Can You Take a Loan From a SIMPLE IRA?

A Savings Incentive Match Plan for Employees Individual Retirement Account, commonly known as a SIMPLE IRA, serves as a retirement savings vehicle for small businesses and their employees. This type of plan offers a streamlined approach to retirement savings, allowing both employers and employees to contribute. SIMPLE IRAs are available to businesses with 100 or fewer employees that do not offer other retirement plans. They are designed to be easy to establish and maintain, providing a cost-effective way for small businesses to offer retirement benefits.

SIMPLE IRA Loan Prohibition

A central characteristic of a SIMPLE IRA is that it does not permit loans. You cannot borrow against your SIMPLE IRA balance, unlike some other employer-sponsored retirement plans like 401(k)s. This restriction is a key aspect of how these accounts are regulated by the Internal Revenue Service (IRS).

The IRS considers any attempt to borrow from a SIMPLE IRA, or to use it as collateral for a loan, as a “prohibited transaction.” Such an action could lead to the entire account balance being considered a taxable distribution. This ensures the funds within a SIMPLE IRA are preserved for retirement savings.

Accessing Funds Through Withdrawals

Account holders can access funds from a SIMPLE IRA only through distributions or withdrawals. These are permanent distributions of money from the account. To initiate a withdrawal, you need to contact the plan custodian or financial institution holding your SIMPLE IRA.

A specific rule for SIMPLE IRAs is the “two-year rule.” If you take a distribution within two years of the date you first participated in the SIMPLE IRA plan, special penalty tax rules apply. This two-year period starts when your employer makes the first contribution to your account.

Tax Consequences of Withdrawals

All distributions from a SIMPLE IRA are subject to ordinary income tax in the year they are received. In addition to income tax, early withdrawals incur a penalty. If you withdraw funds before reaching age 59½, a 10% early withdrawal penalty applies to the taxable amount.

The penalty is higher if the withdrawal occurs within the first two years of your participation in the SIMPLE IRA plan. In this scenario, the early withdrawal penalty increases to 25% of the withdrawn amount. For example, a $10,000 early withdrawal within this two-year window would incur a $2,500 penalty, plus applicable income taxes. However, certain exceptions exist that may allow you to avoid these additional taxes, such as distributions made due to disability, for qualified higher education expenses, or for a first-time home purchase, up to $10,000.