SIMPLE IRA 2-Year Rule: Rollovers, 25% Penalty, and Exceptions

The SIMPLE IRA two-year rule locks your account down for the first 24 months after your employer’s first contribution posts. During that window, the only place you can move the money without triggering tax is another SIMPLE IRA. Any other transfer, rollover, or withdrawal is treated as a distribution, and if you’re under 59½ the early withdrawal penalty is 25% rather than the usual 10%.¹ Once the two years pass, the account behaves like a traditional IRA for rollover purposes.

When the Two-Year Clock Starts

The clock begins on the first day your employer deposits contributions into your SIMPLE IRA.² That could be your first salary deferral or the employer’s first matching contribution, whichever hits first. The date you enrolled, the date you became eligible, and the date the plan was set up don’t matter. Only the actual deposit does.

Check your earliest account statement for the exact date. That single date controls when you can roll money out to a traditional IRA, when the penalty drops from 25% to 10%, and when the account can accept rollovers in. If you left one job and enrolled in a second employer’s SIMPLE IRA, each account carries its own two-year clock keyed to the first contribution into that specific account.

What You Can Do During the Two Years

Moving money from one SIMPLE IRA to another SIMPLE IRA is the only transfer you can make freely inside the window.¹ The safest method is a direct trustee-to-trustee transfer: the current custodian sends the funds straight to the new SIMPLE IRA provider, you never touch the money, and the IRS doesn’t treat it as a distribution. There’s no annual cap on direct transfers.

You can also do an indirect 60-day rollover between two SIMPLE IRAs. You receive the funds and redeposit them into the new SIMPLE IRA within 60 calendar days. Miss the deadline and the whole amount becomes a taxable distribution subject to the 25% penalty. The one-per-year rollover limit applies to indirect rollovers across all your IRAs.¹ For most people, the direct transfer is the obvious choice.

Ask both institutions to code the movement as a SIMPLE-to-SIMPLE transfer so it doesn’t accidentally get reported as a taxable distribution.

What You Cannot Do During the Two Years

Any attempt to move SIMPLE IRA funds into a traditional IRA, SEP IRA, 401(k), 403(b), or governmental 457(b) inside the two-year window is treated as a taxable distribution. The IRS doesn’t care that the money landed in another qualified account. If the clock hasn’t expired, the transaction is not a valid rollover, and you owe income tax on the full amount plus the 25% penalty if you’re under 59½.¹

Roth conversions carry the same restriction. During the waiting period, any amount you shift from the SIMPLE IRA to a Roth IRA is treated as a withdrawal, so you owe income tax on the converted amount plus the 25% penalty if you’re under 59½.¹ If your employer offers Roth SIMPLE IRA contributions under SECURE 2.0, the same two-year transfer restriction applies to those Roth contributions.³

The restriction also blocks inbound rollovers. You cannot roll money from a traditional IRA, SEP IRA, 401(k), 403(b), or 457(b) into your SIMPLE IRA until the two years have passed. Two permanent limits sit outside the clock: SIMPLE IRAs can never accept rollovers from Roth IRAs or designated Roth accounts, and the one-per-year rule still applies to any inbound indirect rollover.⁴

The 25% Early Withdrawal Penalty

Take a distribution from your SIMPLE IRA before the two-year period ends and while you’re under 59½, and the usual 10% early withdrawal penalty is replaced by a 25% penalty.⁵ It’s calculated on the full amount withdrawn and stacks on top of the regular income tax owed on the distribution.

The penalty drops to 10% once either the two-year period has passed or you reach age 59½, whichever comes first. If you’re already over 59½ but still inside the two-year window, no additional penalty applies, though you still owe income tax on any distribution.¹ The same treatment applies to a botched rollover: if you push funds to a traditional IRA during the two years, it’s a distribution, and the 25% rate hits the full amount.

Exceptions That Waive the Penalty

Several exceptions eliminate the additional tax entirely, even inside the two-year window. If one applies, you avoid both the 25% and the 10% penalty, though regular income tax on the distribution still stands.⁶

Reaching age 59½.
Disability that leaves you unable to engage in substantial gainful activity, expected to last indefinitely or result in death.
Death of the account owner (beneficiaries owe no additional penalty).
Unreimbursed medical expenses above 7.5% of your adjusted gross income.
Health insurance premiums while unemployed, if you’ve received unemployment compensation for at least 12 consecutive weeks.
Higher education expenses for you, your spouse, children, or grandchildren.
Up to $10,000 for a first-time home purchase.
A series of substantially equal periodic payments based on life expectancy, taken at least annually.
Qualified reservist distribution for military reservists called to active duty for at least 180 days.
An IRS levy against the account for a tax debt.

SECURE 2.0 added two more exceptions that reach SIMPLE IRAs. Domestic abuse victims can withdraw up to the lesser of $10,000 or 50% of the account balance without penalty. An emergency personal expense exception allows one withdrawal per calendar year of up to the lesser of $1,000 or the vested balance above $1,000. Both apply to distributions made after December 31, 2023.⁶

After the Two Years End

Once the clock runs out, your SIMPLE IRA assets become fully portable. You can roll them tax-free into a traditional IRA, SEP IRA, or an employer plan such as a 401(k), 403(b), or 457(b).⁷ Standard rollover rules take over from there. Roth conversions become available too, with the converted amount included in income for that year.

Financial institutions often want documentation of your first contribution date before processing a rollover without withholding. Keep your earliest SIMPLE IRA statements. If you can’t find them, contact the original custodian or your former employer’s plan administrator.

Reporting the Penalty on Your Tax Return

When you take a distribution during the two-year period, your custodian reports it on Form 1099-R using distribution code S in box 7. That code tells the IRS the withdrawal came from a SIMPLE IRA within the first two years and no known exception applies.³

You calculate and report the 25% penalty yourself on Part I of Form 5329, filed with your annual return. Line 4 is where you apply the 25% rate in place of the standard 10% for SIMPLE IRA distributions taken within the two-year window.⁸ Qualifying exceptions get claimed on the same form. Withholding at the source often won’t cover the full penalty, so estimated tax payments may be needed to avoid an underpayment charge on top.

If Your Employer Ends the Plan Before the Clock Runs Out

The two-year period is tied to the first contribution date, not to the plan’s existence. If your employer terminates the SIMPLE IRA plan before your clock ends, the restriction still applies.² An employer can’t terminate or amend the plan mid-year; they have to keep it going through year-end and fund the contributions promised to employees.

After the plan winds down, your SIMPLE IRA still sits at whatever custodian holds it. You’ve just stopped receiving new contributions. If time remains on the clock, the only move available is a transfer to another SIMPLE IRA until the two years are up.

1
Internal Revenue Service. SIMPLE IRA Withdrawal and Transfer Rules
2
Internal Revenue Service. Retirement Plans FAQs Regarding SIMPLE IRA Plans
3
Internal Revenue Service. Instructions for Forms 1099-R and 5498
4
Internal Revenue Service. Expansion of Rollover Options Includes Savings Incentive Match Plan for Employees (SIMPLE) IRA Plans
5
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
6
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
7
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
8
Internal Revenue Service. Instructions for Form 5329