My wife mentioned to her friends that I know a thing or two about personal finance and investing. One of her friends — I’ll call him Jake (not his real name) — changed jobs recently. He asked me to look at his retirement plan account from his previous employer.
I asked Jake what type of account it was. He didn’t know. He thought it was a Roth IRA but I told him an employer plan wouldn’t be a Roth IRA because a Roth IRA is a personal account. He sent me a recent statement, which shows it’s a SIMPLE IRA.
Lower Contribution Limits
A SIMPLE IRA is an oddball in workplace retirement plans. It can only be offered by a small employer with no more than 100 employees. The employer sets up a SIMPLE IRA plan and each employee sets up a SIMPLE IRA under the plan.
Both the employee and the employer contribute to the account, as they do in a 401(k) plan. The annual contribution limit is lower. The employee contribution limit in a SIMPLE IRA is about 30% less than the employee contribution limit in a 401(k). The age-50+ catch-up contribution limit is less than half of the same limit in a 401(k). Don’t ask me why.
SECURE Act 2.0 raised the SIMPLE IRA contribution limit by 10% for employers with 25 or fewer employees. Employers with 26-100 employees can also have the higher contribution limit if they increase their match or non-elective contributions.
There was no Roth version of SIMPLE IRA before 2023. All contributions before 2023 were pre-tax. SECURE Act 2.0 authorized Roth SIMPLE IRA starting in 2023 but it’s optional. Each employer’s plan must allow it before employees can choose the Roth option. Most brokers haven’t updated their plans to allow it yet. For example, both Fidelity’s and Schwab’s SIMPLE IRA plans still only allow pre-tax contributions. As a result, most employers haven’t been able to update their SIMPLE IRA plans to add the Roth option yet.
Expensive Broker
The employer usually sets up a SIMPLE IRA plan with a broker. It’s helpful if the employer knows better to set up the SIMPLE IRA plan with a mainstream broker such as Fidelity or Charles Schwab but many small employers are sold the SIMPLE IRA plan by an expensive full-service broker.
The SIMPLE IRA plan is an employer-sponsored plan but the SIMPLE IRA accounts under the plan are technically personal accounts. Unlike a 401(k), a SIMPLE IRA plan doesn’t offer a menu of investment options. Each employee can invest in anything they want in the SIMPLE IRA. The full-service broker can charge loads and/or asset management fees in the SIMPLE IRA.
In theory, an employee can open a SIMPLE IRA at any financial institution of their choice under some SIMPLE IRA plans (“5304 SIMPLE”). In practice, employees don’t know they have this choice. The employer also discourages setting up accounts elsewhere because they want to send payroll contributions to only one place. It’s next to impossible for an employee to open a SIMPLE IRA at a different broker without the employer’s participation. As a result, employees go with the flow and use the broker chosen by the employer.
Jake’s SIMPLE IRA was like that. His former employer had a full-service broker “help” all the employees with investments in their SIMPLE IRA. The broker put three actively managed mutual funds in his account. Those funds were C shares with an expense ratio of 1.4% – 1.9% plus a backend load of 1% on shares sold within 12 months.
Escape Hatch After Two Years
One upside of a SIMPLE IRA is that it has an escape hatch after two years. Unlike a 401(k) account, which has to stay with the employer’s plan until the employee terminates employment or reaches age 59-1/2, an active employee can roll over the SIMPLE IRA after participating in the SIMPLE IRA plan for two years.
If you have a bad SIMPLE IRA with an expensive broker, you can transfer it to a Traditional IRA after bearing it for two years. New contributions will still go into the SIMPLE IRA but you can roll over the existing money to a Traditional IRA for lower fees and keep rolling over once a year or however frequently you prefer. The broker that has your SIMPLE IRA may charge a transfer-out fee for each transfer.
You’re stuck if you’re still within the first two years. Even if you already terminated employment, a SIMPLE IRA can only roll over to another SIMPLE IRA in the first two years. In theory, you can set up a SIMPLE IRA elsewhere to accept the rollover. In practice, it’s difficult to find a broker to set up a SIMPLE IRA on your own without an employer.
Rollover to Traditional IRA
Fortunately, Jake already had the SIMPLE IRA for longer than two years. I called both Fidelity and Schwab to confirm that they could accept the existing C shares mutual funds in his SIMPLE IRA and they wouldn’t charge a commission to sell those funds. I told Jake he could open a Traditional IRA with either Fidelity or Schwab and submit a Transfer of Assets request through the new account. He chose Fidelity. The shares came over after a week. The broker for the SIMPLE IRA charged him $125 for the transfer.
I suggested waiting until the purchase history came over through the ACATS transfer before selling those expensive actively managed funds. This reduced the backend load charged by the funds because the backend load doesn’t apply to older shares. I also suggested buying a Fidelity Freedom Index Fund with the proceeds. Fidelity didn’t charge a fee for selling the expensive funds or buying the target date index fund. The expense ratio of the Fidelity Freedom Index Fund is 0.12%, which is less than 1/10th of the expense ratio of those old funds. I showed Jake how to turn on dividend reinvestment.
Jake is happy when it’s all done. I’m happy I was able to help him. The rollover was unnecessarily complicated because his SIMPLE IRA was with an expensive broker. His former employer didn’t know better. He had no choice but to go with whatever the employer had set up. Jake is in his twenties. Getting a retirement account out of the hands of an expensive broker at an early age will have a positive impact on his retirement.
If you’re reading this blog, you know more about these subjects than people in your circles. Young people working for small employers especially tend to have bad retirement plans. Let them know you have this knowledge. Help them when they ask. It’s rewarding to set a young person on the right track.
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GeezerGeek says
Great article. I had never heard of a SIMPLE IRA. I can’t recall ever seeing a news article about them and I think I am better informed than most other folks about financial matters. As you said, it certainly “is an oddball in workplace retirement plans”.
Sharon says
Hi Harry, It was a pleasure to meet you briefly at the end of the Bogleheads conference.
Thanks for the very interesting post. I do have a question. You write there’s not a Roth version of a SIMPLE IRA. I thought Secure 2.0 now allows employers to set up SIMPLE IRAs. Am I mistaken?
M B Walker says
You’re correct. SECTION 601 OF THE SECURE 2.0 ACT allows for a Simple Roth IRA. The employer must agree to allow it, it’s not automatic.
Harry Sit says
Hi, Sharon! You’re right! SECURE Act 2.0 authorized Roth SIMPLE IRA starting in 2023 but it’s optional. Each employer’s plan must allow it before employees can choose the Roth option. Most brokers haven’t updated their plans to allow it yet. For example, both Fidelity’s and Schwab’s SIMPLE IRA plans still only allow pre-tax contributions. As a result, most employers haven’t been able to update their SIMPLE IRA plans to add the Roth option yet. I’ll edit the post to correct this part. Thank you for bringing it up.
Alan from Big Easy says
One overlooked advantage of a SIMPLE IRA over a traditional IRA. Contributions made to a SIMPLE IRA after age 70 are not blocked for QCD (charitable distributions) to satisfy RMDs.
I have been semi-retired and self employed for several years. I plan to meet all my RMDs with QCDs (no taxes). As self employed & age 71/72 this year, I put my earnings into a SIMPLE IRA at Schwab (and take my Medicare premium deduction as self employed). I can distribute my RMD as a QCD every year (and maybe avoid a hike in Medicare premiums).
Question, if I roll my SIMPLE IRA contributions after age 70 into a traditional IRA, are they subject to the over 70 rule for QCDs ?
Does the
Harry Sit says
A rollover to a Traditional IRA doesn’t count as a contribution to the Traditional IRA. It doesn’t affect the amount eligible for a QCD.
TJ says
I had a small Simple IRA at Vanguard for a micro business. I only had revenue for one or two years. rolled it over to a Rollover IRA at Vanguard as soon as I could, which was easy enough.
Thankfully before the Vanguard/Ascensus debacle.
I don’t plan to do any more SIMPLE’s even if I do start businesses in the future.
Neil Jonas says
I dont see anything in the irs code that says an employee can set up a simple ira, in fact, the irs says specifically only an employer can do it. The plan rollover is done by the employer as well. The notion that an employee can rollover from a simple ira plan or 401k plan to a traditional ira isn’t new and is very commonly done but I dont see what that has to do with the employer?The employee can just continue to rollover as you then state somewhat contrary to your assertion that the employee can open their own “simple ira plan” account which is available in neverland or ? Am I wrong on this?
I am not challenging you, but the above is my understanding. Schwab allows roth in simple ira, and while you say an employer is not smart because he or she uses a “mainstream” brokerage, who would you suggest they use to get a roth option simple ira employee benefits plan? I have looked and only one or two at this point offer it, and they are schwab and captial, both major brokerages. What are the chances that simple ira will allow non deductible after tax contributions into the roth simple ira or otherwise?
Harry Sit says
The post pointed out that a SIMPLE IRA “plan” and a SIMPLE IRA “account” are two separate things. Don’t mix them together. The plan can only be established by the employer. The account can be established by the employee at any institution of their choice in a 5304-SIMPLE plan. You see this in the IRS Form 5304-SIMPLE. At the bottom half of page 3, the employee tells the employer “I select the following financial institution to serve as the trustee, custodian, or issuer of my SIMPLE IRA” and gives the name of the custodian and the account number. The employee isn’t required to go with the custodian that the employer selected.
It’s a separate question whether any private financial institution offers a SIMPLE IRA account type to an employee independently without the employer also choosing that institution for the SIMPLE IRA plan. The IRS allows it. Many financial institutions choose not to offer it for commercial reasons. As a result, employees suffer when the employer chooses a bad custodian.
I didn’t say an employer is not smart for choosing a “mainstream” brokerage. It’s the opposite. Mainstream brokerages are better than “full service” brokers for the employees. Roth SIMPLE IRA is new. SECURE 2.0 Act allowed it starting in 2023 but the IRS hasn’t issued the full regulations for it yet. That’s why most places don’t offer it at this moment. I don’t see Schwab offering the Roth option in its SIMPLE IRA plans but if you’re sure it does, Schwab would be a good choice.
Finally, while it’s common for a terminated employee to roll over from the previous employer’s plan, the unique rollover feature in a SIMPLE IRA plan is that an employee under age 59-1/2 can roll over from the SIMPLE IRA plan to a personal IRA while still actively employed by that employer. Active employees under 59-1/2 can’t do that in a 401k plan.
Neil Jonas says
thanks for the feedback. i am learning recently about all of this after being burned by my cpa who also tries to sell life insurance and silly simple ira plans he profits from.
i found this company and it looks exactly what i am looking for with good consumer reviews, both self directed roth simple ira retirement plan for small business. if it checks out, i will let you know. https://www.madisontrust.com/what-is-a-self-directed-simple-ira/
i am meeting virtually with schwab next week to see what they offer for certain roth option or not with simple ira. capital does offer roth option but they seem very expensive and have bad consumer reviews.
I do have a follow up query if you have any thoughts knowing you are not an advisor and we are just chatting, if i as an employee of my office which is own 100% as s corp want to roll over my simple ira with max contribution of the 16k or whatever it is and “roll over” to a personal ira am i bound by the personal ira limits in any way? would it impact a back door roth strategy? If I get a roth option on my simple ira is there any reason to do the rollover that you can see?
thank you.