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Replacing a SIMPLE IRA with a 401(k) – Frequently Asked Questions

Brian Furgala

January 3, 2024

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We’ve talked with many small business owners thinking about replacing their current SIMPLE IRA (Savings Incentive Match Plan for Employees) with a new 401(k) plan. During these meetings, the most common questions we receive are: 

    • Is a 401(k) plan or a SIMPLE IRA best for my small business? 
    • What are the steps for replacing a SIMPLE IRA with a 401(k) plan? 
    • Can SIMPLE IRA participants roll their account to the new 401(k) plan? 

If you’re a business owner with a SIMPLE IRA today, we would like to help you answer these questions so you can make well-informed decisions for your business and employees. 

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Is a 401(k) plan or a SIMPLE IRA best for my small business?

401(k) plans are the best-known type of employer-sponsored retirement plans today, but they may not always be the best fit for a small business. An IRA-based retirement plan – like a SIMPLE IRAmay be a better alternative. A good way to determine which fits best for your business is to lay out the key differences between the two plan types. 

 

401(k) Plan 

SIMPLE IRA 

Annual Deferral Limit 

$23,000 + $7,500 catch-up for 2024 

$16,000 + $3,500 catch-up for 2024 

Roth Contributions Allowed? 

Yes 

Yes, starting in 2023

Employer Contributions Required? 

No, unless a safe harbor plan

Yes, 3% matching contribution or 2% nonelective contribution 

Discretionary Employer Contributions Allowed? 

Yes, total contribution limit of $69,000 ($76,500 including catch-up) for 2024 

No, limited to required employer contributions 

Non-Discrimination Testing? 

Yes, unless safe harbor 

No 

Form 5500? 

Yes 

No 

Flexible Eligibility Standards? 

Yes 

No 

Vesting Schedules 

Yes 

No 

Participant Loans? 

Yes 

No 

Ability To Have Another Retirement Plan? 

Yes 

No, SIMPLE IRA must be the sole plan 

In general, a 401(k) plan is the better choice when higher contribution limits or plan design flexibility are needed. For example, SIMPLE IRAs cannot allow discretionary contributions. In a 401(k) plan, discretionary contributions can be tailored to meet a wide range of employer goals - such as profit sharing. 

If these plan design features and higher contribution limits are unnecessary, then a SIMPLE IRA can be an excellent alternative due to its ease of administration and low costs. However, it’s not uncommon for employees (or prospective employees) to view SIMPLE IRAs as inferior to 401(k) plans. This feeling can sometimes be overcome with education, but employee perception is also something to consider when choosing between a SIMPLE IRA and 401(k) plan. 

What are the steps for terminating a SIMPLE IRA?

You may have started with a SIMPLE IRA, but now your needs and goals have changed. Replacing one with a 401(k) plan takes some planning due to the following IRS rules: 

    • All SIMPLE IRAs operate on a calendar year basis. 
    • A SIMPLE IRA must generally be the sole retirement plan in effect for the year. 
    • To terminate a SIMPLE IRA, employees must be notified at least 60 days prior to year-end (November 2nd). 

The process for terminating a SIMPLE IRA at year-end involves two steps: 

    1. Notify your employees prior to November 2nd that the SIMPLE IRA will be terminated at year-end.
    2. Notify your SIMPLE IRA provider that the plan has been terminated and that contributions will cease. 

You don’t need to notify the IRS that your SIMPLE IRA plan has been discontinued. 

Can a SIMPLE IRA be replaced mid-year by a 401(k) plan?

Starting in 2024, a SIMPLE IRA can be replaced mid-year with a safe harbor 401(k) plan due to law change under SECURE 2.0. The replacement plan can be either a traditional or QACA safe harbor 401(k) plan. The safe harbor 401(k) plan must be effective as of the termination date of the SIMPLE IRA. 

This mid-year replacement ability can be really beneficial for businesses that miss the notification requirement for terminating a SIMPLE IRA at year-end. For example, assume Emily sponsors a SIMPLE IRA for her business and decides to terminate it on November 30, 2023: 

    • Without the law change, the earliest date Emily could make the termination effective is December 31, 2024, because she failed to notify employees prior to November 2, 2023. In other words, Emily would have to continue the SIMPLE IRA for all of 2024. 
    • With the law change, she can terminate the SIMPLE IRA earlier in 2024 if Emily is replacing it with a safe harbor 401(k) plan. If Emily decided to terminate the SIMPLE IRA as of August 1, 2024, the safe harbor 401(k) plan needs to be in operation as of that date. 

We are still waiting for additional guidance from the IRS on mid-year replacements, such as whether there will be a notice requirement to employees. 

Does a special contribution limit apply in the replacement year?

Yes, to avoid potential abuse, employees (including the small business owner) are restricted to an aggregate elective deferral limit – including catch-up contributions – during the replacement year. The limit is based on the number of days covered in each plan. Going back to our example, if the replacement is done on August 1, 2024, Emily’s 2024 elective deferral limit – contributed to either the SIMPLE IRA or 401(k) plan – would be $18,434.25 ($23,610.96 if over age 50). 

This is determined by taking the number of days covered in the SIMPLE IRA multiplied by its contribution limit (212/365 x 15,500 (19,000 including catch-up) = $9,002.74 ($11,035.62) and adding the number of days covered in the 401(k) plan multiplied by its contribution limit (153/365 x 22,500 (30,000 including catch-up) = $9,431.51 ($12,575.34). 

Can SIMPLE IRA participants roll their account to the new 401(k) plan?

Yes, but there may be a catch depending upon how long they have participated in the SIMPLE IRA. Employees in a SIMPLE IRA must wait until they have participated for two years before they are allowed to rollover their account to a 401(k) plan. For their first two years, SIMPLE IRAs can only be rolled to another SIMPLE IRA. 

This 2-year period commences on the date that contributions are first made to the SIMPLE IRA. Using our example from above in which the SIMPLE IRA is terminated as of August 1, 2024: 

    • Any of Emily’s employees who had their first contribution made on or after August 1, 2022, would have to wait for the 2-year period to end before rolling their SIMPLE IRA account into the 401(k) plan. During the 2-year period and beyond, these employees would be permitted to maintain their SIMPLE IRA account even though new contributions are not permitted. 
    • Any of Emily’s employees who had contributions made prior to August 1, 2022, would be able to immediately roll their SIMPLE IRA account into the 401(k) plan, even if subsequent contributions were made after that date. 

Replacing a SIMPLE IRA with a 401(k) takes planning!

Although SIMPLE IRAs may be the best fit for certain small businesses, they may not continue to be the best fit over time. The process for replacing a SIMPLE IRA with a 401(k) plan is not particularly complicated. Moreover, the ability to replace a SIMPLE IRA mid-year with a safe harbor 401(k) plan helps small businesses make the transition easier. 

With a little knowledge and planning, the decision to use a SIMPLE IRA or replace it with a 401(k) plan can be smooth and stress-free. 

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