SIMPLE IRA plans can be a great starting point for small businesses interested in offering retirement benefits. However, with lower limits and an inability to include loan provisions, employers may be interested in transitioning to a more robust 401(k) plan.
In the past, the IRS required a SIMPLE IRA to be in place for an entire year before a transition could occur. As a result, a 401(k) plan could only be initiated at the beginning of the year. Luckily, new rules allow employers to move from a SIMPLE IRA to a 401(k) plan mid-year as long as certain requirements are met.
How a SIMPLE IRA to 401(k) transition works
When moving from a SIMPLE IRA to a 401(k), the plan is not converted. Instead, the SIMPLE IRA plan will be terminated and a new 401(k) plan will be established.
The employer must take formal action to terminate the SIMPLE IRA plan, which may include a board of directors resolution or the equivalent. The employer is not required to notify the IRS of the termination, but they should work with the SIMPLE IRA service provider and their payroll company to ensure proper termination of the plan.
Because there is no requirement to liquidate the SIMPLE IRA accounts, individual accounts will remain for each participant. Participants will have the option to rollover their SIMPLE IRA assets to the 401(k) plan once it is established. The employer will not be able to transfer participant funds from the SIMPLE IRA to the 401(k) on their own.
Requirements for transitioning from a SIMPLE IRA to a 401(k)
Plan type
The plan replacing the SIMPLE IRA must be a safe harbor 401(k). There are several types of safe harbor plans, including a traditional safe harbor, QACA, or Starter 401(k).
Note that due to a lack of guidance on Starter 401(k) transition-year limits, Guideline only allows a Starter 401(k) to be established when the SIMPLE IRA terminates at the end of a year.
Timing
The termination date for the SIMPLE IRA plan and the effective date for the 401(k) plan must be the same. It is important that the employer works with the providers of both the SIMPLE IRA and the 401(k) plan to make sure that these dates are in alignment.
It is not possible to terminate the SIMPLE IRA plan and then take the time to set up the 401(k) plan. If the dates are not aligned, the 401(k) plan cannot be established. Additionally, SIMPLE IRA failures could occur, which would require the employer to work with an ERISA professional to fix the failure.
Notices
There are two separate notice requirements that must be met:
SIMPLE IRA termination notice: This notice must be provided to all employees currently eligible for the SIMPLE IRA plan at least 30 days before the termination date.
The notice must include:
The date of the termination;
A statement that all salary deferrals will stop as of the termination date; and
Notice that employer contributions will not be made on compensation earned after the termination date.
Enhanced safe harbor 401(k) notice: Safe harbor notices are typically provided at least 30 days before the effective date of the 401(k) plan to all employees who will be eligible to enroll. In addition to the information required in a standard safe harbor notice, the notice must also include how the employee contribution limit will be calculated in the year the transition takes place.
401(k) employee contribution limits for the transition year
Because SIMPLE IRA and 401(k) plans have different employee contribution limits, the amount participants can contribute will be prorated for the year of the transition. The prorated amount is calculated based on the limits under both the SIMPLE IRA and the 401(k) plan, as well as the amount the employee contributed to the SIMPLE IRA. Employees can learn how to calculate their limit for the transition year here.
The standard 401(k) contribution limit will apply in all subsequent years.