Rolling Over an Unnecessarily Complicated SIMPLE IRA

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).

SECURE Act 2.0 raised the 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’s no Roth version of a SIMPLE IRA. All contributions to a SIMPLE IRA are pre-tax.

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 plan by an expensive full-service broker.

Unlike a 401(k), a SIMPLE IRA plan doesn’t offer an investment options menu. 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.

Such is the case with Jake’s SIMPLE IRA. His former employer had a full-service broker “help” all the employees with their investments in the SIMPLE IRA. The broker put three actively managed mutual funds in his account. Those funds are C shares with an expense ratio of 1.4% – 1.9% plus a backend load of 1%.

Two-Year Jail Time

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 on your own to accept the rollover. In practice, it’s quite difficult to find a broker to set up a SIMPLE IRA without an employer’s participation.

Rollover to Traditional IRA

Fortunately, Jake already had the SIMPLE IRA for longer than two years. I told him he could open a Traditional IRA with either Fidelity or Schwab and submit a Transfer of Assets request through the new account. Jake chose Fidelity. The shares came over in about a week.

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 drops off on 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. 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. Nor did he. He just went with whatever the employer had set up. Jake is 29. Getting a retirement account out of the hands of an expensive broker at an early age has a positive impact on his retirement.

If you’re reading this blog, you know more 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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