Moment on Money

A Reader Asks #19: Personal Record Retention

A client recently emailed that she was cleaning out old files and wondered how long she should keep certain records. As a result of answering her questions, I have put together some basic guidelines of what to keep and how long to keep it.

	Retention Requirement	Recommendation
Tax Records	3 years min.	7 – 10 years
Bank/Credit Card Statements	None	File with tax records
Deposit Slips/ATM receipts Credit Card Transactions	None	Reconcile with statement then destroy
Pay Stubs	Most recent	File year end with tax records
Medical Records	None	Current physicians, treatments, and mediations. File medical expenses with tax records
Insurance Policies	None	Inforce polices. Maintain list of insurance policies and servicing agent.
Retirement Investment Accounts	None	Year end statement
Non-Retirement Investment Accounts	Cost basis	Year end statements for 7 – 10 years after investment is sold.

Tax Records – Generally the IRS has three years (from the date you filed) to audit your taxes. However, substantial omission of items (generally defined as over/under reporting income by 25%) extends the audit window to six years and there are situations such as filing a false return, willful attempt to avoid taxes, or failure to file a return which may be examined by the IRS at any time without limitation. If you are audited, the IRS can provide a copy of the return(s) you filed, but you need to provide the documentation and information that was used to prepare the return. Many sources recommend destroying tax information after seven years. That is plenty of time to defend yourself in an extended six year audit window. Frankly, you know if you should be concerned about an indefinite tax examination or not. I tend to hold tax documents longer that the standard seven year recommendation. I keep all tax records for ten years. For example, when I filed my 2010 taxes I destroyed my records from the 2000 tax year.

Bank/Credit Card Statements –These are essentially tax records. File them, by tax year, with tax records. Like all tax documents, keep them for ten years and then destroy them.

Deposit Slips/ATM Receipts/Credit Card Transactions – Save these only until the appropriate statement is received and reconciled. Once you know the statement is correct, it is okay to destroy these.

Pay Stubs – As long as your pay stub contains year-to-date information, you only need to retain your most recent pay stub. Keep the last pay stub of the year with your tax records.

Medical Records – It is a very good idea to keep records with the names and addresses of your family's personal physicians, medical history, and current prescriptions/treatments. Having this information at your fingertips will save you time and energy when you need to see a new doctor or have some other reason to summarize your health such as when purchasing insurance or, in some cases, getting a new job. Receipts and records for expenses related to healthcare should be retained with your tax records if you itemize and deduct your medical expenses.

Insurance Policies – Insurance policies are important, but replaceable. More important that keeping the actual policies is to keep the names and contact information for the agent who services your insurance. If need be, the agent can always get a replacement policy for you. But in a time of crisis, your agent should also be the first person you contact to initiate a claim.

Investment Accounts – what you need to keep really depends on the type of investment account

Retirement Accounts (including IRA's, Roth's, 401(k)'s, Pensions etc) – In general, these accounts are tax deferred so they are fully taxable when money is distributed. Throughout the year, you should retain all confirmations and statements. The final statement of the year will usually summarize all of the activity in the account for the year. You should keep this year end summary with your tax records. Roth accounts have a little greater need for recordkeeping. For Roth's, make sure you keep all your year end statements.

Non-Retirement Accounts – In order to calculate the taxes due when an investment is sold, you need to be able to document your cost basis (that is, how much you have paid in to the investment). If you purchased an investment in one "buy order" that can be pretty simple. But if you are making periodic investments over a long period of time, calculating cost basis may be a bit more difficult. Especially since the IRS allows for a couple different methods of keeping and tracking cost basis and there are special rules which apply to some investments like zero coupon bonds. The good news is, you don't really need to worry about it. Worrying about cost basis is your accountants' job. But you do need to provide your account the information they need. Just like retirement accounts, you need to keep a year end of summary of all your activity in your investment accounts. The difference is that you need to keep this information for as long as you own the investment… even if you own the same investment for decades. You should not consider destroying investment year end summaries for at least seven to ten years AFTER YOU SELL the investment. (By the way, new rules for investment companies will make this easier for investors. Soon investment companies will be required to track cost basis on your behalf).

When cleaning out files (especially after the years end), there can be a lot of documents which no longer need to be kept. Remember that DV Financial has a document shredding procedure which is compliant to military standards. As a service to you, you may bring in your documents and put them in our secure and confidential destruction bin. Your documents will be destroyed at no charge.

Have I missed anything? Let me know!

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #18: Iowa Inheritance Tax Question

This comment was left on The Iowa Inheritance Tax post this summer. Doing the research on it brought some unusual twists and turns so it took more time to answer than I would have expected. Despite the delay, I still think it is interesting enough to address.

Thank you so much on your Iowa inheritance tax info. On the tax schedule it had a different tax for, "Unknown heirs, as distinguished from beneficiaries who are not presently ascertainable, due to contingent events." I recently found out that my mother was left around 100,000 in a will, unfortunately my mother passed away many years ago- so according to the lawyer this amount comes to me. Would I fall into this "unknown heir" category possibly?

The key to Iowa Inheritance Tax is the relationship between the decedent (the person who died) and the beneficiary (the person receiving the inheritance). In your scenario, we don't know the relationship between your mother and the decedent. Only that your mother died before the person who's estate is now being settled, and that as your mothers daughter you are entitled to at least a part of her inheritance. It is likely that your mother was named in the decedent's will as a per stirpes beneficiary, which means that if she had already passed then her lineal descendents are entitled to her inheritance. You are a lineal descendant of your mother. If your mother is a lineal descendant of the individual who died, then you would owe no Iowa Inheritance Tax since lineal ascendants and descendants pay no Iowa Inheritance Tax.

I am just going to guess that if that was in fact the case, you never would have asked the question.

I am not an attorney, but I do have access to some through my support systems. They did some research for me and even called the State of Iowa for clarification. You see, we cannot figure out any scenario where Schedule F would actually apply. Once you know who the beneficiary is the tax would be based on that person's relationship to the decedent and be covered under Schedule B or C, or not taxed as a lineal ascendant / descendant. When they called the State, the contact person there could not provide an example of a Schedule F scenario and told us that she has never seen Schedule F actually invoked.

That got us thinking about why someone would want to invoke Schedule F. That is when we noticed that the tax rate on Schedule F is 5%, while schedules B and C have higher brackets. Are you attempting to reduce the amount of tax due by employing schedule F rates instead of schedule B or C?

Obviously there are facts and details which have been omitted and make all the difference in this scenario. This is not intended as tax or other legal advice. For advice on your specific situation you should contact an attorney who is well versed in the Iowa Inheritance Tax.

By the way, it has brought to my attention that my post on The Iowa Inheritance Tax has a tax rate schedule which is out of date. Here is the most current Iowa Inheritance Tax Rate Schedule.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #17: Taxing Annuity Changes

This question came recently via emai:

Dear Mr. Dinkin,

I found your website after searching the web for an answer to a 1099-R question. I thought your website was helpful, but I'm not sure how to decipher the 1099-R I received.

My situation is this. My husband and I took out annuities through [company name removed] for our children; one in 1987 and the other in 1988. We took these annuities out for each of them as a 'college savings account'. Each of the annuities had both my husband's name and the individual child's name on them. My husband was listed as the owner and our child was listed as the annuitant.

Both of the children turned 21, we of course still had the annuities. When they turned 21 the annuities were turned over to them, without our request. The company said this happened because they turned the 'age of majority.' My husband and I gladly relinquished this money to them, but we ended up receiving a 1099-R form for them and had to claim it on our income taxes due to a code of 1 in box 7 on the 1099-R.

I learned about these codes by reading your article Unlocking Box 7. I simply don't understand why we had to pay taxes on these contractual annuities when there was no cash distribution.

Is it possible for you to help me shed some light on this puzzle?

I can shed some light on this, but unfortunately I may raise more questions than I answer. From my perspective as a financial planner, there are several key issues to consider.

Account Ownership

As presented, something is not quite right in regards to who owns these annuities. Since ownership of the annuities automatically transferred to the children when they reached the age of majority, I do not think the husband ever really owned the annuities. It sounds like the husband was the custodian of the annuities and his role was to act in the best interests of the children until they reached the age of majority and assume the responsibility for themselves. If I am correct that the annuities were set up under UGMA/UTMA, then there was no change of ownership when the children reached the age of majority. On the other hand, if the husband actually was the owner of the annuities then I cannot explain why his property transferred to the children without his consent.

The account ownership issue is quite significant. Not only does that directly affect potential taxes on a change of ownership (see below), but there is also the issue of a potential 10% penalty for premature distribution from an annuity. If the child is the true owner of the annuity, then it makes a poor choice for college funding. While the annuity enjoys tax deferral during accumulation, there is a 10% penalty on amounts withdrawn prior to the owners age 59 ½. My guess is that most parents want their children to receive their education before they are middle aged.

Income Tax

Again, annuities are tax deferred vehicles so no income taxes are due on gains within the contract until they are "recognized". Generally, this means that money is withdrawn from the policy but recognition can also occur when ownership of the annuity is transferred. When the annuity is transferred, the previous owner recognizes (and pays ordinary income tax) on any gain in the annuity. The new owner's cost basis is the value at the time of the ownership change.

I think this is why this person received a 1099. Since there was a change in ownership, the amount in the account at the time of ownership change is reported to the IRS. If that balance is more than the sum of the contributions, the previous owner has an income tax liability. In the email, the person indicated that Box 7 of the 1099 was coded with a 1 which indicates that the owner is younger than age 59 1/2. In addition to income tax the 10% penalty may also apply.

Gift Taxes

Don't overlook this potential problem too. If the annuities are worth more than $13,000 ($12,000 if we are referring to 2008), then you need to consider gift tax consequences too. Since the person in this example is married, they can elect to split the gifts between the spouses which effectively doubles the gift tax threshold.

The account ownership issue continues to puzzle me. Knowing that your children automatically became the account owners, I have to question if your husband was ever the actual owner of the contracts. It seems to me that your husband was acting as the custodian on behalf of your children but then I cannot explain a tax issue on transfer. If your husband truly was the account owner, then I cannot explain why ownership transferred without his consent.

I would definitely bring this to the attention of my tax advisor before filing a tax return.

This is not intended as tax or other legal advice. For advice on your specific situation you should contact your attorney.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #16: A Countrywide IRA

It has been a while since I have answered reader questions. I recently received this email:

I have an IRA with Countrywide. Bank of America has purchased Countrywide.

If I do not want to be a Bank of America customer does the "law" allow me to withdraw my IRA from Bank of America without Bank of America penalizing me for an early withdrawal?

Ah yes, remember Countrywide? That was the "crisis" several months ago before Lehman Brothers, AIG, Freddie, and Fannie. You remember. When life was simple? You are correct. Countrywide was taken over by Bank of America and, for whatever reason, you do not want to be their customer but you do face two potential obstacles.

First, since this is an IRA the federal tax code (I assume this is the "law" you referenced) imposes some fairly severe penalties for accessing your money if you are younger than age 59 ½. Fortunately, this is a pretty easy obstacle to work around. If you transfer your IRA directly to another IRA, the distribution from the old IRA is neither taxable nor does a penalty apply. Your new IRA provider should be quite familiar with a direct transfer and will take care of all the details. You simply sign a direct transfer form, sit back, and let them take care of the details. Of course if you are older than 59 ½, the penalty is no longer an issue but a direct transfer is still your best method of avoiding current income tax.

The bigger potential problem is this particular situation could be the current IRA product. Is it an annuity, mutual fund, certificate of deposit (CD), or a simple savings account? An IRA could be any of these and possibly something else. While a direct transfer avoids current income tax and tax penalties, it does not excuse any charges imposed by the product itself for a premature distribution. The only way to know if your account is subject to a charge is to ask. Just call Bank of America and tell them you are considering a direct transfer for your IRA. Ask them if there are any charges or penalties imposed by your current IRA product. If there are, find out what the charges are, how they are calculated, and how long they last. For example, CD's often require that you forfeit 3 or 6 months of interest. Annuities often have surrender charges which may be imposed from 0 to 10+ years and are a percentage of the balance. Mutual funds may, or may not, have back end sales charges. Savings accounts are usually readily accessible.

Even if you product imposes a cost this just may be the best time to pull the trigger on a change. If your account is exposed to the markets then your balance may be at a low. If your charge for closing your account is a percentage of the balance, the charge is down now too.

Without knowing the specifics of your account I cannot give a specific recommendation, but I hope I have given you enough of a background to help you make your best decision. Just weigh the cost of making a direct transfer (if any) against the reason you do not want to be a Bank of America customer.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #15: Using Retirement Money for Education

A reader emailed:

I have a profit sharing and ESOP plan thru my former employer that was 100% funded by them.  My husband is now attending a graduate program and next year we will have a $30,000.00 loan payment to make.  Can we rollover my Profit sharing and ESOP into an IRA and then use that to pay for this loan without the early withdrawal penalty?

Let's break down your question a bit and discover the key elements.

Profit Sharing and ESOP's are both tax qualified. That means that they are funded with pre-tax dollars which accrue tax deferred and are taxable on distribution. Profit sharing plans, including 401(k)'s, provide a structure for the employer to contribute some of the firm's profits to the employees as a benefit. ESOP is the acronym for Employee Stock Ownership Plan. While the structure may vary from plan to plan, the common element to all ESOP's is a transfer of ownership in the company to the employee.

Now that you no longer work for the firm and are a former employee, you have the option of rolling over both plans into an IRA. This is probably a good idea not only because it gives you complete investment control, but since the ESOP plan is invested only in your former employers stock you may have an imbalanced asset allocation and need to diversify.

Education expenses are one of the exceptions to the 10% penalty on IRA distributions prior to age 59 ½. Once the money is in your IRA, you can pay for your educations expenses (or your spouse or decedents) without paying the penalty. Keep in mind, you will still owe ordinary income tax on the amount distributed from the IRA and may be bumped into a higher tax bracket.

In order to make this work, the educational expenses and the distribution should occur in the same year. The exception does not really apply to paying off a loan. According to IRS Publication 970…

Qualified education expenses.  For purposes of the 10% additional tax, these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.

Notice that student loans are not qualified expenses.

I have to ask, Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached. why pay off the loan at the expense of retirement? Interest paid on student loans has some tax advantages and the net cost of borrowing may be negligible. I suggest you investigate the true costs of the student loan and check with your tax advisor before proceeding.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #14: An SEP whoops!

A recent email from a CPA really has me scratching my head. He wrote:

Hello Art.

I did a Google search on SEP, and your article Reduce taxes now, pay for retirement later came up.  I have a question on SEP's.  A client called me today, for whom we filed a tax return on April 15^th.  We deducted a SEP contribution on her return, however, she informed me that she forgot to make the contribution. 

What are her options?  Can she contribute late and subject herself to possible penalties or does she need to amend automatically?

Please let me know your thoughts.

I have to admit that this is new territory for me. But I am not one to back down from a challenge. I emailed him back and told him that I needed to do a bit of research, but I'd let him know what I found.

This issue is a bit different than the concept I posted about back in February. Since the deadline to make contributions to an SEP is the tax filing date plus extensions, I wrote about a self employed person taking advantage of an extension to simultaneously reduce their taxes and fund their retirement. In this case, the client's tax filing deadline was not extended and has now come and gone. Their SEP contribution deadline has passed.

By the letter of the law it is too late to fund the SEP and the client needs to amend their tax return to remove the deduction they took for the SEP. This would cause an increase in their taxes due which needs to be paid along with whatever tax penalty the IRS will impose for paying late. One question arose when I called the CPA to discuss the matter. Instead of filing an amendment will the IRS allow you to apply for an extension, revoke your return, and later re-file before the extension deadline? If that is allowed administratively, then the client will land on their feet. They would have until September to fund their SEP and re-file the original return. I deferred to the CPA's expertise on the question but he had no personal experience to recall nor could he find any references to filing an extension after the deadline when a timely return was filed. He has asked the IRS for clarification and has promised to let me know what they say. When I find out I will share it with you.

I am a financial planner, not a tax expert. My only suggestion is to consult with your tax expert if you find yourself in a similar situation.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #13: Paying for college with retirement funds

A recent comment asks:

"Art, how do 401(k) and IRA products stack up in the 'distribution for college tuition' category?"

I think there are a couple different facets to this question which have to be examined.

Tax Perspective – Money taken from tax qualified retirement plans are subject to income tax since the contributions have never been taxed. If you are younger than age 59 ½, then the distribution is considered premature and is generally also subject to a 10% penalty. However one of the exceptions to the penalty is distributions made to pay for qualified higher education expenses. Considering only the tax consequences, taking money out of a retirement plan to pay for college tuition is not a terrible choice. After all, the money was contributed pre-tax, had the chance to grow tax deferred, and is subject to ordinary income tax (without penalty) when withdrawn.

Alternative – Just because taking money out of a retirement plan is not a tax nightmare does not mean it is the best option. When it comes to retirement, the Roth IRA works best for most people. In both an IRA (and 401k) and a Roth IRA, money in the plan grows tax deferred. The difference is that with the Roth IRA you pay taxes on the contributions but receive money out of the plan tax free. With the IRA the contributions are made pre-taxes, but the distributions are taxable. Since the goal of these programs is to put in less money than you take out, it generally makes sense to pay taxes on the money you put in. When it comes to saving for college tuition there is a program similar in tax structure to the Roth IRA called 529 plans. Contributions to a 529 plan are not tax deductible but the money accrues tax deferred and withdrawals used to pay for college expenses are taken without paying taxes. If I were to choose between using an IRA or a 529 plan to pay for college, I'd choose a 529 every time.

The Bigger Picture – I'm a parent and I understand the desire to do whatever you can for your children. Yet as a financial planner I see clients repeatedly choose to fund their children's college education over their own retirement and I think that is a mistake. The government gives promising students who lack only the financial resources student loans, but no such programs are available to provide during retirement. I strongly suggest that before withdrawing money from a retirement plan or diverting contributions from retirement to a 529 plan, you should consider the impact. It is simply a matter of priorities.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

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A Reader Asks #12: Should I buy more?

My post about irrational market response spurred another reader question:

My husband had a net gain of -$2600 in his Roth IRA last year. I'm thinking of buying the same stinker fund he bought last year for 2008 (FWIW [for what it's worth], before it fell 20% it had been up 20% or so, and I see no reason it won't eventually rebound, especially if all these RE [Real Estate] bailouts are coming to pass). Thoughts? Email me if you want more details.

My first thought is that as long as the long term prospects for the investment look good and still fit within your timeframe, why not buy more? I often use the analogy of clothes shopping. You are out shopping and see a great shirt. It is exactly what you are looking for and it fits you perfectly. It's fairly priced so you buy one and love it. A month later you are in the same store and see your shirt on the clearance table. You don't get upset. You buy the other three colors you passed on the first time. The same can be said of an investment. If the value decreases and you still like the investment, buy more when the price is low. Now you own more and have a lower cost per share than you did before.

I did email and asked a bit more about the particular investment. Turns out, this is a sector fund. A sector fund is a mutual fund which invests in a particular, specialized market segment. This particular investment is in the Real Estate sector but I have seen specialty funds in other sectors too such as precious metals, health care, technology, etc.

While it makes sense to buy more when the price is down, you do have to stop and consider how purchasing more would affect the balance of the asset allocation in your portfolio. Sector funds should generally be limited to 5% - 10% of the portfolio. If you are really, really bullish on a particular sector maybe 15% - 20% … maybe. My only concern is that if this person were to buy more, what would their asset allocation look like?

If the portfolio is not thrown out of balance and the long term prospects of the fund are good (in both a growth and timeframe), buying more of a depressed fund seems smart to me.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

A Reader Asks #11: A Countrywide Financial Customer

Last week I wrote about the irrational market response to the rumors (now confirmed) that Bank of America was looking to purchase Countrywide Financial. With the reader's permission, I would like to share a Q & A we had via email as it raises an issue I had never thought about before. It started with:

Hey Art ~ I heard about Countrywide between some debates a few nights ago… my mortgage is actually with Countrywide. I am guessing that there is no reason to be concerned but I just thought I would ask you since you know a lot more about these things than I do. As a customer is there anything that I should watch out for?

I responded that as a customer, there is not much to worry about. Bank of America confirmed that they negotiated to purchase Countrywide but they also announced that they will operate it as a separate unit until at least 2009. I also pointed out that as the borrower; they already had everything they needed from Countrywide… their money!

Their response is what raised my eyebrows and made me realize I had not thought of everything. They responded:

I didn't figure I had to worry… I was somewhat curious about the insurance… my mortgage is set up with everything together (PMTI) and I am curious to see if Bank of America contacts my insurance and makes the changes necessary… I will keep an eye on it when the change happens.

Since Bank of America is keeping Countrywide separate, my guess is that they will keep the Countrywide name and entity too. That would mean no changes would be necessary.

This deal saves Countrywide from the threat of bankruptcy (at least for now). But it does beg another question … What happens to your escrow if your lender goes bankrupt? Are the funds you escrowed subject to the lenders creditors? My gut instinct tells me these funds are not an asset of the lender. Banks carry deposits on their balance sheets as a liability since it is your money, not theirs; but should we trust my gut?

I emailed a couple of attorneys and asked them. No attorney ever really wants to render an opinion when they are not involved in a specific case. One attorney I contacted said he would be surprised if escrow funds were not protected, but also pointed out that he had nothing to concrete base his assumption on (this question is far from his area of legal expertise). West Des Moines Business Lawyer Rush Nigut found a Federal Trade Commission fact sheet for consumers on "How to Manage Your Mortgage If Your Lender Closes or Files for Bankruptcy" which implies that escrow funds should be unaffected.

It seems like your escrow would be okay, but can anyone provide more guidance?

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

A Reader Asks #10: SIMPLE IRA vs. 401(k)

Here is the other reader question I have been a bit slow to answer.

What are the advantages and disadvantages of offering a 401(k) vs. a SIMPLE IRA plan to employees of a company with 15 employees?

I am going to answer your question from the employee perspective since I believe that is what you are asking. Perhaps the biggest difference to an employee between a 401(k) and a SIMPLE IRA is the maximum contribution and catch up provisions. In 2007, a 401(k) has a maximum employee contribution of $15,500 with a $5000 catch up provision for employees age 50 and older. A SIMPLE maxes out at $10,500 with a $2500 catch up provision.

The other big difference for an employee has to do with premature distributions. In a 401(k), withdrawals taken prior to age 59 ½ will generally be subject to a 10% tax penalty. If the same premature withdrawal were taken from a SIMPLE and the account is less than two years old, then the tax penalty is a whopping 25%. This higher penalty restricts rollovers and transfers within the first two years so the employee may find a SIMPLE more restrictive than other types of retirement plans.

I find it interesting that you specifically asked about the employee differences. Most of the time, the employee does not get a choice. They are limited to the plan their employer selects so most of the time we look at the differences from an employer perspective. Since the SIMPLE plan is only available to employers with fewer than 100 employees, most of the time the employer who is considering a SIMPLE plan is also an employee. Often the selection is made solely on the employers desire to defer more than the maximum allowable in the SIMPLE.

But an employer also has two other big differences to consider. The 401(k) is a form of a profit sharing plan. There may be a backlash from the employees if this was to happen, but the employer is not required to contribute on behalf of the employee. A SIMPLE plan requires employer contributions. The only choice the employer gets is a selection between making a 2% non-elective contribution for every employee and matching the employee's contributions up to 3%.

However, most employers tend to focus on the administrative costs. A 401(k) has both testing and reporting requirements which must be met and maintained. Unless this is the employer's area of expertise they will probably need to pay someone to administer the plan. For a 15 employee company, this cost will generally run a couple of thousand dollars a year.

Related reading:

• SIMPLE IRA Plan (official IRS website)
• SIMPLE IRA Plan
• For Entrepreneurs A SIMPLE IRA May Be Best
• The Different Types of IRA's
• What is a SIMPLE IRA?

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