Replacing your SIMPLE IRA with a 401(k) midyear

Small business owners have several options when choosing a retirement plan. This list includes SIMPLE IRAs, SEP IRAs, Solo 401(k)s, 401(k)s, profit-sharing plans, and more. For some small companies, SIMPLE IRAs offer a straightforward retirement savings option—but what about when the business grows and a SIMPLE IRA is no longer the best fit?

What is a SIMPLE IRA?

If you need a refresher, a SIMPLE IRA (Savings Incentive Match Plan for Employees Individual Retirement Account) is a retirement savings plan designed for small businesses with fewer than 100 employees. 

Small businesses generally choose SIMPLE IRAs for their simplicity, low cost, and tax advantages. These plans are easy to set up and manage, with minimal paperwork and lower administrative fees. They allow both employers and employees to contribute, providing flexibility in savings. With tax benefits, employers can deduct contributions, while employees can defer taxes until retirement.

However, SIMPLE IRAs have limitations, including lower contribution limits compared to other retirement plans and restrictions on offering additional retirement plans within the same year. 

What are the benefits of switching a SIMPLE IRA to a 401(k)?

Different retirement plans offer businesses and individuals various advantages. Switching from a SIMPLE IRA to a 401(k) can benefit employers and their employees by offering higher contribution limits, loan provisions, and more. However, each option has unique features, fees, and investment choices. 

If you are considering switching your SIMPLE IRA to a 401(k), you should know that SECURE Act 2.0 established some key changes to retirement planning for small businesses.

What you need to know about new SECURE Act 2.0 provisions

The SECURE Act 2.0, originally signed in December 2022, has provisions rolling out over the subsequent years. By design, it encourages small businesses to begin offering retirement benefits plans by providing tax credits and other benefits.

Most relevant to SIMPLE IRA plans, eligible employers can terminate a SIMPLE IRA plan midyear if the employer replaces the SIMPLE IRA plan with a safe harbor 401(k) plan (including Qualified Automatic Contribution Agreement (QACA) plans) .

Key takeaway: Effective in 2024, if you are a business owner currently offering a SIMPLE IRA, you are now eligible to replace it with a 401(k) plan midyear. 

Does this mean a business can switch from a SIMPLE IRA to a 401(k) mid-year? 

Yes, switching from a SIMPLE IRA to a 401(k) midyear is now possible and there is no penalty to employers who choose to do so. Before the SECURE Act 2.0, shifting from a SIMPLE IRA required timing at the end of year to coordinate with a 401(k) plan effective on January 1 of the following year. Failure to timely provide the 60-day SIMPLE IRA termination notice meant you had to wait another year before you could switch to a 401(k) plan. Now, it’s easier for small businesses to replace a SIMPLE IRA with a 401(k) that provides more flexibility to support your team’s growth.

Who is eligible for a midyear SIMPLE IRA conversion?

Starting in 2024, any business currently sponsoring a SIMPLE IRA can make the conversion. To be eligible, businesses that terminate their SIMPLE IRA plan midyear must adopt a safe harbor 401(k) plan immediately following the termination date of their old plan. Safe harbor plans must have at least three months of deferrals in their first year. This means that a SIMPLE IRA must terminate no later than September 30, and the safe harbor plan must begin no later than October 1 of each calendar year.

How to terminate a SIMPLE IRA plan midyear

A midyear conversion to a safe harbor 401(k) can benefit businesses that missed the notification requirement at year-end or decide it is time to make a change midyear. Now, employers electing a midyear conversion to a 401(k) are required to provide two notices to participants at the same time:

• SIMPLE IRA termination notice sent 30 days in advance of the plan termination date.

• Safe harbor notice sent 30 days in advance of the new 401(k) plan’s effective date. This notice communicates the plan's provisions and the prorated contribution limits (see more detail below).

Additionally, the two-year investment requirement for SIMPLE IRAs is waived for midyear conversions if the funds are rolled over to another 401(k) or 403(b) plan. Employers must continue contributing to the SIMPLE IRA until the termination date, and again, the 401(k) must be effective immediately following the SIMPLE IRA termination date.

What you need to know about prorated contribution limits

If you make a midyear switch to a safe harbor 401(k), participants in each plan will have prorated elective deferral limits, including catch-up contributions, during the replacement year.

Prorated contribution limits are based on the number of days covered in each plan. 

• The IRS allows these contributions to be added together for a total deferral limit. Then, the participant's 401(k) deferral rate maximum is reduced by any deferrals previously made to the SIMPLE IRA.

• Example: If a plan sponsor terminates the SIMPLE IRA on July 31, 2024, and launches a safe harbor 401(k) plan midyear on August 1, 2024, combined elective deferral limits for the participants for the year are $18,915.07 ($24,080.82 including catch-up contributions if over age 50) for 2024. The SIMPLE IRA maximum deferral would be $9,336.99 ($11,379.45 if over age 50).   

Deciding if a retirement plan switch is right for your business

The right type of plan depends on your business’s needs. Whether you're hoping to attract and retain talent or are experiencing other signs that you’ve outgrown your existing retirement savings option, like the need for easier administration or greater flexibility in plan design, there's a plan out there for you. 

Interested in learning more about starting an affordable, accessible retirement plan? Contact us to learn about our small business 401(k) plans.

SIMPLE IRA to 401(k) mid-year conversion FAQs

How do participants rollover their SIMPLE IRA into a 401(k)? 

To rollover a SIMPLE IRA into a 401(k), participants typically need to initiate a direct rollover by contacting both their current and new plan administrators. They will guide you through the necessary paperwork and facilitate the transfer of funds.

What is the 2-year rule for a SIMPLE IRA?

The 2-year rule for SIMPLE IRA refers to the requirement that funds from a SIMPLE IRA cannot be rolled over into another retirement account, such as a traditional IRA or a 401(k), within two years of the initial contribution to the SIMPLE IRA without facing penalties.

For the first two years a participant is contributing to their SIMPLE IRA, their assets can only be rolled into another SIMPLE IRA. This means that if your SIMPLE IRA has been in operation for less than two years, your contributions cannot be rolled over to a 401(k) until the two-year period has ended.

Note that the two-year investment requirement for SIMPLE IRAs is waived for midyear conversions if the funds are rolled over to another 401(k) or 403(b) plan.