In a traditional IRA, only the owner of the account contributes to it. There is another type of IRA, called a Savings Incentive Match PLan for Employees, cleverly acronymed SIMPLE IRA.
Many business owners — especially small business owners — hoping to provide a retirement savings benefit for their employees begin that journey by offering a SIMPLE IRA, because they are easy to set up and maintain. But as time passes, companies often outgrow their SIMPLE IRA and seek to replace it with something more robust, such as a 401(k) plan.
SECURE Act Makes It Easier
SECURE Act 2.0 rolled out many new ways to enhance retirement savings for employees and support employers in growing towards retirement for their company. New provisions allow employees to access and grow their assets in a more diverse way. One of the more helpful changes to come from this legislation is that SIMPLE IRA’s are now able to transition to Safe Harbor 401(k) plans mid-year rather than at year end.
This can have a huge impact, since many business owners want to save more money as the plan year progresses and they have a better forecast on the company’s earnings. 401(k) plans have the big advantage of allowing larger contributions. Additionally, they come with more flexibility for employer contributions into the plan and additional features such as loans, Roth contributions and many more.
The transition from SIMPLE IRA to 401(k) can be a smooth one, if advisors understand the necessary details.
Detail 1: Safe Harbor Requirement
The new 401(k) plan must be a Safe Harbor plan if the company is making the change at any time other than the start of the plan year, and the plan must be a matching or a QACA plan. Most small companies prefer Safe Harbor plans, because it allows them to bypass annual required noncompliance testing, saving them money and hassle.
Detail 2: Employee Notification
Employers are required to provide a notice of the termination of the SIMPLE IRA and the beginning of the Safe Harbor 401(k) plan. It’s important that there is no loss of contribution opportunities by the employees, so the SIMPLE should end no more than one day prior to the 401(k) plan begins.
Employees should receive a 30-day notice of transition. It is good practice for the company to send out a notice 30 days prior to the 401(k) plan going live, but many providers will send out a Safe Harbor notice for the new plan which can suffice.
Detail 3: Prorated Contribution Limits
Since contribution limits vary between the two plan types, contribution limits will necessarily be prorated. It’s important that the company keep track of these amounts in year one so that over contributing does not become an issue. SIMPLE IRA assets are not required to rollover to the 401(k) plan so it is difficult for the 401(k) provider to know how much each participant has contributed prior to the 401(k) establishment.
The calculator method is as follows:
- (number of days in the SIMPLE / 365 days) x $16,000 = prorated amount for the SIMPLE
- (number of days in the 401(k) / 365 days in the year) x $23,000 = prorated amount in the 401(k) plan
- Prorated amount in the SIMPLE + prorated amount in the 401(k) plan = total contribution amount for the transition year.
Advisors can help their clients by tracking these prorated amounts and ensuring both plans are in compliance.
Detail 4: SIMPLE IRA Closing
The SIMPLE IRA plan is required to end and can not transfer or merge into the 401(k) plan. The new plan will start and receive contributions, while the old SIMPLE plan will close and no longer receive any funds.
Detail 5: Waiver for 2-Year Rule
Contributions to a SIMPLE IRA are required to stay in the plan for a minimum of 2 years from the first contribution date before transferring elsewhere. SECURE Act 2.0 now makes it possible for employees to roll their IRA assets to the new 401(k) plan without waiting the 2 years.
A Good Plan for Employees
Transitioning from a SIMPLE IRA to a 401(k) plan will result in long term benefits for the employee and employer alike. By taking advantage of this new option, employees will have a robust retirement option for savings and the employer will have a more appealing benefit for future and current employees.
401GO offers a wide range of 401(k) plan designs at an affordable price, and our conversion team is on hand to help you make a smooth transition from a SIMPLE IRA to a new Safe Harbor 401(k) plan.
