SIMPLE Individual Retirement Account (IRA) plans can be a great starting point for small businesses looking to offer retirement benefits. However, with lower contribution limits and no loan provisions, you may want to transition to a more robust 401(k) plan. New IRS rules now allow employers to move from a SIMPLE IRA to a 401(k) plan mid-year, as long as certain requirements are met. This article explains how the transition works, what requirements you need to meet, and how contribution limits are prorated for the transition year.
When you move from a SIMPLE IRA to a 401(k), the plan is not converted. Instead, the SIMPLE IRA plan is terminated, and a new 401(k) plan is established.
You need to take formal action to terminate the SIMPLE IRA plan, which may include a board of directors resolution or the equivalent. You are not required to notify the IRS of the termination, but you should work with the SIMPLE IRA service provider and your payroll company to make sure the plan is properly terminated.
Because there is no requirement to liquidate the SIMPLE IRA accounts, individual accounts will remain for each participant. Participants will have the option to roll over their SIMPLE IRA assets to the 401(k) plan once it is established. You will not be able to transfer participant funds from the SIMPLE IRA to the 401(k) on your own.
There are three requirements you need to meet to transition from a SIMPLE IRA to a safe harbor 401(k).
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, qualified automatic contribution arrangement (QACA), or Starter 401(k).
Note: Due to a lack of guidance on Starter 401(k) transition-year limits, we only allow a Starter 401(k) to be established when the SIMPLE IRA terminates at the end of a year.
The termination date for the SIMPLE IRA plan and the effective date for the 401(k) plan must be the same. Work with the providers of both the SIMPLE IRA and the 401(k) plan to make sure these dates are aligned.
You cannot terminate the SIMPLE IRA plan and then take time to set up the 401(k) plan separately. If the dates are not aligned, the 401(k) plan cannot be established. Additionally, SIMPLE IRA failures could occur, which would require you to work with an Employee Retirement Income Security Act (ERISA) professional to fix the failure.
There are two separate notice requirements you need to meet:
SIMPLE IRA termination notice — Provide this notice 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
Notice that employer contributions will not be made on compensation earned after the termination date
Enhanced safe harbor 401(k) notice — Provide this to all employees who will be eligible to enroll at least 30 days before the effective date of the 401(k) plan. In addition to the information required in a standard safe harbor notice, this notice must also explain how the employee contribution limit will be calculated in the transition year
Because SIMPLE IRAs and 401(k) plans have different employee contribution limits, participants' contributions are 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.
The standard 401(k) contribution limit will apply in all subsequent years.