Mid-Year Conversion of a SIMPLE IRA to a 401(k)

February 15th, 2024 | By Theresa Conti

Secure 2.0 had many changes to retirement plans. Another one that we need to talk about is the option to terminate a SIMPLE plan mid-year if we adopt a Safe Harbor plan to replace it. This provision is effective for 2024 and later plan years and is a necessary change to the current SIMPLE IRA termination rules.

• So first let’s recap what the rules were:

• A SIMPLE IRA had to be operated on a calendar year basis.
• A SIMPLE IRA needed to be terminated and employees notified at least 60 days prior to the year-end.
• A SIMPLE IRA generally needed to be the sole retirement plan that was in effect for the year.
• A SIMPLE IRA is generally available to any small business with 100 or fewer employees.
• A contribution is required by the employer of either a matching contribution (up to 3% of compensation) or a nonelective contribution for all eligible employees (2% of compensation).
• The employee can choose to contribute to the IRA (up to $16,000 plus catch up of $3,500 if age 50 or over).
• Employer contributions are always 100% vested.
• Annual notice is required to all employees and employees who earned at least $5,000 in compensation during the 2 years before the current calendar year or expects to earn at least $5,000 during the current calendar year are eligible to participate.

The fact that we can now replace a SIMPLE IRA with a traditional Safe Harbor 401(k) or a QACA 401(k) really helps businesses who may miss the notification requirement for terminating the SIMPLE IRA at year end.

• There are some specific items that must be done to correctly replace a SIMPLE IRA with a Safe Harbor 401(k) plan so here we go:

• The Safe Harbor 401(k) plan will be a new plan and will have a short plan year (so if we make the change as of June 30th, the short plan year for the new 401(k) plan will be July 1st to December 31st of that year)
• Since we will have a short plan year, any limits for contributions will be based on weighted contribution limits so an example of our June 30th conversion date is as follows:
  • SIMPLE IRA contribution limit of $16,000 would be divided by 2 ($8,000)
  • Safe Harbor 401(k) contribution limit of $23,000 would also be divided by 2 ($11,500)
  • Total deferral limit for each participant would be $19,500 ($8,000 + $11,500)
• Since we have a short plan year, other limits like compensation and 415 will also be limited/be pro-rated based on the short plan year (example is the 2024 compensation limit is $275,000 but we would only include compensation up to $137,500 for the half year of the new Safe Harbor plan)
• Notices are required including the notification of the termination of the SIMPLE IRA at least 30 days before the termination and specify the date of the end of salary reduction contributions and the Safe Harbor notice for the new plan must be provided at the same time and include the information about the weighted contribution limit
• The employer must still make any contributions through the termination date of the SIMPLE IRA
• Distributions from the SIMPLE IRA are no longer required to be held for the first 2 years of participation and can be rolled over to a 401(k) or 403(b) plan
• The establishment of the new Safe Harbor 401(k) plan is an exception to the rule that prohibited a SIMPLE IRA and another plan in the same year as long as they are not active simultaneously
• There is still a 3 month requirement to adopt a Safe Harbor plan in a plan year, therefore if we are using a calendar year, the new Safe Harbor 401(k) plan will need to be in place by October 1st (otherwise the employer should keep the SIMPLE IRA for that year and plan to start the new plan on January 1st of the following year)

As SECURE 2.0 unfolds and questions arise, the JULY team is here to help.