account.
As such, contributions made to Simple IRAs are usually not subject to income tax. Employees who wish to avoid tax rules on their Simple IRAs upon resignation should wait until two years have passed before trying to rollover their contributions.
Beneficiaries and Your Simple IRA
You must be aware that beneficiaries of your contributions are subject to tax. This is because any salary from a retirement plan is considered to be part of a taxable estate once it has been withdrawn, regardless of the amount. As such, if your beneficiaries don't want to pay tax on your salary, they need to make sure not to withdraw the compensation before the two year period has passed.
If you pass away, different rules apply to the compensation they are eligible for. There isn't a limit on how much compensation your beneficiaries can withdraw to an account with an eligible financial institution. However, this contribution can be subject to tax. The amount is generally considered to be part of a taxable estate once it's separated from any retirement plans you are or were covered by as a small business employee. Small business employers may continue to make contributions to your account if you pass away. However, these contributions should be matching your salary. Also, there is a limit on the amount that they can pay in compensation.
Preparing for Retirement
It's important that you plan for retirement tax while you're still an employee. You must make sure you understand the contributions that you have access to and your tax responsibilities when you retire. As an employee of a small business, you should first discuss the types of tax you need to pay once you retire. It would help if you also explored what types of compensation you may be eligible for. Depending on your employer's plan, you may be eligible for some reduction. This usually relies on the contribution of the business, though.
Small business employees generally have to make matching, regular tax contributions upon retirement. If you are unsure of the amount you need to pay, you must discuss this with a tax advisor. Regardless of your age, it's a good idea to get a thorough understanding of your tax responsibilities once you've first retired. You still need to pay some amount of tax.
Your employer can pay contributions directly into your Simple IRA. The employer can pay a flat rate or make matching contributions. If you aren't of retirement age in the year that you resign, you need to wait two years before you can access this account.